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                                                                    EXHIBIT 10.7

                             STANDARD FORM LEASE

PARTIES: This Lease, executed in duplicate at Cupertino, California, on August
____, 1996, by and between Berg & Berg Developers, a California General
Partnership, and Photon Dynamics, Inc., a California Corporation, hereinafter
called respectively Lessor and Lessee, without regard to number or gender.

USE: Witnesseth: That Lessor hereby leases to Lessee, and Lessee hires from
     ----------
Lessor, for the purpose of conducting therein office, research and development,
light manufacturing, and warehouse activities, and any other legal activity; and
for no other purpose without obtaining the prior written consent of Lessor.

PREMISES: The real property with appurtenances as shown on Exhibit A. 1,
composed of 4 buildings, (the "Premises") situated in the City of San Jose,
County of Santa Clara, State of California, and more particularly described as
follows:

     Lessee's portion of the building is 52,000 square feet including all
     improvements thereto as outlined in red (tile "Building") as shown on
     Exhibit A.2 including the right to use up to 182 unreserved parking spaces
     at the Premises. The address for the leased portion of file Premises is
     6325 San Ignacio, San Jose, California. Lessee's pro-rata share of the
     building is 51%.

TERM: The term shall be for sixty (60) months unless extended pursuant to
Section 35 of this Lease (the "Lease Term"), commencing on the Commencement Date
as defined in Section 1), and ending on the day sixty (60) months thereafter.

RENT: Base rent shall be payable in monthly installments as follows:

                                    Base rent     Estimated CAC     Total
                                    ---------     -------------     -----
          Months 1 through 12        $46,540         $8,320*       $54,860

Monthly base rent shall increase by 3% on the annual anniversary of the
Commencement Date each year during the Lease Term over the prior year's rent.
* CAC charges to be adjusted per Common Area Charges Section below.

Base rent as scheduled above shall be payable in advance on or before the first
day of each calendar month during the Lease Term. The term "Rent," as used
herein, shall be deemed to be and to mean the base monthly rent and all other
sums required to be paid by Lessee pursuant to the terms of this Lease. Rent
shall be paid in lawful money of the United States of America, without offset or
deduction, and shall be paid to Lessor at such place or places as may be
designated from time to time by Lessor. Rent for any period less than a calendar
month shall be a pro rata portion of the monthly installment. Upon execution of
this Lease, Lessee shall deposit with Lessor the first month's rent.

SECURITY DEPOSIT: Lessee shall deposit with Lessor in trust the sum of Fifty-
Four Thousand Eight Hundred Sixty Dollars ($54,860) (the "Security Deposit").
The Security Deposit shall be held by Lessor as security for the faithful
performance by Lessee of all of the terms, covenants, and conditions of this
Lease applicable to Lessee. If Lessee commits a default as provided for herein,
including but not limited to a default with respect to the provisions contained
herein relating to the condition of the Premises, Lessor may (but shall not be
required to) use, apply or retain all or any part of the Security Deposit for
the payment of any amount which Lessor may spend by reason of default by Lessee.
If any portion of the Security Deposit is so used or applied, Lessee shall,
within ten days after 
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written demand therefor, deposit cash with Lessor in an amount sufficient to
restore the Security Deposit to its original amount. Lessee's failure to do so
shall be a default by Lessee. Any attempt by Lessee to transfer or encumber
its interest in the Security Deposit shall be null and void. Upon execution of
this Lease, Lessee shall deposit with Lessor the Security Deposit.

LATE CHARGES: Lessee hereby acknowledges that a late payment made by Lessee to
Lessor of Rent and other sums due hereunder will cause Lessor to incur costs not
contemplated by this Lease, the exact amount of which will be extremely
difficult to ascertain. Such costs include, but are not limited to, processing
and accounting charges, and late charges, which may be imposed on Lessor
according to the terms of any mortgage or trust deed covering the Premises.
Accordingly, if any installment of Rent or any other sum due from Lessee is not
received by Lessor or Lessor's designee within ten (10) days after such amount
is due, Lessee shall pay to Lessor a late charge equal to five (5%) percent of
such overdue amount. The parties hereby agree that such late charge represents a
fair and reasonable estimate of the costs Lessor will incur by reason of late
payments made by Lessee. Acceptance of such late charges by Lessor shall in no
event constitute a waiver of Lessee's default with respect to such overdue
amount, nor shall it prevent Lessor from exercising any of the other rights and
remedies granted hereunder. Notwithstanding the above, Lessee shall not be
required to pay a late charge if it is the result of a non-recurring unusual
event such as a accounting error.

QUIET ENJOYMENT: Lessor covenants and agrees with Lessee that upon Lessee paying
Rent and performing its covenants and conditions under this Lease, Lessee shall
and may peaceably and quietly have, hold and enjoy the Premises for the Lease
Term, subject, however, to the rights reserved by Lessor hereunder.

COMMON AREA CHARGES: Lessee shall pay to Lessor, as additional Rent, an amount
equal to Lessee's pro-rata share of the total common area charges of the
Premises and the total common area charges for the Building as defined below
(the common area charges for the Premises and the common area charges for the
Building collectively referred to herein as ("CAC")). Lessee shall pay to Lessor
as Rent, on or before the first day of each calendar month during the Lease
Term, subject to adjustment and reconciliation as provided hereinbelow, the sum
of Eight Thousand Three Hundred Twenty Dollars ($8,320), said sum representing
Lessee's estimated monthly payment of Lessee's percentage share of CAC. It is
understood and agreed that Lessee's obligation under this paragraph shall be
prorated to reflect the Commencement Date and the end of the Lease Term.

Lessee's estimated monthly payment of CAC payable by Lessee during the calendar
year in which the Lease commences is set forth above. At or prior to the
commencement of each succeeding calendar year term (or as soon as practical
thereafter), Lessor shall provide Lessee with Lessee's estimated monthly payment
for CAC which Lessee shall pay to Lessor as Rent. Within 120 days of the end of
the calendar year and the end of the Lease Term, Lessor shall provide Lessee a
statement of actual CAC incurred including capital reserves for the preceding
year or other applicable period in the case of a termination year. If such
statement shows that Lessee has paid less than its actual percentage, then
Lessee shall on demand pay to Lessor the amount of such deficiency. If such
statement shows that Lessee has paid more than its actual percentage, then
Lessor shall, at its option, promptly refund such excess to Lessee or credit the
amount thereof to the Rent next becoming due from Lessee. Lessor reserves the
right to revise any estimate of CAC if the actual or projected CAC show an
increase or decrease in excess of 10% from an earlier estimate for the same
period. In such event, Lessor shall provide a revised estimate to Lessee,
together with an explanation of the reasons therefor, and Lessee shall revise
its monthly payments accordingly. Lessor's and Lessee's obligation with respect
to adjustments at the end of the Lease Term or earlier expiration of this Lease
shall survive the Lease Term or earlier expiration.

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As used in this Lease, CAC shall include, but are not limited to (i) items
specified as CAC items in Paragraphs 5(b), 6, 16 and 31; (ii) utility costs
related to the common areas of the Premises as shown on Exhibit A.1 (iii) all
costs and expenses including but not limited to supplies, materials, equipment
and tools used or required in connection with the operation and maintenance of
the Premises; (iv) licenses, permits and inspection fees; (v) all other costs
incurred by Lessor in maintaining and operating the Premises; (vi) all reserves
for capital replacements; and (vii) an amount equal to five percent (5%) of the
aggregate of all CAC, as compensation for Lessor's accounting and processing
services. Lessee shall have the right to review the CAC applicable to this Lease
annually.

COMMENCEMENT DATE MEMORANDUM: When the actual Commencement Date is determined,
the parties shall execute a Commencement Date Memorandum setting forth the
Commencement Date, the expiration date of the Lease Term and any required
adjustments to base rent as provided in this Lease, but failure to do so shall
not affect the continuing validity and enforceability of this Lease, which shall
remain in full force and effect.

IT IS FURTHER MUTUALLY AGREED BETWEEN THE PARTIES AS FOLLOWS:

1. POSSESSION: Possession shall be deemed tendered and the term shall commence
upon the first to occur of the following (the "Commencement Date"): (i) the
Lessee Interior Improvements are Substantially Complete or (ii) Lessee occupies
the Building and commences to conduct business operations or (iii) if Lessor is
prevented from or delayed in completing its work under Section 2 of this Lease
due to Lessee Delays, such work will be deemed Substantially Complete as of the
date on which it would have been Substantially Complete had it not been for such
Lessee Delays. It is the intention of Lessee and Lessor that November 1, 1996
shall be the Commencement Date.

