##### Table of Contents









UNITED STATES SECURITIES AND EXCHANGE COMMISSION


Washington, D.C. 20549





Form 10-K/ A


Amendment No. 3


|   |  |                                                                                                 
|-- |  | ------------------------------------------------------------------------------------------------
|þ  |  | ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
    SECURITIES EXCHANGE ACT OF 1934        
|   |  | For the fiscal year ended September 30, 2004                                                    
|or
|  
|o  |  | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF
    THE
    SECURITIES EXCHANGE ACT OF 1934
|   |  | For the transition period
    from                    to                                        

Commission File Number 0-27234





Photon Dynamics, Inc.


(Exact name of registrant as specified in its charter)


|                                |  |                    
|------------------------------- |  | -------------------
|California                      |  | 94-3007502         
|(State or other jurisdiction of |  | (I.R.S. Employer   
|incorporation or organization)  |  | 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 o






DOCUMENTS INCORPORATED BY REFERENCE












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PHOTON DYNAMICS, INC.


ANNUAL REPORT ON FORM 10-K/ A


FOR THE FISCAL Year Ended SEPTEMBER 30, 2004


Explanatory Note to Form 10-K Amendment No. 3










---










PHOTON DYNAMICS, INC.


ANNUAL REPORT ON FORM 10-K/A, AMENDMENT NO. 3


FOR THE FISCAL YEAR ENDED SEPTEMBER 30, 2004


TABLE OF CONTENTS


|             |  |                                                                                           |    |      |    | 
|------------ |  | ----------------------------------------------------------------------------------------- | -- | ---- | -- | 
|             |  |                                                                                           |    | Page |   
|             |  |                                                                                           |    |      |   
|PART I.     
|Item 1.      |  | Business                                                                                  |    |      | 2  | 
|PART II.    
|Item 6.      |  | Selected Financial Data                                                                   |    |      | 11 | 
|Item 7.      |  | Managements Discussion and Analysis
    of Financial Condition and Results of Operations |    |      | 12 | 
|Item 8.      |  | Financial Statements and Supplementary
    Data                                           |    |      | 41 | 
|             |  | REPORT OF ERNST & YOUNG LLP,
    INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM            |    |      | 42 | 
|             |  | CONSOLIDATED BALANCE SHEETS                                                               |    |      | 43 | 
|             |  | CONSOLIDATED STATEMENTS OF OPERATIONS                                                     |    |      | 44 | 
|             |  | CONSOLIDATED STATEMENTS OF
    SHAREHOLDERS EQUITY                                       |    |      | 45 | 
|             |  | CONSOLIDATED STATEMENTS OF CASH FLOWS                                                     |    |      | 46 | 
|             |  | NOTES TO CONSOLIDATED FINANCIAL
    STATEMENTS                                            |    |      | 48 | 
|Item 9A.     |  | Controls and Procedures                                                                   |    |      | 90 | 
|PART IV.    
|Item 15.     |  | Exhibits and Financial Statement
    Schedules                                            |    |      | 92 | 
|Signatures   |  |                                                                                           | 97 |     
|EXHIBIT 23.1
|EXHIBIT 31.1
|EXHIBIT 31.2
|EXHIBIT 32.1



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##### Table of Contents



SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS


This Annual Report on Form 10-K contains forward-looking
statements within the meaning of Section 27A of the
Securities Act of 1933 and Section 21E of the Securities
Exchange Act of 1934. All statements included or incorporated by
reference in this Annual Report on Form 10-K other than
statements of historical fact, are forward-looking statements.
You can identify these and other forward-looking statements by
the use of words such as may, will,
could, anticipate, expect,
intend, believe, continue or
the negative of such terms, or other comparable terminology.
Forward-looking statements also include the assumptions
underlying or relating to such statements.


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 under the caption
Factors Affecting Operating Results in Part II
Item 7 Managements Discussion and Analysis of
Financial Condition and Results of Operations 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 Securities and Exchange Commission and future events or
circumstances could differ significantly from the
forward-looking statements included herein. Accordingly, we
caution readers not to place undue reliance on such statements
and we expressly assume no obligation to update the
forward-looking statements included in this report after the
date hereof except as required by law.