"Substantially Complete" shall mean that: (i) Lessor has tendered possession of
Building to Lessee, (ii) Lessor has met all legal requirements for occupancy,
(iii) The Lessee Interior improvements are materially complete per the approved
plans, exclusive of telephone or other communication systems, punchlist items
and there remains no incomplete or defective items of work which would
materially adversely affect Lessee's intended use of the Premises and (iv) said
interior of the building is in a "broom clean" condition.

2. LESSEE'S IMPROVEMENTS: The "Lessee Interior Improvements" shall be defined as
all items as shown on attached Exhibit B and shall be constructed by independent
contractors to be employed by and under the supervision of Lessor, in accordance
with complete plans and specifications prepared by Lessor and approved by Lessee
("Lessee Improvement Plans"), to be attached hereto as Exhibit B.1. Lessee and
its designated representatives, shall at all times during the construction of
the Lessee Interior Improvements have access to the Building to monitor the
progress of construction and Lessor's compliance with its obligation hereunder;
provided however, that such access shall not unreasonably interfere with the
activities of Lessor or its contractors. If Lessor notifies Lessee that any
fittings, finishes or other materials included in the specifications for the
Lessee Interior Improvements cannot be obtained within fifteen (15) days after
placing an order therefor for fittings, finishes, or other materials specified
by Lessee, Lessee shall be responsible for selecting alternative fittings,
finishes or other materials which can be obtained within said fifteen (15) day
period, or, if Lessee does not specify any alternative, Lessee shall be
responsible for any delay beyond said fifteen (15) day period including Rent for
each day of delay.

Lessor shall be responsible for ensuring that the Lessee Interior Improvements
conform to the approved plans and all applicable statutes, rules, regulations,
ordinances, and San Jose Building Department interpretations necessary for
occupancy.

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For any contract to be entered into between Lessor and any contractor furnishing
labor or materials in connection with the construction of the Lessee Interior
Improvements where the payment due under such contract is estimated by Lessor to
be in excess of One Hundred Thousand Dollars $100,000, Lessor shall request bids
from at least three (3) qualified contractors selected by Lessor for bidding.
Lessor will accept the lowest qualified bid. Lessee shall have the opportunity
to review the qualified bidders list and may select a bidder of their choice for
any bid provided the bidder meets Lessor's reasonable requirements.

Lessor shall be responsible for and shall pay the cost of the Lessee Interior
Improvements up to the amount of Six Hundred Ninety Thousand Dollars ($690,000)
(the "TI Allowance"). In the event the cost of the Lessee Interior Improvements
is less than the TI Allowance, the monthly base rent under the Lease shall be
reduced by $15.83 per month for every $1,000 dollars the costs are less than the
TI Allowance. Costs in excess of the TI Allowance, if ally, and the cost of
clean room estimated at $280,000 will not be incurred without advance approval
of Lessee. Any approved cost over the TI Allowance shall be paid for by Lessee
in cash within fifteen (15) days after Lessor has provided Lessee with evidence
that the work approved is complete.

Lessor shall be entitled to a construction management fee covering its overhead
and profit on the TI work of six percent (6%). All costs for Lessee Interior
Improvements shall be documented and subject to verification by Lessee.

Notwithstanding Lessor's responsibility for the TI Allowance, if at any time
after the execution of the Lease and upon the first occurrence only, Lessee's
cash position falls below One Million Five Hundred Thousand Dollars
($1,500,000), Lessee shall immediately reduce the principal amount of the TI
Allowance by paying to Lessor cash, the amount of which shall be determined with
reference to the following months of the Lease Term:
 
          Months 1 through 12       $300,000
          Months 13 through 24       250,000
          Months 25 through 36       200,000
          Months 37 through 48       100,000

After receipt of any required payments from Lessee to reduce the principal
amount of the TI Allowance, Lessor shall provide Lessee with a recalculation of
rent for the balance of the Lease Term.

Lessor shall use its best efforts to cause the Commencement Date of the initial
term to occur not later than November 1, 1996. If the Commencement Date has not
occurred by December 1, 1996, Lessee shall receive one day of base rent
abatement for each day after December 1, 1996 until the Commencement Date.
Lessor and Lessee agree that having a Commencement Date after December 1, 1996
will cause Lessee and Lessor to incur costs not contemplated by this Lease, the
exact amount of which will be extremely difficult to ascertain. Accordingly, the
parties hereby agree that Lessee's right to the abatement of base rent specified
herein represents a fair and reasonable settlement for both parties and neither
party shall have further liability to the other for any damages. If the
Commencement Date has not occurred by December 1, 1996, Lessee may at its sole
option, by written notice to Lessor, have the right to terminate this Lease at
any time after December 1, 1996 until the Commencement Date. Notwithstanding
anything to the contrary herein, all dates stated herein shall be extended for
the number of days Lessor is unable to Substantially Complete the Building as a
result of delays (i) due to governmental actions (other than governmental action
of refusing to approve work which fails to comply with the law or the building
permit) which occurs after receipt of normal building permits, (ii) due to acts
of God, (iii) due to circumstances beyond Lessor's control, (iv) after thirty
(30) days that the City of San Jose requires to issue a building permit after
plan submittal by Lessor, and (v) due to Lessee Delays. "Lessee Delays" means a
delay in Substantial Completion 

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resulting from (a) Lessee's failure to meet Lessee's deadlines for approval as
shown on Exhibit E, (b) delays due to change orders, (c) delays due to
Lessee's failure to meet the deadlines for approving any plans or change
orders, and (d) delays because of the inability to obtain any product,
materials, design, color, fitting, or finish pursuant to this Section 2.
Lessee shall have a minimum of 3 business days to approve or disapprove any
preliminary plans or change orders and a minimum of 10 business days to
approve or disapprove any final plans. If Lessee does not disapprove any plans
or change orders within the time period set forth herein in writing, Lessor
may proceed on the basis that the plans or change orders are approved by
Lessee. If plans or change orders are disapproved, Lessee shall state the
reason for disapproval and Lessor and Lessee shall act in good faith to
resolve any issues. Lessor shall charge Lessee $250 per change order after the
fifth (5th) change order for processing.

2.1 ACCEPTANCE OF PREMISES AND COVENANTS TO SURRENDER: Lessor represents that
the Premises shall be in good order and repair, and shall comply with all
requirements for occupancy as of the Commencement Date. Lessee agrees on the
last day of the Lease Term, or on the sooner termination of this Lease, to
surrender the Building to Lessor in Good Condition and Repair. Good Condition
and Repair ("Good Condition and Repair") shall not mean original condition, but
shall mean that the Building are in a commercially acceptable condition suitable
for occupancy by a reasonable lessee. The interior walls of all office and
warehouse areas, the floors of all office and warehouse areas, all suspended
ceilings and any carpeting are to be cleaned and in Good Condition and Repair.
Lessee also agrees to surrender unto Lessor all alterations, additions, and
improvements which may have been made in, to, or on the Building by Lessee,
except that Lessee shall ascertain from Lessor, within (30) days before the end
of the Lease Term or earlier termination of this Lease, whether Lessor desires
to have the Building or any part or parts thereof restored to their condition as
of the Commencement Date of this Lease; if Lessor shall so desire, then Lessee
shall restore said Building or such part or parts thereof before the end of the
Lease Term or earlier termination of this Lease at Lessee's sole cost and
expense. Lessee, on or before the end of the Lease Term or sooner termination of
this Lease, shall remove all its personal property and trade fixtures from the
Building, and all such property not so removed shall be deemed to be abandoned
by Lessee. Lessee shall reimburse Lessor for all disposition costs incurred by
Lessor relative to Lessee's abandoned property. If the Building are not
surrendered at the end of the Lease Term or earlier termination of this Lease,
Lessee shall indemnify Lessor against loss or liability resulting from any delay
caused by Lessee in surrendering the Building including, without limitation, any
claims made by any succeeding Lessee founded on such delay.

3.  USES PROHIBITED: Lessee shall not commit, or suffer to be committed, any
waste upon the Premises, or any nuisance, or other act or thing which may
disturb the quiet enjoyment of any other tenant in or around the buildings in
which the subject Premises are located or allow any sale by auction upon the
Premises, or allow the Premises to be used for any improper, immoral, unlawful
or objectionable purpose, or place any loads upon the floor, walls, or ceiling
which may endanger the structure, or use any machinery or apparatus which will
in any manner vibrate or shake the Building, or place any harmful liquids in the
drainage system of the building. No waste materials or refuse shall be dumped
upon or permitted to remain upon any part of the Premises outside of the
building proper. No materials, supplies, equipment, finished products or semi-
finished products, raw materials or articles of any nature shall be stored upon
or permitted to remain on any portion of the Premises outside of the building
structure, unless approved by the local, state federal or other applicable
governing authority. Lessor consents to Lessee's use of materials which are
incidental to the normal, day-to-day operations of any office user, such as
copier fluids, cleaning materials, etc., but this does not relieve Lessee of any
of its obligations not to contaminate the Premises or related real property or
violated any Hazardous Materials Laws.

4.  ALTERATIONS AND ADDITIONS: Lessee shall not make, or suffer to be
made, any alteration or addition to the Building, or any part thereof, without
the express, advance written consent of Lessor; any addition or alteration to

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said Building, except movable furniture and trade fixtures, shall become at once
a part of the realty and belong to Lessor at the end of the Lease Term or
earlier termination of this Lease. Alterations and additions which are not
deemed as trade fixtures shall include HVAC systems, lighting systems,
electrical systems, partitioning, carpeting, or any other installation which has
become an integral part of the Building. Lessee agrees that it will not proceed
to make such alterations or additions until all required government permits have
been obtained and after having obtained consent from Lessor to do so, until five
(5) days from the receipt of such consent, so that Lessor may post appropriate
notices to avoid any liability to contractors or material suppliers for payment
for Lessee's improvements. Lessee shall at all times permit such notices to be
posted and to remain posted until the completion of work. At the end of the
Lease Term or earlier termination of this Lease, Lessee shall remove and shall
be required to remove its special tenant improvements and all related equipment
installed by Lessee at or during the Lease Term and Lessee shall return the
Building to the condition that existed before the installation of the special
tenant improvements. Notwithstanding the above, Lessor agrees to allow any
reasonable alterations and improvements and will use its best efforts to notify
Lessee at the time of approval if such improvements or alterations are to be
removed at the end of the Lease Term or earlier termination of this Lease.

5. MAINTENANCE OF PREMISES:

(a) Lessee shall at its sole cost and expense keep and maintain the interior of
the Building, including, but not limited to, all lighting systems, temperature
control systems, clean room systems other than base HVAC units and plumbing
systems, in Good Condition and Repair, including any required replacements.
Lessee shall maintain all wall surfaces and floor coverings in Good Condition
and Repair, free of holes, gouges, or defacements.

(b) Lessor shall keep and maintain in Good Condition and Repair including
replacements, at Lessee's expense, based on a pro-rata share of cost based on
square footage or costs directly related to Lessee's use of the Premises the
following, which shall be included in the monthly CAC:

     1.   The exterior of the building, any appurtenances and every part
     thereof, including but not limited to, glazing, sidewalks, parking areas,
     electrical systems, HVAC systems, roof membrane, and painting of exterior
     walls.

     2.   The HVAC by a service contract with a licensed air conditioning and
     heating contractor which contract shall provide for a minimum of quarterly
     maintenance of all air conditioning and heating equipment at the Building
     including HVAC repairs or replacements which are either excluded from such
     service contract or any existing equipment warranties.

     3.   The landscaping by a landscape contractor to water, maintain, trim and
     replace, when necessary, any shrubbery and landscaping at the Premises.

     4.   The roof membrane by a service contract with a licensed reputable
     roofing contractor which contract shall provide for a minimum of semi-
     annual maintenance, cleaning of storm gutters, drains, removing of debris
     and trimming overhanging trees, repair of the roof and application of a
     finish coat every five years at the Building.

     5.   Extermination services.
     6.   Fire monitoring services.

(c)  Lessee hereby waives any and all rights to make repairs at the expense of
     Lessor as provided in Section 1942 of the Civil Code of the State of
     California, and all rights provided for by Section 1941 of said Civil Code.

(d)  Lessor shall be responsible for the repair of any structural defects in the
     Building including the roof structure (not membrane), exterior walls and
     foundation during the Lease Term.

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6. HAZARD INSURANCE: Lessee shall not use, or permit said Premises, or any part
thereof, to be used, for any purpose other than that for which said Premises are
hereby leased; and no use shall be made or permitted to be made of the Premises,
nor acts done, which may cause a cancellation of any insurance policy covering
said building, or any part thereof, nor shall Lessee sell or permit to be kept,
used or sold, in or about said Premises, any article which may be prohibited by
a standard form fire insurance policy. Lessee shall, at its sole cost and
expense, comply with any and all requirements, pertaining to said Premises, of
any insurance organization or company, necessary for the maintenance of
reasonable fire and general liability insurance, covering said building and
appurtenances. Lessor agrees to purchase and keep in force fire and extended
coverage insurance covering loss or damage to the Premises in amounts not to
exceed the full replacement cost of said Premises as determined by Lessor, with
proceeds payable to Lessor. Lessee acknowledges that the insurance referenced
above does not include coverage for Lessee's personal property. In the event of
a loss per the insurance provisions of this paragraph, Lessee shall be
responsible for deductibles up to a maximum of $5,000 per occurrence. Lessee
agrees to pay to the Lessor as additional Rent, on demand, the full cost of said
insurance as evidenced by insurance billings to the Lessor which shall be
included in Lessee's monthly CAC.  If said insurance billings cover the
Premises, and Lessee does not occupy the entire Premises, the insurance premiums
and deductibles shall be allocated to the portion of the Premises occupied by
Lessee on a pro-rata square footage or other equitable basis, as determined by
Lessor. It is understood and agreed that Lessee's obligation under this
paragraph will be prorated to reflect the Commencement Date and the end of the
Lease Term.

Lessor and Lessee hereby waive any rights each may have against the other
related to any loss or damage caused to Lessor or Lessee as the case may be, or
to the Premises, the Building, or its contents, and which may arise from any
risk generally covered by fire and extended coverage insurance. The parties
shall provide that their respective insurance policies insuring the property or
the personal property include a waiver of any right of subrogation which said
insurance company may have against Lessor or Lessee, as the case may be. Lessor
shall maintain in full force and effect, a policy of rental loss insurance, in
an amount equal to the amount of Rent payable by Lessee commencing on the date
of loss during the next ensuing one (1) year, as reasonably determined by Lessor
with proceeds payable to Lessor ("Loss of Rents Insurance"). Lessee shall
reimburse Lessor for the full cost of said rental loss insurance coverage.

7. ABANDONMENT: Lessee shall not vacate or abandon the Building at any time
during the Lease Term; and if Lessee shall abandon, vacate or surrender the
Building, or be dispossessed by process of law, or otherwise, any personal
property belonging to Lessee and left on the Building shall be deemed to be
abandoned, at the option of Lessor. Notwithstanding the above, the Building
shall not be considered vacated or abandoned if Lessee maintains the Building in
Good Condition and Repair, provides security and is not in default.

8. FREE FROM LIENS: Lessee shall keep the subject Premises and the property in
which the subject Premises are situated, free from any and all liens including
but not limited to liens arising out of any work performed, materials furnished,
or obligations incurred by Lessee. However, the Lessor shall allow Lessee to
contest a lien claim, so long as the claim is discharged prior to any
foreclosure proceeding being initiated against the property and provided Lessee
provides Lessor a bond if the lien exceeds $5,000.

9. COMPLIANCE WITH GOVERNMENTAL REGULATIONS: Lessee shall, at its sole cost and
expense, comply with all of the requirements of all local, municipal, state and
federal authorities now in force, or which may hereafter be in force, pertaining
to Lessee's use and occupancy of the said Premises, and shall faithfully observe
in the use of the Premises all local and municipal ordinances and state and
federal statutes now in force or which may hereafter be in force.

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10.   LESSEE'S INSURANCE: Lessee, as a material part of the consideration to be
rendered to Lessor, hereby waives all claims against Lessor and Lessor's Agents
for damages to goods, wares and merchandise, and all other personal property in,
upon or about said Premises, and for injuries to persons in, upon or about said
Premises, from any cause arising at any time, and Lessee will hold Lessor and
Lessor's Agents exempt and harmless from any damage or injury to any person, or
to the goods, wares and merchandise and all other personal property of any
person, arising from the use or occupancy of the Premises by Lessee, or from the
failure of Lessee to keep the Building in good condition and repair, as herein
provided. Lessee shall secure and keep in force a standard policy of commercial
general liability insurance and property damage policy covering the Premises,
including parking areas, insuring the Lessee.  A certificate of said policy
naming Lessor as an additional insured shall be delivered to Lessor and will
have a combined single limit for both bodily injury, death and property damage
in an amount not less than five million dollars ($5,000,000.00). The limits of
said insurance shall not, however, limit the liability of Lessee hereunder.
Lessee shall obtain a written obligation on the part of the insurer to notify
Lessor 30 days in advance in writing before any cancellation thereof Lessee
shall obtain, at Lessee's sole cost and expense, a policy of fire and extended
coverage insurance including coverage for direct physical loss special form, and
a sprinkler leakage endorsement insuring the personal property of Lessee. The
proceeds from any personal property damage policy shall be payable to Lessee.
Lessee shall, at its sole cost and expense, comply with all of the insurance
requirements of all local, municipal, state and federal authorities now in
force, or which may hereafter be in force, pertaining to Lessee's use and
occupancy of the said Premises.