1



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PART I







|        |         
|------- | --------
|Item 1. | Business

Introduction








www.photondynamics.com


Industry




| |                                       
| | --------------------------------------
| | Flat Panel Display Industry Background





2



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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 Phase. The second phase, cell assembly, is the
    joining of the TFT array plate and the color filter plate with
    liquid crystal material.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
|
| | 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.


3



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| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | 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% of flat panel display costs, in contrast to
    only approximately 10% for semiconductors, according to industry
    sources. Higher material costs expose the flat panel display
    manufacturer to higher costs due to yield loss throughout the
    manufacturing process. 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, repair and inspection
    equipment that can be reconfigured quickly and accurately for
    different panel sizes, with minimal production downtime.                                                                                                                                                  

Products






| |                          
| | -------------------------
| | Yield Management Products



Flat Panel Display Array Test Systems. tm


4



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tm


Flat Panel Display Array Repair Systems. tm


tm


Flat Panel Display Inspection Systems. tm




| |                             
| | ----------------------------
| | Customer Service and Support



Customers






5



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Sales and Service








Research and Development






Manufacturing






6



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Suppliers




Intellectual Property




7



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|                          |       |                  |    |    |          |  |    |    | 
|------------------------- | ----- | ---------------- | -- | -- | -------- |  | -- | -- | 
|                          |       | Patents in Force |   
|                          |       |                  |   
|                          |       | U.S.             |    |    | Non-U.S. | 
|                          |       |                  |    |    |          | 
|Yield Management Products |       |                  | 32 |    |          |  | 23 |   
|Process Products          |       |                  | 8  |    |          |  | 4  |   
|Other                     |       |                  | 2  |    |          |  | 1  |   
|                          |       |                  |    |    |          | 
|                          | Total |                  |    | 42 |          |  |    | 28 | 
|                          |       |                  |    |    |          | 



Backlog




Competition












8



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Employees






Business Combinations














9



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Executive Officers of the Registrant




|                     |  |     |    |  |          |                                                
|-------------------- |  | --- | -- |  | -------- | -----------------------------------------------
|Name                 |  | Age |    |  | Position
|                     |  |     |    |  |         
|Malcolm J. Thompson  |  |     | 59 |  |          | Executive Chairman of the Board of Directors   
|Jeffrey A. Hawthorne |  |     | 47 |  |          | Chief Executive Officer, President and Director
|Richard Okumoto      |  |     | 52 |  |          | Chief Financial Officer and Secretary          
|Steve Song           |  |     | 49 |  |          | Vice President, Worldwide Sales                
|Mark Merrill         |  |     | 41 |  |          | Vice President, Marketing                      

Malcolm J. Thompson


Jeffrey A. Hawthorne


Richard Okumoto


Steve Song


Mark Merrill


10



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PART II







|        |                        
|------- | -----------------------
|Item 6. | Selected Financial Data