11.   ADVERTISEMENTS AND SIGNS: Lessee shall not place or permit to be placed,
in, upon or about the Premises any unusual or extraordinary signs, or any
signs not approved by the city, local, state, federal or other applicable
governing authority. Lessee shall not place, or permit to be placed upon the
Premises, any signs, advertisements or notices without the written consent of
the Lessor, and such consent shall not be unreasonably withheld. A sign so
placed on the Premises shall be so placed upon the understanding and agreement
that Lessee will remove same at the end of the Lease Term or earlier
termination of this Lease and repair any damage or injury to the Premises
caused thereby, and if not so removed by Lessee, then Lessor may have the same
removed at Lessee's expense.

12.   UTILITIES: Lessee shall pay for all water , gas , heat, light, power,
telephone and other utilities supplied to the Building. Any charges for sewer
usage or related fees shall be the obligation of Lessee and paid for by Lessee.
If any such services are not separately metered to Lessee, Lessee shall pay a
reasonable proportion of all charges which are jointly metered, the
determination to be made by Lessor acting reasonably and on any equitable basis.
Lessor shall not be liable to Lessee for any disruption in any of the utility
services to the Building or Premises.

13.   ATTORNEY'S FEES: In case suit should be brought for the possession of the
Building or Premises, for the recovery of any sum due hereunder, or because of
the breach of any other covenant herein, the losing party shall pay to the
prevailing party reasonable attorney's fee which shall be deemed to have accrued
on the commencement of such action and shall be enforceable whether or not such
action is prosecuted to judgment.

14.1  DEFAULT: The occurrence of any of the following shall constitute a
default and breach of this Lease by Lessee: a) Any failure by Lessee to pay Rent
or to make any other payment required to be made by Lessee hereunder when due if
not cured within ten (10) days after written notice thereof by Lessor to Lessee;
b) The abandonment or vacation of the Premises by Lessee except as provided in
Section 7; c) A failure by Lessee to observe and perform any other provision of
this Lease to be observed or performed by Lessee, where such failure continues
for thirty days after written notice thereof by Lessor to Lessee; provided,
however, that if the nature of such default is such that the same cannot be
reasonably cured within such thirty (30) day period, Lessee shall not be deemed
to be in

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<PAGE>
 
default if Lessee shall, within such period, commence such cure and thereafter
diligently prosecute the same to completion; d) The making by Lessee of any
general assignment for the benefit of creditors; the filing by or against
Lessee of a petition to have Lessee adjudged a bankrupt or of a petition for
reorganization or arrangement under any law relating to bankruptcy; e) the
appointment of a trustee or receiver to take possession of substantially all
of Lessee's assets or Lessee's interest in this Lease, or the attachment,
execution or other judicial seizure of substantially all of Lessee's assets
located at the Premises or of Lessee's interest in this Lease.

14.2 SURRENDER OF LEASE: In the event of any such default by Lessee, then in
addition to any other remedies available to Lessor at law or in equity, Lessor
shall have the immediate option to terminate this Lease before the end of the
Lease Term and all rights of Lessee hereunder, by giving written notice of
such intention to terminate. In the event that Lessor terminates this Lease
due to a default of Lessee, then Lessor may recover from Lessee: a) the worth
at the time of award of any unpaid Rent which had been earned at the time of
such termination; plus b) the worth at the time of award of unpaid Rent which
would have been earned after termination until the time of award exceeding the
amount of such rental loss that the Lessee proves could have been reasonably
avoided; plus c) the worth at the time of award of the amount by which the
unpaid Rent for the balance of the Lease Term after the time of award exceeds
the amount of such rental loss that the Lessee proves could have been
reasonably avoided; plus d) any other amount necessary to compensate Lessor
for all the detriment proximately caused by Lessee's failure to perform his
obligations under this Lease or which in the ordinary course of things would
be likely to result therefrom; and e) at Lessor's election, such other amounts
in addition to or in lieu of the foregoing as may be permitted from time to
time by applicable California law. As used in (a) and (b) above, the "worth at
the time of award" is computed by allowing interest at the rate of Wells
Fargo's prime rate plus two percent (2%) per annum. As used in (c) above, the
"worth at the time of award" is computed by discounting such amount at the
discount rate of the Federal Reserve Bank of San Francisco at the time of
award plus one percent (1%).

14.3 RIGHT OF ENTRY AND REMOVAL: In the event of any such default by Lessee,
Lessor shall also have the right, with or without terminating this Lease, to re-
enter the Building and remove all persons and property from the Building; such
property may be removed and stored in a public warehouse or elsewhere at the
cost of and for the account of Lessee.

14.4 ABANDONMENT: In the event of the vacation or abandonment, except as
provided in Section 7, of the Building by Lessee or in the event that Lessor
shall elect to re-enter as provided in paragraph 14.3 above or shall take
possession of the Premises pursuant to legal proceeding or pursuant to any
notice provided by law, and Lessor does not elect to terminate this Lease as
provided in paragraph 14.2 above, then Lessor may from time to time, without
terminating this Lease, either recover all Rent as it becomes due or relet the
Building or any part thereof for such term or terms and at such rental rates and
upon such other terms and conditions as Lessor, in its sole discretion, may deem
advisable with the right to make alterations and repairs to the Building. In the
event that Lessor elects to relet the Building, then Rent received by Lessor
from such reletting shall be applied; first, to the payment of any indebtedness
other than Rent due hereunder from Lessee to Lessor; second, to the payment of
any cost of such reletting; third, to the payment of the cost of any alterations
and repairs to the Building; fourth, to the payment of Rent due and unpaid
hereunder; and the residue, if any, shall be held by Lessor and applied to the
payment of future Rent as the same may become due and payable hereunder. Should
that portion of such Rent received from such reletting during any month, which
is applied by the payment of Rent hereunder according to the application
procedure outlined above, be less than the Rent payable during that month by
Lessee hereunder, then Lessee shall pay such deficiency to Lessor immediately
upon demand therefor by Lessor. Such deficiency shall be calculated and paid
monthly. Lessee shall also pay to Lessor, as soon as ascertained, any costs and
expenses incurred by 

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<PAGE>
 
Lessor in such reletting or in making such alterations and repairs not covered
by the rentals received from such reletting.

14.5 NO IMPLIED TERMINATION: No re-entry or taking possession of the Building by
Lessor pursuant to 14.3 or 14.4 of this Article 14 shall be construed as an
election to terminate this Lease unless a written notice of such intention is
given to Lessee or unless the termination thereof is decreed by a court of
competent jurisdiction. Notwithstanding any reletting without termination by
Lessor because of any default by Lessee, Lessor may at any time after such
reletting elect to terminate this Lease for any such default.

15. SURRENDER OF LEASE: The voluntary or other surrender of this Lease by
Lessee, or a mutual cancellation thereof, shall not work a merger, and shall, at
the option of Lessor, terminate all or any existing subleases or sub tenancies,
or may, at the option of Lessor, operate as an assignment to him of any or all
such subleases or sub tenancies.