|                                                                                                                                                     |         |                          |         |      |                                       |   |         |       |      |   |         |      |     |      |         |       |      |   |        |      | 
|---------------------------------------------------------------------------------------------------------------------------------------------------- | ------- | ------------------------ | ------- | ---- | ------------------------------------- | - | ------- | ----- | ---- | - | ------- | ---- | --- | ---- | ------- | ----- | ---- | - | ------ | ---- | 
|                                                                                                                                                     |         | Year Ended September 30, |        
|                                                                                                                                                     |         |                          |        
|                                                                                                                                                     |         | 2004                     |         |      | 2003                                  |   |         | 2002  |      |   | 2001    |      |     | 2000 |        
|                                                                                                                                                     |         |                          |         |      |                                       |   |         |       |      |   |         |      |     |      |        
|                                                                                                                                                     |         | (Restated)               |         |      | (In thousands, except per share data) |  
|Statements of Operations Data:                                                                                                                       |         |                          |         |      |                                       |   |         |       |      |   |         |      |     |      |         |       |      |   |        |     
|Revenue                                                                                                                                              |         | $                        | 141,870 |      |                                       | $ | 67,196  |       |      | $ | 49,342  |      |     | $    | 38,319  |       |      | $ | 64,221 |     
|Income (loss) from operations                                                                                                                        |         |                          | 6,860   |      |                                       |   | (30,692 | )     |      |   | 3,402   |      |     |      | (7,304  | )     |      |   | 11,994 |     
|Income (loss) from continuing operations before discontinued
    operations and cumulative effect of a change in accounting
    principle            |         |                          | 11,085  | (1)  |                                       |   | (27,780 | )(2)  |      |   | 6,230   | (3)  |     |      | (2,349  | )(4)  |      |   | 12,952 |     
|Income (loss) from discontinued operations                                                                                                           |         |                          | (1,391  | )    |                                       |   | (44,592 | )     |      |   | (28,032 | )    |     |      | (4,218  | )     |      |   | 583    |     
|Income (loss) before cumulative effect of a change in accounting
    principle                                                                       |         |                          | 9,694   |      |                                       |   | (72,372 | )     |      |   | (21,802 | )    |     |      | (6,567  | )     |      |   | 13,535 |     
|Cumulative effect of change in accounting principle                                                                                                  |         |                          |        |      |                                       |   |        |       |      |   |        |      |     |      | (6,560  | )(5)  |      |   |       |     
|Net income (loss)                                                                                                                                    |         | $                        | 9,694   |      |                                       | $ | (72,372 | )     |      | $ | (21,802 | )    |     | $    | (13,127 | )     |      | $ | 13,535 |     
|Income (loss) per share from continuing operations before
    discontinued operations and cumulative effect of a change in
    accounting principle: |         |                          |         |      |                                       |   |         |       |      |   |         |      |     |      |         |       |      |   |        |     
|                                                                                                                                                     | Basic   |                          | $       | 0.67 | (1)                                   |   | $       | (1.73 | )(2) |   | $       | 0.39 | (3) |      | $       | (0.18 | )(4) |   | $      | 1.08 | 
|                                                                                                                                                     | Diluted |                          | $       | 0.65 | (1)                                   |   | $       | (1.73 | )(2) |   | $       | 0.37 | (3) |      | $       | (0.18 | )(4) |   | $      | 0.99 | 

11



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|                                                                                          |         |                          |         |       |                                       |   |         |       |      |   |         |       |      |      |         |       |      |   |         |      | 
|----------------------------------------------------------------------------------------- | ------- | ------------------------ | ------- | ----- | ------------------------------------- | - | ------- | ----- | ---- | - | ------- | ----- | ---- | ---- | ------- | ----- | ---- | - | ------- | ---- | 
|                                                                                          |         | Year Ended September 30, |        
|                                                                                          |         |                          |        
|                                                                                          |         | 2004                     |         |       | 2003                                  |   |         | 2002  |      |   | 2001    |       |      | 2000 |        
|                                                                                          |         |                          |         |       |                                       |   |         |       |      |   |         |       |      |      |        
|                                                                                          |         | (Restated)               |         |       | (In thousands, except per share data) |  
|Income (loss) per share from discontinued operations:                                     |         |                          |         |       |                                       |   |         |       |      |   |         |       |      |      |         |       |      |   |         |     
|                                                                                          | Basic   |                          | $       | (0.08 | )                                     |   | $       | (2.77 | )    |   | $       | (1.76 | )    |      | $       | (0.32 | )    |   | $       | 0.05 | 
|                                                                                          | Diluted |                          | $       | (0.08 | )                                     |   | $       | (2.77 | )    |   | $       | (1.67 | )    |      | $       | (0.32 | )    |   | $       | 0.04 | 
|Income (loss) per share before cumulative effect of a change in
    accounting principle: |         |                          |         |       |                                       |   |         |       |      |   |         |       |      |      |         |       |      |   |         |     
|                                                                                          | Basic   |                          | $       | 0.58  |                                       |   | $       | (4.50 | )    |   | $       | (1.37 | )    |      | $       | (0.50 | )    |   | $       | 1.13 | 
|                                                                                          | Diluted |                          | $       | 0.57  |                                       |   | $       | (4.50 | )    |   | $       | (1.30 | )    |      | $       | (0.50 | )    |   | $       | 1.04 | 
|Cumulative effect per share of a change in accounting principle,
    net of tax benefit:  |         |                          |         |       |                                       |   |         |       |      |   |         |       |      |      |         |       |      |   |         |     
|                                                                                          | Basic   |                          | $       |      |                                       |   | $       |      |      |   | $       |      |      |      | $       | (0.50 | )(5) |   | $       |     | 
|                                                                                          | Diluted |                          | $       |      |                                       |   | $       |      |      |   | $       |      |      |      | $       | (0.50 | )(5) |   | $       |     | 
|Net income (loss) per share:                                                              |         |                          |         |       |                                       |   |         |       |      |   |         |       |      |      |         |       |      |   |         |     
|                                                                                          | Basic   |                          | $       | 0.58  | (1)                                   |   | $       | (4.50 | )(2) |   | $       | (1.37 | )(3) |      | $       | (1.00 | )(4) |   | $       | 1.13 | 
|                                                                                          | Diluted |                          | $       | 0.57  | (2)                                   |   | $       | (4.50 | )(2) |   | $       | (1.30 | )(3) |      | $       | (1.00 | )(4) |   | $       | 1.04 | 
|Balance Sheet Data:                                                                       |         |                          |         |       |                                       |   |         |       |      |   |         |       |      |      |         |       |      |   |         |     
|Cash, cash equivalents and short-term investments                                         |         | $                        | 84,155  |       |                                       | $ | 116,469 |       |      | $ | 170,143 |       |      | $    | 84,091  |       |      | $ | 102,726 |     
|Working capital                                                                           |         |                          | 132,335 |       |                                       |   | 125,624 |       |      |   | 190,188 |       |      |      | 99,457  |       |      |   | 126,042 |     
|Total assets                                                                              |         |                          | 207,900 |       |                                       |   | 161,919 |       |      |   | 249,159 |       |      |      | 158,635 |       |      |   | 155,054 |     
|Shareholders equity                                                                      |         |                          | 159,959 |       |                                       |   | 144,143 |       |      |   | 226,143 |       |      |      | 143,308 |       |      |   | 131,800 |     






|    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             
|--- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(1) | Includes a goodwill impairment charge of $665,000, purchased
    intangible asset write-off of $2.1 million, acquired
    in-process research and development charge of $210,000 in
    connection with the acquisition of certain assets from Quantum
    Composers, Inc., gain on fixed assets of $427,000 related to the
    sale of the TFT-LCD Backlight Inverter Business, and
    amortization of intangibles of $789,000.                                                                                                           
|   
|(2) | Includes a goodwill impairment charge of $10.0 million
    related to the Akcron and RTP Assets, purchased intangible asset
    write-off of $3.5 million related to the Akcron and RTP
    Assets, and an acquired in- process research and development
    charge of $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 amortization of
    intangibles of $1.2 million.
|   
|(3) | Includes an acquired in-process research and development charge
    of $410,000 in connection with the acquisition of Akcron.                                                                                                                                                                                                                                                                                                                                                                                                               
|   
|(4) | Includes acquisition related charges of $1.4 million in
    connection with the acquisition of Image Processing Systems
    Inc., as well as restructuring charges of $976,000.                                                                                                                                                                                                                                                                                                                                                             
|   
|(5) | We recorded a non-cash charge of $6.6 million, net of tax,
    or $0.50 per diluted share, to reflect the cumulative
    effect of an accounting change as of October 1, 2000
    related to the adoption of SEC Staff Accounting
    Bulletin No. 101, Revenue Recognition in
    Financial Statements.                                                                                                                                                                                                                                  




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 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 Securities Exchange Act of 1934. Actual
results could differ materially from


12



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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 this discussion, especially under the
caption Factors Affecting Operating Results, and
elsewhere in this Annual Report on Form 10-K. Generally,
the use of words such as may, will,
could, anticipate, expect,
intend, believe, continue or
the negative of such terms, or other comparable terminology and
similar expressions identify forward-looking statements. The
information included in this Form 10-K is as of the filing
date with the Securities and Exchange Commission and future
events or circumstances could differ significantly from the
forward-looking statements included herein. Accordingly, we
caution readers not to place undue reliance on such
statements.


Recent Developments




| |           
| | ----------
| | Background







| |                         
| | ------------------------
| | Results of Investigation





| |                                                                                                                                                                                                                                                                                                                                                                        
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | 1) Incomplete documentation of sales arrangements: Certain
    elements of certain sales arrangements with customers were not
    reflected in Photon Dynamics customary sales documents
    and, as a result, Photon Dynamics overstated revenue for the
    value of the undelivered elements within those arrangements.                                            
|
| | 2) Unidentified elements in sales arrangements: Certain
    elements of certain sales arrangements with customers contained
    in Photon Dynamics customary sales documents were either
    not identified or not properly analyzed and, as a result, Photon
    Dynamics overstated revenue for the value of the undelivered
    elements within those arrangements.
|
| | 3) Inappropriate amounts deferred: Certain undelivered
    elements within certain sales arrangements were not deferred at
    the appropriate amount and, as a result, Photon Dynamics did not
    recognize the appropriate amount of revenue for the undelivered
    elements.                                                                                      