16. TAXES: Lessee shall pay and discharge punctually and when the same shall
become due and payable without penalty, all real estate taxes, personal
property taxes, taxes based on vehicles utilizing parking areas in the
Premises, taxes computed or based on rental income (other than federal, state
and municipal net income taxes), Environmental Surcharges, privilege taxes,
excise taxes, business and occupation taxes, school fees or surcharges, gross
receipts taxes, sales and/or use taxes, employee taxes, occupational license
taxes, water and sewer taxes, assessments (including, but not limited to,
assessments for public improvements or benefit), assessments for local
improvement and maintenance districts, and all other governmental impositions
and charges of every kind and nature whatsoever, regardless of whether now
customary or within the contemplation of the parties hereto and regardless of
whether resulting from increased rate and/or valuation, or whether
extraordinary or ordinary, general or special, unforeseen or foreseen, or
similar or dissimilar to any of the foregoing (all of the foregoing being
hereinafter collectively called "Tax" or "Taxes") which, at any time during
the Lease Term, shall be applicable or against the Premises, or shall become
due and payable and a lien or charge upon the Premises under or by virtue of
any present or future laws, statutes, ordinances, regulations, or other
requirements of any governmental authority whatsoever. The term "Environmental
Surcharge" shall include any and all expenses, taxes, charges or penalties
imposed by the Federal Department of Energy, Federal Environmental Protection
Agency, the Federal Clean Air Act, or any regulations promulgated thereunder,
or any other local, state or federal governmental agency or entity now or
hereafter vested with the power to impose taxes, assessments or other types of
surcharges as a means of controlling or abating environmental pollution or the
use of energy (i) generally imposed on similar properties in a wide geographic
area without regard to whether the properties are subject to the tax are
contaminated by Hazardous Materials and which is part of a comprehensive plan
imposed by a governmental unit or (ii) imposed with respect to the Premises as
the result of presence of Hazardous Materials for which Lessee is required to
indemnify Lessor under Section 33. The term "Tax" shall include, without
limitation, all taxes, assessments, levies, fees, impositions or charges
levied, imposed, assessed, measured, or based in any manner whatsoever (i) in
whole or in part on the Rent payable by Lessee under this Lease, (ii) upon or
with respect to the use, possession, occupancy, leasing, operation or
management of the Premises, (iii) upon this transaction or any document to
which Lessee is a party creating or transferring an interest or an estate in
the Premises, (iv) upon Lessee's business operations conducted at the
Premises, (v) upon, measured by or reasonably attributable to the cost or
value of Lessee's equipment, furniture, fixtures and other personal property
located on the Premises or the cost or value of any leasehold improvements
made in or to the Premises by or for Lessee, regardless of whether title to
such improvements shall be in Lessor or Lessee, or (vi) in lieu of or
equivalent to any Tax set forth in this Section 16. In the event any such
Taxes are payable by Lessor and it shall not be lawful for Lessee to reimburse
Lessor for such Taxes, then the Rent payable thereunder shall be increased to
net Lessor the same net rent after imposition of any such Tax upon Lessor as
would have been payable to Lessor prior to the imposition of any 

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<PAGE>
 
such Tax. It is the intention of the parties that Lessor shall be free from
all such Taxes and all other governmental impositions and charges of every
kind and nature whatsoever. However, nothing contained in this Section 16
shall require Lessee to pay any Federal or State income, franchise, estate,
inheritance, succession, transfer or excess profits tax imposed upon Lessor.
If any general or special assessment is levied and assessed against the
Premises, Lessor agrees to use its best reasonable efforts to cause the
assessment to become a lien on the Premises securing repayment of a bond sold
to finance the improvements to which the assessment relates which is payable
in installments of principal and interest over the maximum term allowed by
law. It is understood and agreed that Lessee's obligation under this paragraph
will be prorated to reflect the Commencement Date and the end of the Lease
Term. It is further understood that if Taxes cover the Premises and Lessee
does not occupy the entire Premises, the Taxes will be allocated to the
portion of the Premises occupied by Lessee based on a pro-rata square footage
or other equitable basis. Taxes billed by Lessor to Lessee shall be included
in the monthly CAC.

Subject to any limitations or restrictions imposed by any deeds of trust or
mortgages now or hereafter covering or affecting the Premises, Lessee shall have
the right to contest or review the amount or validity of any Tax by appropriate
legal proceedings but which is not to be deemed or construed in any way as
relieving, modifying or extending Lessee's covenant to pay such Tax at the time
and in the manner as provided in this Section 16. However, as a condition of
Lessee's right to contest, if such contested Tax is not paid before such contest
and if the legal proceedings shall not operate to prevent or stay the collection
of the Tax so contested, Lessee shall, before instituting any such proceeding,
protect the Premises and the interest of Lessor and of the beneficiary of a deed
of trust or the mortgagee of a mortgage affecting the Premises against any lien
upon the Premises by a surety bond, issued by an insurance company acceptable to
Lessor and in an amount equal to one and one-half (1 1/2) times the amount
contested or, at Lessor's option, the amount of the contested Tax and the
interest and penalties in connection therewith. Any contest as to the validity
or amount of any Tax, whether before or after payment, shall be made by Lessee
in Lessee's own name, or if required by law, in the name of Lessor or both
Lessor and Lessee. Lessee shall defend, indemnify and hold harmless Lessor from
and against any and all costs or expenses, including attorneys' fees, in
connection with any such proceedings brought by Lessee, whether in its own name
or not. Lessee shall be entitled to retain any refund of any such contested Tax
and penalties or interest thereon which have been paid by Lessee. Nothing
contained herein shall be construed as affecting or limiting Lessor's right to
contest any Tax at Lessor's expense.

17. NOTICES: Unless otherwise provided for in this Lease, any and all
written notices or other communication (the "Communication") to be given in
connection with this Lease shall be given in writing and shall be given by
personal delivery, facsimile transmission or by mailing by registered or
certified mail with postage thereon or recognized overnight courier, fully
prepaid, in a sealed envelope addressed to the intended recipient as follows:
 
(a) to the Lessor at:  10050 Bandley Drive
                       Cupertino, California 95014
                       Attention:  Carl E. Berg
                       Fax No: (408) 725-1 626

(b) to the Lessee at:  6325 San lgnacio
                       San Jose, California
                       Attention: CFO
                       Fax No:

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<PAGE>
 
or such other addresses, facsimile number or individual as may be designated by
a Communication given by a party to the other parties as aforesaid. Any
Communication given by personal delivery shall be conclusively deemed to have
been given and received on a date it is so delivered at such address provided
that such date is a business day, otherwise on the first business day following
its receipt, and if given by registered or certified mail, on the day on which
delivery is made or refused or if given by recognized overnight courier, on the
first business day following deposit with such overnight courier and if given by
facsimile transmission, on the day on which it was transmitted provided such day
is a business day, failing which, on the next business day thereafter.

18. ENTRY BY LESSOR: Lessee shall permit Lessor and its agents to enter into
the Building at all reasonable times using the minimum amount of interference
and inconvenience to Lessee and Lessee's business, subject to any security
regulations of Lessee, for the purpose of inspecting the same or for the
purpose of maintaining the Building, or for the purpose of making repairs,
alterations or additions to any other portion of said Building, including the
erection and maintenance of such scaffolding, canopies, fences and props as
may be required, without any rebate of Rent and without any liability to
Lessee for any loss of occupation or quiet enjoyment of the Premises; and
shall permit Lessor and his agents, at any time within ninety (90) days prior
to the end of the Lease Term, to place upon said Premises any usual or
ordinary "For Sale" or "For Lease" signs and exhibit the Premises and the
Building to prospective tenants at reasonable hours.

19. DESTRUCTION OF PREMISES: In the event of a partial destruction of the said
Premises during the Lease Term from any cause which is covered by Lessor's
property insurance, Lessor shall forthwith repair the same, provided such
repairs can be made within ninety (90) days under the laws and regulations of
State, Federal, County, or Municipal authorities, but such partial destruction
shall in no way annul or void this Lease, except that Lessee shall be entitled
to a proportionate reduction of Rent while such repairs are being made to the
extent of payments received by Lessor under its Loss of Rents Insurance
coverage. With respect to any partial destruction which Lessor is obligated to
repair or may elect to repair under the terms of this paragraph, the provision
of Section 1932, Subdivision 2, and of Section 1933, Subdivision 4, of the
Civil Code of the State of California are waived by Lessee. In the event that
the Building is destroyed to all extent greater than thirty-three and one-
third (33 1/3%) of the replacement cost thereof, Lessor may, at its sole
option, elect to terminate this Lease, whether the subject Premises is insured
or not. A total destruction of the Building shall terminate this Lease.
Notwithstanding the above, Lessor is only obligated to repair or rebuild to
the extent of available insurance proceeds including any deductible amount.
Should Lessor determine that insufficient or no insurance proceeds are
available for repair or reconstruction of Premises, Lessor, at its sole
option, may terminate the Lease. Lessee shall have the option of continuing
this Lease by agreeing to pay all repair costs to the subject Premises.

20. ASSIGNMENT AND SUBLETTING: Lessee shall not assign this Lease, or any
interest therein, and shall not sublet the said Building or any part thereof, or
any right or privilege appurtenant thereto, or cause any other person or entity
(a bona fide subsidiary or affiliate of Lessee excepted) to occupy or use the
Building, or any portion thereof, without the advance written consent of Lessor.
Any such assignment or subletting without such consent shall he void, and shall,
at the option of the Lessor, terminate this Lease. This Lease shall not, or
shall an)' interest therein, be assignable, as to the interest of Lessee, by
operation of law, without the written consent of Lessor. Notwithstanding
Lessor's obligation to provide reasonable approval, Lessor reserves the right to
withhold its consent for any proposed sublessee or assignee of Lessee if the
proposed sublessee or assignee is a user or generator of Hazardous Materials. If
Lessee desires to assign its rights under this Lease or to sublet, all or a
portion of the subject Building to a party other than a bona fide subsidiary or
affiliate of Lessee, Lessee shall first notify Lessor of the proposed terms and
conditions of such assignment or subletting. Lessor shall have the right of
first refusal to enter into a direct Lessor-Lessee relationship with such party
under such proposed terms and conditions, in which

PAGE 12
<PAGE>
 
event Lessee shall be relieved of its obligations hereunder to the extent of
the Lessor-lessee relationship entered into between Lessor and such third
party. Notwithstanding the foregoing, Lessee may assign this Lease to a
successor in interest, whether by merger or acquisition, provided there is no
substantial reduction in the net worth of the resulting entity and the
resulting entity is not a user or generator of Hazardous Materials. Whether or
not Lessor's consent to a sublease or assignment is required, in the event of
any sublease or assignment, Lessee shall be and shall remain primarily liable
for the performance of all conditions, covenants, and obligations of Lessee
hereunder and, in the event of a default by an assignee or sublessee, Lessor
may proceed directly against the original Lessee hereunder and/or any other
predecessor of such assignee or sublessee without the necessity of exhausting
remedies against said assignee or sublessee.

21. CONDEMNATION: If any part of the Building shall be taken for any public or
quasi-public use, under any statute or by right of eminent domain or private
purchase in lieu thereof, and a part thereof remains which is susceptible of
occupation hereunder, this Lease shall as to the part so taken, terminate as of
the date title vests in the condemnor or purchaser, and the Rent payable
hereunder shall be adjusted so that the Lessee shall be required to pay for the
remainder of tile Lease Term only that portion of Rent as the value of the part
remaining. The rental adjustment resulting will be computed at the same Rental
rate for the remaining part not taken; however, Lessor shall have the option to
terminate this Lease as of the date when title to the part so taken vests in the
condemnor or purchaser. If all of the Building, or such part thereof be taken so
that there does not remain a portion susceptible for occupation hereunder, this
Lease shall thereupon terminate. If a part or all of the Building be taken, all
compensation awarded upon such taking shall be payable to the Lessor. Lessee may
file a separate claim and be entitled to any award granted to Lessee.

22. EFFECTS OF CONVEYANCE: The term "Lessor" as used in this Lease, means only
the owner for the time being of the land and building constituting the
Premises, so that, in the event of any sale of said land or building, or in
the event of a Lease of said building, Lessor shall be and hereby is entirely
freed and relieved of all covenants and obligations of Lessor hereunder, and
it shall be deemed and construed, without further agreement between the
parties and the purchaser of any such sale, or the Lessor of the building,
that the purchaser or lessor of the building has assumed and agreed to carry
out any and all covenants and obligations of the Lessor hereunder. If any
security is given by Lessee to secure the faithful performance of all or any
of the covenants of this Lease on the part of Lessee, Lessor may transfer and
deliver the security, as such, to the purchaser at any such sale of the
building, and thereupon the Lessor shall be discharged from any further
liability.

23. SUBORDINATION: This Lease, in the event Lessor notifies Lessee in writing,
shall be subordinate to any ground lease, deed of trust, or other
hypothecation for security now or hereafter placed upon the real property at
which the Premises are a part and to any and all advances made on the security
thereof and to renewals, modifications, replacements and extensions thereof.
Lessee agrees to promptly execute any documents which may be required to
effectuate such subordination. Notwithstanding such subordination, if Lessee
is not in default and so long as Lessee shall pay the Rent and observe and
perform all of the provisions and covenants required under this Lease,
Lessee's right to quiet possession of the Premises shall not be disturbed or
effected by any subordination.

24. WAIVER: The waiver by Lessor of any breach of any term, covenant or
condition, herein contained shall not be construed to be a waiver of such term,
covenant or condition or any subsequent breach of the same or any other term,
covenant or condition therein contained. The subsequent acceptance of Rent
hereunder by Lessor shall not be deemed to be a waiver of Lessee's breach of any
term, covenant, or condition of the Lease.

PAGE 13
<PAGE>
 
25. HOLDING OVER: Any holding over after the end of the Lease Term requires
Lessor's written approval prior to the end of the Lease Term, which,
notwithstanding any other provisions of this Lease, Lessor may withhold and
shall be construed to be a tenancy at sufferance from month to month. Lessee
shall pay to Lessor monthly base rent equal to one and one-half (1.5) times the
monthly base rent installment due in the last month of the Lease Term and all
other additional rent and all other terms and conditions of the Lease shall
apply, so far as applicable. Holding over by Lessee without written approval of
Lessor shall subject Lessee to the liabilities and obligations provided for in
this Lease and by law, including, but not limited to those in Section 2.1 of
this Lease. Lessee shall indemnify and hold Lessor harmless against any loss or
liability resulting from any delay caused by Lessee in surrendering the
Building, including without limitation, any claims made or penalties incurred by
any succeeding lessee or by Lessor. No holding over shall be deemed or construed
to exercise any option to extend or renew this Lease in lieu of full and timely
exercise of any such option as required hereunder.

26. SUCCESSORS AND ASSIGNS: The covenants and conditions herein contained
shall, subject to the provisions as to assignment, apply to and bind the
heirs, successors, executors, administrators and assigns of all of the parties
hereto; and all of the parties hereto shall be jointly and severally liable
hereunder.

27. ESTOPPEL CERTIFICATES: Lessee shall at any time during the Lease Term,
upon not less than ten (10) days prior written notice from Lessor, execute and
deliver to Lessor a statement in writing certifying that, this Lease is
unmodified and in full force and effect (or, if modified, stating the nature
of such modification) and the dates to which the Rent and other charges have
been paid in advance, if any, and acknowledging that there are not, to
Lessee's knowledge, any uncured defaults on the part of Lessor hereunder or
specifying such defaults if they are claimed. Any such statement may be
conclusively relied upon by any prospective purchaser or encumbrancer of the
Premises. Lessee's failure to deliver such a statement within such time shall
be conclusive upon the Lessee that (a) this Lease is in full force and effect,
without modification except as may be represented by Lessor, (b) there are 110
uncured defaults in Lessor's performance.

28. TIME: Time is of the essence of the Lease.

29. CAPTIONS: The headings on titles to the paragraphs of this Lease are not a
part of this Lease and shall have no effect upon the construction or
interpretation of any part thereof. This instrument contains all of the
agreements and conditions made between the parties hereto and may not be
modified orally or in any other manner than by an agreement in writing signed
by all of the parties hereto or their respective successors in interest.

30. PARTY NAMES: Landlord and Tenant may be used in various places in this
Lease as a substitute for Lessor and Lessee respectively.

31. EARTHQUAKE INSURANCE: As a condition of Lessor agreeing to waive the
requirement for earthquake insurance, Lessee agrees that it will pay, as
additional Rent, which shall be included in the monthly CAC, an amount not to
exceed twenty thousand eight hundred dollars ($20,800) per year for earthquake
insurance if Lessor desires to obtain some form of earthquake insurance in the
future, if and when available, on terms acceptable to Lessor.

32. HABITUAL DEFAULT: Notwithstanding anything to the contrary contained in
Section 14 herein, Lessor and Lessee agree that if Lessee shall have defaulted
in the payment of Rent for three or more times during any twelve month period
during the Lease Term, then such conduct shall, at the option of the Lessor,
represent a separate event of default which cannot be cured by Lessee. Lessee
acknowledges that the purpose of this provision is to prevent

PAGE 14
<PAGE>
 
repetitive defaults by the Lessee under the Lease, which constitute a hardship
to the Lessor and deprive the Lessor of the timely performance by the Lessee
hereunder.