13



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Overview




| |            
| | -----------
| | Our Company











| |   |                                                                                                                                                                                                      
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | The level of capital expenditures of flat panel display
    manufacturers, which in turn depends on the current and
    anticipated market demand for products utilizing flat panel
    displays, and
|
| |  | The relative competitiveness of our products and services.                                                                                                                                           



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| |                                     
| | ------------------------------------
| | Focus on Flat Panel Display Industry









| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | Gross margin improvement: We have instituted supply chain
    management programs with all key suppliers to focus on volume
    purchase agreements. We have developed cost reduction programs
    focused at vertical integration of some purchased assemblies,
    building some subassemblies both with lower cost outside
    providers and lower cost in-house manufacturing. We have also
    established product quality programs focused at improving
    product reliability and reducing product warranty costs.
|
| |  | Production capacity expansion: We have moved into a new
    facility to increase our manufacturing capacity in response to
    increasing demand for our products. Our new facility provides a
    larger area to manufacture our larger Generation 6 and 7
    products and we have been hiring additional staff to support
    increased production.                                                                                                                                                                    
|
| |  | Asia localization: We continue to build up our Asia local
    management and customer support resources in order to meet our
    customers expectations of local product support and local
    engineering support.                                                                                                                                                                                                                                                                                                      
|
| |  | Quality improvement: We are continuing to implement
    processes to drive product quality improvement and ease of use
    for our customers.                                                                                                                                                                                                                                                                                                                                                                             
|
| |  | Vertical Integration: We have consolidated some of our
    core technology through vertical acquisition of key suppliers to
    reduce product costs, and continue to explore opportunities to
    further reduce product costs in this manner.                                                                                                                                                                                                                                                                           





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| |                              
| | -----------------------------
| | Acquisitions and Dispositions

Acquisition of TORC Assets.


Acquisition of Quantum Composers Assets.


Acquisition of Summit Imaging Assets.


Acquisition of RTP Assets.


Acquisition of Akcron.


Acquisition of ISIS Assets.








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Industry
















| |        
| | -------
| | Backlog



Critical Accounting Policies and Estimates




17



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| |                    
| | -------------------
| | Revenue Recognition











| |                                
| | -------------------------------
| | Allowance for Doubtful Accounts





18



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| |            
| | -----------
| | Inventories







| |         
| | --------
| | Warranty







| |                               
| | ------------------------------
| | Goodwill and Intangible Assets





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| |                             
| | ----------------------------
| | Contingencies and Litigation



Results of Operations




| |                                                         
| | --------------------------------------------------------
| | Fiscal Years Ended September 30, 2004, 2003 and
    2002



|                    |                                     |                          |       |      |      |  |       |      |  |  |       |      | 
|------------------- | ----------------------------------- | ------------------------ | ----- | ---- | ---- |  | ----- | ---- |  |  | ----- | ---- | 
|                    |                                     | Year Ended September 30, |      
|                    |                                     |                          |      
|                    |                                     | 2004                     |       |      | 2003 |  |       | 2002 | 
|                    |                                     |                          |       |      |      |  |       |      | 
|                    |                                     | (Restated)               |       |      |      |  |      
|Revenue             |                                     |                          | 100.0 | %    |      |  | 100.0 | %    |  |  | 100.0 | %   
|Cost of revenue     |                                     |                          | 59.2  |      |      |  | 65.6  |      |  |  | 52.3  |     
|                    |                                     |                          |       |      |      |  |       |      | 
|Gross margin        |                                     |                          | 40.8  |      |      |  | 34.4  |      |  |  | 47.7  |     
|Operating expenses: |                                     |                          |       |      |      |  |       |      |  |  |       |     
|                    | Research and development            |                          |       | 20.9 |      |  |       | 33.9 |  |  |       | 22.0 | 
|                    | Selling, general and administrative |                          |       | 12.5 |      |  |       | 20.5 |  |  |       | 17.9 | 
|                    | Goodwill impairment charge          |                          |       | 0.5  |      |  |       | 14.9 |  |  |       |     | 
|                    | Impairment of purchased intangibles |                          |       | 1.5  |      |  |       | 5.3  |  |  |       |     | 
|                    | Impairment of fixed assets          |                          |       | 0.2  |      |  |       |     |  |  |       |     | 
|                    | Gain on sale of fixed assets        |                          |       | (0.3 | )    |  |       |     |  |  |       |     | 