33. HAZARDOUS MATERIALS

33.1 DEFINITIONS: As used in this Lease, the following terms shall have the
following meaning:

     a.   The term "Hazardous Materials" shall mean (i) polychlorinated
     biphenyls; (ii) radioactive materials and (iii) any chemical, material or
     substance now or hereafter defined as or included in the definitions of
     "hazardous substance" "hazardous water", "hazardous material", "extremely
     hazardous waste", "restricted hazardous waste" under Section 25115, 25117
     or 15122.7, or listed pursuant to Section 25140 of the California Health
     and Safety Code, Division 20, Chapter 6.5 (Hazardous Waste Control Law),
     (ii) defined as "hazardous substance" under Section 25316 of the California
     Health and Safety Code, Division 20, Chapter 6.8 (Carpenter-Presley-Tanner
     Hazardous Substances Account Act), (iii) defined as "hazardous material",
     "hazardous substance", or "hazardous waste" under Section 25501 of the
     California Health and Safety Code, Division 20, Chapter 6.95 (Hazardous
     Materials Release, Response, Plans and Inventory), (iv) defined as a
     "hazardous substance" tinder Section 25181 of the California Health and
     Safety Code, Division 201, Chapter 6.7 (Underground Storage of Hazardous
     Substances), (v) petroleum, (vi) asbestos, (vii) listed under Article 9 or
     defined as "hazardous" or "extremely hazardous" pursuant to Article II of
     Title 22 of the California Administrative Code, Division 4, Chapter 20,
     (viii) defined as "hazardous substance" pursuant to Section 311 of the
     Federal Water Pollution Control Act, 33 U.S.C. 1251 et seq. or listed
     pursuant to Section 1004 of the Federal Water Pollution Control Act (33
     U.S.C. 1317), (ix) defined as a "hazardous waste", pursuant to Section 1004
     of the Federal Resource Conservation and Recovery Act, 42 U.S.C. 6901 et
     seq., (x) defined as "hazardous substance" pursuant to Section 101 of the
     Comprehensive Environmental Responsibility Compensations, and Liability
     Act, 42 U.S.C. 9601 et seq., or (xi) regulated under the Toxic Substances
     Control Act, 156 U.S.C. 2601 et seq.

     b.   The term "Hazardous Materials Laws" shall mean any local, state and
     federal laws, rules, regulations, or ordinances relating to the use,
     generation, transportation, analysis, manufacture, installation, release,
     discharge, storage or disposal of Hazardous Material.

     c.   The term "Lessor's Agents" as used herein shall mean Lessor's agents,
     representatives, employees, contractors, subcontractors, directors,
     officers and partners.

     d.   The term "Lessee's Agents" as used herein shall mean Lessee's agents,
     representatives, employees, contractors, subcontractors, directors,
     officers, partners, invitees or any other person in or about the Premises.

33.2 LESSEE'S RIGHT TO INVESTIGATE: Lessee shall be entitled to cause such
inspection, soils and ground water tests, and other evaluations to be made of
the Premises as Lessee deems necessary regarding (i) the presence and use of
Hazardous Materials in or about the Premises, and (ii) the potential for
exposure to Lessee's employees and other persons to any Hazardous Materials
used and stored by previous occupants in or about the Premises. Lessee shall
provide Lessor with copies of all inspections, tests and evaluations. Lessee
shall indemnify, defend and hold Lessor harmless from any cost, claim or
expense arising from such entry by Lessee or from the performance of any such
investigation by such Lessee.

33.3 LESSOR'S REPRESENTATIONS: Lessor hereby represents and warrants to the
best of Lessor's knowledge that the Premises are, as of the date of this
Lease, in compliance with all Hazardous Material Laws.

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<PAGE>
 
33.4 LESSEE'S OBLIGATION TO INDEMNIFY: Lessee, at its sole cost and expense,
shall indemnify, defend, protect and hold Lessor and Lessor's Agents harmless
from and against any and all cost or expenses, including those described under
subparagraphs i, ii and iii herein below set forth, arising from or caused in
whole or in part, directly or indirectly by:

     a.   Lessee's or Lessee's Agents' use, analysis, storage, transportation,
     disposal, release, threatened release, discharge or generation of Hazardous
     Material to, in, on, under, about or from the Premises; or

     b.   Lessee's or Lessee's Agents failure to comply with Hazardous Material
     laws; or

     c.   Any release of Hazardous Material to, in, on, under, about, from or
     onto the Premises caused by Lessee or Lessee's Agents, except ground water
     contamination from other parcels where the source is from off the Premises
     not arising from or caused by Lessee or Lessee's Agents.

The cost and expenses indemnified against include, but are not limited to the
following:
     i.   Any and all claims, actions, suits, proceedings, losses, damages,
     liabilities, deficiencies, forfeitures, penalties, fines, punitive damages,
     cost or expenses;

     ii.  Any claim, action, suit or proceeding for personal injury (including
     sickness, disease, or death), tangible or intangible property damage,
     compensation for lost wages, business income, profits or other economic
     loss, damage to the natural resources of the environment, nuisance,
     pollution, contamination, leaks, spills, release or other adverse effects
     on the environment;

     iii. The cost of any repair, clean-up, treatment or detoxification of the
     Premises necessary to bring the Premises into compliance with all Hazardous
     Material Laws, including the preparation and implementation of any closure,
     disposal, remedial action, or other actions with regard to the Premises,
     and expenses (including, without limitation, reasonable attorney's fees and
     consultants fees, investigation and laboratory fees, court cost and
     litigation expenses).

33.5 LESSEE'S OBLIGATION TO REMEDIATE CONTAMINATION: Lessee shall, at its sole
cost and expense, promptly take any and all action necessary to remediate
contamination of the Premises by Hazardous Materials arising or occurring as a
result of acts or omissions of Lessee or Lessee's Agents during the Lease
Term.

33.6 OBLIGATION TO NOTIFY: Lessor and Lessee shall each give written notice to
the other as soon as reasonably practical of (i) any communication received
from any governmental authority concerning Hazardous Material which related to
the Premises and (ii) any contamination of the Premises by Hazardous Materials
which constitutes a violation of any Hazardous Material Laws.

33.7 SURVIVAL: The obligations of Lessee under this Section 33 shall survive
the Lease Term or earlier termination of this Lease.

33.8 CERTIFICATION AND CLOSURE: On or before the end of the Lease Term or
earlier termination of this Lease, Lessee shall deliver to Lessor a
certification executed by Lessee stating that, to the best of Lessee's
knowledge, there exists no violation of Hazardous Material Laws resulting from
Lessee's obligation in Paragraph 33. If pursuant to local ordinance, state or
federal law, Lessee is required, at the expiration of the Lease Term, to
submit a closure plan for the Premises to a local, state or federal agency,
then Lessee shall furnish to Lessor a copy of such plan.

33.9 PRIOR HAZARDOUS MATERIALS: Notwithstanding anything contained to the
contrary herein, Lessee shall have no obligation to clean up or to hold Lessor
harmless or make any payment with respect to, any Hazardous Material or wastes
discovered on the Premises which were not introduced into, in, on, about, from
or under the Premises 

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<PAGE>
 
during the Lease Term or ground water contamination from other parcels where
the source is from off the Premises not arising from or caused by Lessee or
Lessee's Agents.

34. BROKERS: Lessor and Lessee represent that they have not utilized or
contacted a real estate broker or finder with respect to this Lease other than
Cornish & Carey ("C&C") and Lessee agrees to indemnify and hold Lessor
harmless against any claim, cost, liability or cause of action asserted by any
broker or finder claiming through Lessee other than C&C. Lessor shall at its
sole cost and expense pay the brokerage commission per Lessor's standard
commission schedule to C&C in connection with this transaction. Lessor
represents and warrants that it has not utilized or contacted a real estate
broker or finder with respect to this Lease other than C&C and Lessor agrees
to indemnify and hold Lessee harmless against any claim, cost, liability or
cause of action asserted by any broker or finder claiming through Lessor.

35. OPTION TO EXTEND

A. Option: Lessor hereby grants to Lessee one (1) option to extend the Lease
   ------                                                             
Term, with the extended term to be for a period of five (5) years, on the
following terms and conditions:

     (i) Lessee shall give Lessor written notice of its exercise of its option
     to extend no earlier than twenty-four (24) calendar months, nor later than
     six (6) calendar months before the Lease Term would end but for said
     exercise. Time is of the essence.

     (ii) Lessee may not extend the Lease Term pursuant to any option granted by
     this section 35 if Lessee is in default as of the date of the exercise of
     its option. If Lessee has committed a default by Lessee as defined in
     Section 14 or 32 that has not been cured or waived by Lessor in writing by
     the date that any extended term is to commence, then Lessor may elect not
     to allow the Lease Tern' to be extended, notwithstanding any notice given
     by Lessee of an exercise of this option to extend.

     (iii) All terms and conditions of this Lease shall apply during the
     extended term, except that the base rent and rental increases for each
     extended term shall be determined as provided in Section 35 (B) below

     (iv) Once Lessee delivers a notice of exercise of its options to extend the
     Lease Term, Lessee may not withdraw such exercise and subject to the
     provisions of this Section 35, such notice shall operate to extend the
     Lease Term. Upon any extension of the Lease Term pursuant to this Section
     35, the term "Lease Term" as used in this Lease shall thereafter include
     the then extended term.

     (v) The option rights of Photon Dynamics, Inc. granted under this Section
     35 are granted for Photon Dynamics, Inc.'s personal benefit and may not be
     assigned or transferred by Photon Dynamics, Inc. or exercised if Photon
     Dynamics, Inc. is not occupying the Building at the time of exercise.

B. Extended Term Rent - Option Period: The monthly Rent for the Building
   ----------------------------------
during the extended term shall equal to ninety-five percent (95%) of the fair
market monthly Rent for the Building as of the commencement date of the
extended term, but in no case, less than the Rent during the last month of the
prior Lease term. Promptly upon Lessee's exercise of the option to extend,
Lessee and Lessor shall meet and attempt to agree on the fair market monthly
Rent for the Building as of the commencement date of the extended term. In the
event the parties fail to agree upon the amount of the monthly Rent for the
extended term prior to commencement thereof, the monthly Rent for the extended
term shall be determined by appraisal in the manner hereafter set forth;
provided, however, that in no event shall the monthly Remit for the extended
term be less than in the immediate preceding period. 

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Annual base rent increases during the extended term shall be three percent
(3%) per year. In the event it becomes necessary under this paragraph to
determine the fair market monthly Rent of the Building by appraisal, Lessor
and Lessee each shall appoint a real estate appraiser who shall be a member of
the American Institute of Real Estate Appraiser ("AIREA") and such appraisers
shall each determine the fair market monthly Rent for the Building taking into
account the value of the Premises and the amenities provided by the outside
areas, the common areas, and the Building, and prevailing comparable Rentals
in the area. Such appraisers shall, within twenty (20) business days after
their appointment, complete their appraisals and submit their appraisal
reports to Lessor and Lessee. If the fair market monthly Rent of the Building
established in the two (2) appraisals varies by five percent (5%) or less of
the higher Rent, the average of the two shall be controlling. If said fair
market monthly Rent varies by more than five percent (5%) of the higher
Rental, said appraisers, within ten (10) days after submission of the last
appraisal, shall appoint a third appraiser who shall be a member of the AIREA
and who shall also be experienced in the appraisal of Rent values and
adjustment practices for commercial properties in the vicinity of the
Building. Such third appraiser shall, within twenty (20) business days after
his appointment, determine by appraisal the fair market monthly Rent of the
Building taking into account the same factors referred to above, and submit
his appraisal report to Lessor and Lessee. The fair market monthly Rent
determined by the third appraiser for the Building shall be controlling,
unless it is less than that set forth in the lower appraisal previously
obtained, in which case the value set forth in said lower appraisal shall be
controlling, or unless it is greater than that set forth in the higher
appraisal previously obtained in which case the Rent set for in said higher
appraisal shall be controlling. If either Lessor or Lessee fails to appoint an
appraiser, or if an appraiser appointed by either of them fails, after his
appointment to submit his appraisal within the required period in accordance
with the foregoing, the appraisal submitted by the appraiser properly
appointed and timely submitting his appraisal shall be controlling. If the two
appraisers appointed by Lessor and Lessee are unable to agree upon a third
appraiser within the required period in accordance with the foregoing,
application shall be made within twenty (20) days thereafter by either Lessor
or Lessee to AIREA, which shall appoint a member of said institute willing to
serve as appraiser. The cost of all appraisals under this subparagraph shall
be borne equally be Lessor and Lessee.

36. APPROVALS: Whenever in this Lease the Lessor's or Lessee's consent is
required, such consent shall not be unreasonably or arbitrarily withheld or
delayed. In the event that the Lessor or Lessee does not respond to a request
for any consents which may be required of it in this Lease within ten business
days of the request of such consent in writing by the Lessee or Lessor, such
consent shall be deemed to have been given by the Lessor or Lessee.

37. AUTHORITY: Each party executing this Lease represents and warrants that he
or she is duly authorized to execute and deliver the Lease. If executed on
behalf of a corporation, that the Lease is executed in accordance with the by-
laws of said corporation (or a partnership that the Lease is executed in
accordance with the partnership agreement of such partnership), that no other
party's approval or consent to such execution and delivery is required, and
that the Lease is binding upon said individual, corporation (or partnership)
as the case may be in accordance with its terms.

38. (a) INDEMNIFICATION OF LESSEE: Lessor shall indemnify and hold Lessee
harmless for the negligent acts amid willful misconduct of Lessor and Lessor's
Agents in not performing Lessor's obligations under the Lease provided Lessee
has given Lessor written notice with adequate time to cure of any obligations
which it believes Lessor has not performed per the terms of the Lease.
Notwithstanding this indemnification, Lessor shall have no liability nor
obligation for consequential damages, including but not limited to, damages
for loss of use or profits.

    (b) INDEMNIFICATION OF LESSOR: Except to the extent caused by the sole
negligence or willful misconduct of Lessor or Lessor's Agents, Lessee shall
defend, indemnify and hold Lessor harmless from and against any amid all
obligations, losses, costs, expenses, claims, demands, attorney's fees ,
investigation costs or liabilities on account 

PAGE 18
<PAGE>
 
of, or arising out of the use, condition or occupancy of the Premises or any
act or omission to act of Lessee or Lessee's Agents or any occurrence in,
upon, about or at the Premises, including, without limitation, any of the
foregoing provisions arising out of the use, generation, manufacture,
installation, release, discharge, storage, or disposal of Hazardous Materials
by Lessee or Lessee's Agents. It is understood that Lessee is and shall be in
control and possession of the Premises and that Lessor shall in no event be
responsible or liable for any injury or damage or injury to any person
whatsoever, happening on, in, about, or in connection with the Premises, or
for any injury or damage to the Premises or any part thereof This Lease is
entered into on the express condition that Lessor shall not be liable for, or
suffer loss by reason of injury to person or property, from whatever cause,
which in any way may be connected with the use, condition or occupancy of the
Premises or personal property located herein. The provisions of this Lease
permitting Lessor to enter and inspect the Premises are for the purpose of
enabling Lessor to become informed as to whether Lessee is complying with the
terms of this Lease and Lessor shall be under no duty to enter, inspect or to
perform any of Lessee's covenants set forth in this Lease. Lessee shall
further indemnify, defend and hold harmless Lessor from and against any and
all claims arising from any breach or default in the performance of any
obligation to Lessee's part to be performed under the terms of this Lease. The
provisions of Section 38 shall survive the Lease Term or earlier termination
of this Lease with respect to any damage, injury or death occurring during the
Lease Term.

39. LESSOR'S LIABILITY: If Lessee should recover a money judgment against
Lessor arising in connection with this Lease, the judgment shall be satisfied
only out of the Lessor's interest in the Building and neither Lessor or any of
its partners shall be liable personally for any deficiency.

40. MISCELLANEOUS PROVISIONS: All rights and remedies hereunder are cumulative
and not alternative to the extent permitted by law and are in addition to all
other rights or remedies in law and in equity.

41. CHOICE OF LAW: This lease shall be construed and enforced in accordance
with the substantive laws of the State of California. The language of all
parts of this lease shall in all cases be construed as a whole according to
its fair meaning and not strictly for or against either Lessor or Lessee.

42. ENTIRE AGREEMENT: This Lease is the entire agreement between the parties,
and there are no agreements or representations between the parties except as
expressed herein. Except as otherwise provided for herein, no subsequent
change or addition to this Lease shall be binding unless in writing and signed
by the parties hereto.

IN WITNESS WHEREOF, Lessor and Lessee have executed these presents, the day and
year first above written.

LESSOR                                    LESSEE
BERG & BERG DEVELOPERS                    PHOTON DYNAMICS, INC.

By:  ________________________________     By:__________________________________
signature of authorized representative    signature of authorized representative


______________________________________    __________________________________
printed name                              printed name


______________________________________    __________________________________
title                                     title

PAGE 19
<PAGE>
 
______________________________________    __________________________________
date                                      date

PAGE 20
<PAGE>
 
                                   Exhibit E
                           Lessee Approval Deadlines



Lease signed                                           08/05/96



Approval of preliminary floor plan, single line        08110196


Final selection of all material and interior finishes 
for construction such as carpet, ceramic tile, paint 
and any other lessee selected materials & finishes     08/15/96


Lessee shall not unreasonably withhold approval of final shell or interior plans
if they conform in general to the preliminary site plan, preliminary elevation,
and floor plans.

The Commencement Date shall be extended one day for each day Lessee does not
meet each deadline set forth on this Exhibit E.

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                             [MAP APPEARS HERE]

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                             [MAP APPEARS HERE]

<PAGE>
 
                            [CHART APPEARS HERE]

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                            [CHART APPEARS HERE]