20



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|                                                                                             |                                              |                          |      |     |      |  |        |      |      |  |       |     |      | 
|-------------------------------------------------------------------------------------------- | -------------------------------------------- | ------------------------ | ---- | --- | ---- |  | ------ | ---- | ---- |  | ----- | --- | ---- | 
|                                                                                             |                                              | Year Ended September 30, |     
|                                                                                             |                                              |                          |     
|                                                                                             |                                              | 2004                     |      |     | 2003 |  |        | 2002 |     
|                                                                                             |                                              |                          |      |     |      |  |        |      |     
|                                                                                             |                                              | (Restated)               |      |     |      |  |       
|                                                                                             | Acquired in-process research and development |                          |      | 0.1 |      |  |        | 3.7  |      |  |       | 0.8 |     
|                                                                                             | Amortization of intangible assets            |                          |      | 0.6 |      |  |        | 1.8  |      |  |       |    |     
|                                                                                             |                                              |                          |      |     |      |  |        |      |     
|                                                                                             |                                              | Total operating expenses |      |     | 36.0 |  |        |      | 80.1 |  |       |     | 40.8 | 
|                                                                                             |                                              |                          |      |     |      |  |        |      |     
|Income (loss) from operations                                                                |                                              |                          | 4.8  |     |      |  | (45.7  | )    |      |  | 6.9   |    
|Interest income and other, net                                                               |                                              |                          | 3.4  |     |      |  | 4.4    |      |      |  | 5.9   |    
|                                                                                             |                                              |                          |      |     |      |  |        |      |     
|Income (loss) from continuing operations before income taxes and
    discontinued operations |                                              |                          | 8.2  |     |      |  | (41.3  | )    |      |  | 12.8  |    
|Provision for income taxes                                                                   |                                              |                          | 0.4  |     |      |  | 0.1    |      |      |  | 0.2   |    
|                                                                                             |                                              |                          |      |     |      |  |        |      |     
|Income (loss) from continuing operations before discontinued
    operations                  |                                              |                          | 7.8  |     |      |  | (41.4  | )    |      |  | 12.6  |    
|Loss from discontinued operations                                                            |                                              |                          | (1.0 | )   |      |  | (66.4  | )    |      |  | (56.8 | )  
|                                                                                             |                                              |                          |      |     |      |  |        |      |     
|Net income (loss)                                                                            |                                              |                          | 6.8  | %   |      |  | (107.7 | )%   |      |  | (44.2 | )% 
|                                                                                             |                                              |                          |      |     |      |  |        |      |     

Revenue


|        |  |                   |         |                        |                   |  |     |      |  |   |        |  |  |        |        |  |      |  |    |   |  |   |        | 
|------- |  | ----------------- | ------- | ---------------------- | ----------------- |  | --- | ---- |  | - | ------ |  |  | ------ | ------ |  | ---- |  | -- | - |  | - | ------ | 
|        |  | Fiscal Year Ended |         |                        | Fiscal Year Ended | 
|        |  | September 30,     |         |                        | September 30,     | 
|        |  |                   |         |                        |                   | 
|        |  | 2004              |         |                        | Change            |  |     | 2003 |  |   | 2003   |  |  | Change |        |  | 2002 | 
|        |  |                   |         |                        |                   |  |     |      |  |   |        |  |  |        |        |  |      | 
|        |  | (Restated)        |         |                        |                  
|        |  |                   |         | (Dollars in thousands) |                  
|Revenue |  | $                 | 141,870 |                        |                   |  | 111 | %    |  | $ | 67,196 |  |  | $      | 67,196 |  |      |  | 36 | % |  | $ | 49,342 | 



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| |             
| | ------------
| | Gross Margin

|             |  |                   |    |   |                   |  |    |      |  |  |      |   |  |        |    |   |      |  |     |    |  |  |    |  
|------------ |  | ----------------- | -- | - | ----------------- |  | -- | ---- |  |  | ---- | - |  | ------ | -- | - | ---- |  | --- | -- |  |  | -- | -
|             |  | Fiscal Year Ended |    |   | Fiscal Year Ended | 
|             |  | September 30,     |    |   | September 30,     | 
|             |  |                   |    |   |                   | 
|             |  | 2004              |    |   | Change            |  |    | 2003 |  |  | 2003 |   |  | Change |    |   | 2002 | 
|             |  |                   |    |   |                   |  |    |      |  |  |      |   |  |        |    |   |      | 
|             |  | (Restated)        |    |   |                   |  |    |      |  |  |      |   | 
|Gross Margin |  |                   | 41 | % |                   |  | 19 | %    |  |  | 34   | % |  |        | 34 | % |      |  | (28 | )% |  |  | 48 | %





| |   |                                                                                                                                                                                                                        
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | The full manufacturing integration of the
    ArrayCheckertm
    high-speed cameras, acquired as part of our acquisition of
    assets from Summit Imaging in May 2003;                                                
|
| |  | A higher percentage of revenue recognized after installation and
    final customer acceptance, which typically has a higher margin
    than revenue billed on the associated items that were previously
    delivered;
|
| |  | Improved manufacturing efficiencies resulting from a more stable
    design of our Generation 5 products, which were introduced in
    fiscal 2003;                                                                    
|
| |  | Elimination of our use of a third-party contract
    manufacturer; and                                                                                                                                                 
|
| |  | Manufacturing cost reduction due to sourcing of some raw
    materials and subassemblies in Asia.                                                                                                                      





| |   |                                                                                                                                                                            
| | - | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | Longer cycle times and inefficiencies brought about by the
    addition and training of a second manufacturing shift during our
    second quarter;                        
|
| |  | Higher initial costs related to the first production build of
    our dual-camera
    ArrayCheckertm
    and our Generation 6
    ArraySavertm
    systems                 
|
| |  | The temporary loss of capacity early in our second quarter
    caused by the move to our new facility; and                                                                 
|
| |  | Higher warranty costs, rework costs and expedite fees incurred
    as a result of the execution issues surrounding the production
    ramp up in our Generation 6 products.





| |   |                                                                                                                                                                                                                                                                                      
| | - | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | Our revenue mix between higher margin
    ArrayCheckertm
    systems and lower margin
    ArraySavertm
    systems;                                                                                                                                                                  
|
| |  | The costs of increasing customer service staff to support the
    increased demands of our customers;                                                                                                                                                                                
|
| |  | The challenges associated with our steep manufacturing ramp up,
    including gaining efficiencies or reducing manufacturing cycle
    times from a new manufacturing staff and costs associated with
    accelerating material procurement to support the ramp up in
    production;
|
| |  | The inefficiencies of building new products;                                                                                                                                                                                                                                         
|
| |  | Costs associated with the integration of Quantum Composers and
    Tucson Optical Research Corporation; and                                                                                                                                                                          
|
| |  | Competitive pricing pressures, particularly in the array repair
    market.                                                                                                                                                                                                          

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| |                         
| | ------------------------
| | Research and Development

|                   |  |                        |        |   |                   |  |    |      |  |   |        |   |  |        |        |   |      |  |     |   |  |   |        |  
|------------------ |  | ---------------------- | ------ | - | ----------------- |  | -- | ---- |  | - | ------ | - |  | ------ | ------ | - | ---- |  | --- | - |  | - | ------ | -
|                   |  | Fiscal Year Ended      |        |   | Fiscal Year Ended | 
|                   |  | September 30,          |        |   | September 30,     | 
|                   |  |                        |        |   |                   | 
|                   |  | 2004                   |        |   | Change            |  |    | 2003 |  |   | 2003   |   |  | Change |        |   | 2002 | 
|                   |  |                        |        |   |                   |  |    |      |  |   |        |   |  |        |        |   |      | 
|                   |  | (Dollars in thousands) |       
|Expense            |  | $                      | 29,701 |   |                   |  | 30 | %    |  | $ | 22,786 |   |  | $      | 22,786 |   |      |  | 109 | % |  | $ | 10,878 |  
|Percent of Revenue |  |                        | 21     | % |                   |  |    |      |  |   | 34     | % |  |        | 34     | % |      |  |     |   |  |   | 22     | %

tm tm






| |   |                                                                                                                   
| | - | ------------------------------------------------------------------------------------------------------------------
| |  | Ramp up our cell/module program to address mass production
    requirements;                                      
|
| |  | Increase our efforts on Generation 7 products and launch
    development programs for Generation 7.5 products; and
|
| |  | Expand our repair product offering.                                                                               





| |                                    
| | -----------------------------------
| | Selling, General and Administrative

|                   |  |                   |        |   |                   |                        |    |      |  |   |        |   |  |        |        |   |      |  |    |   |  |   |       |  
|------------------ |  | ----------------- | ------ | - | ----------------- | ---------------------- | -- | ---- |  | - | ------ | - |  | ------ | ------ | - | ---- |  | -- | - |  | - | ----- | -
|                   |  | Fiscal Year Ended |        |   | Fiscal Year Ended |                       
|                   |  | September 30,     |        |   | September 30,     |                       
|                   |  |                   |        |   |                   |                       
|                   |  | 2004              |        |   | Change            |                        |    | 2003 |  |   | 2003   |   |  | Change |        |   | 2002 | 
|                   |  |                   |        |   |                   |                        |    |      |  |   |        |   |  |        |        |   |      | 
|                   |  |                   |        |   |                   | (Dollars in thousands) |    |      |  |   |       
|Expense            |  | $                 | 17,780 |   |                   |                        | 29 | %    |  | $ | 13,763 |   |  | $      | 13,763 |   |      |  | 55 | % |  | $ | 8,853 |  
|Percent of Revenue |  |                   | 13     | % |                   |                        |    |      |  |   | 21     | % |  |        | 21     | % |      |  |    |   |  |   | 18    | %





| |                                                                   
| | ------------------------------------------------------------------
| | Impairment of Goodwill, Purchased Intangibles and Fixed
    Assets



24



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| |                             
| | ----------------------------
| | Gain on Sale of Fixed Assets





| |                                             
| | --------------------------------------------
| | Acquired In-Process Research and Development

|                   |  |                        |     |   |                   |  |     |      |  |   |       |   |  |        |       |   |      |  |     |   |  |   |     |  
|------------------ |  | ---------------------- | --- | - | ----------------- |  | --- | ---- |  | - | ----- | - |  | ------ | ----- | - | ---- |  | --- | - |  | - | --- | -
|                   |  | Fiscal Year Ended      |     |   | Fiscal Year Ended | 
|                   |  | September 30,          |     |   | September 30,     | 
|                   |  |                        |     |   |                   | 
|                   |  | 2004                   |     |   | Change            |  |     | 2003 |  |   | 2003  |   |  | Change |       |   | 2002 | 
|                   |  |                        |     |   |                   |  |     |      |  |   |       |   |  |        |       |   |      | 
|                   |  | (Dollars in thousands) |    
|Expense            |  | $                      | 210 |   |                   |  | (92 | )%   |  | $ | 2,474 |   |  | $      | 2,474 |   |      |  | 503 | % |  | $ | 410 |  
|Percent of Revenue |  |                        | 0.1 | % |                   |  |     |      |  |   | 4     | % |  |        | 4     | % |      |  |     |   |  |   | 1   | %







25



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tm






| |                                  
| | ---------------------------------
| | Amortization of Intangible Assets

|                   |  |                        |     |   |                   |  |     |      |  |   |       |   |  |        |       |   |      |  |   |  |  |   |   | 
|------------------ |  | ---------------------- | --- | - | ----------------- |  | --- | ---- |  | - | ----- | - |  | ------ | ----- | - | ---- |  | - |  |  | - | - | 
|                   |  | Fiscal Year Ended      |     |   | Fiscal Year Ended
|                   |  | September 30,          |     |   | September 30,    
|                   |  |                        |     |   |                  
|                   |  | 2004                   |     |   | Change            |  |     | 2003 |  |   | 2003  |   |  | Change |       |   | 2002
|                   |  |                        |     |   |                   |  |     |      |  |   |       |   |  |        |       |   |     
|                   |  | (Dollars in thousands)
|Expense            |  | $                      | 789 |   |                   |  | (36 | )%   |  | $ | 1,236 |   |  | $      | 1,236 |   |      |  |  |  |  | $ |  | 
|Percent of Revenue |  |                        | 0.6 | % |                   |  |     |      |  |   | 1.8   | % |  |        | 1.8   | % |      |  |   |  |  |   |  | 





| |                               
| | ------------------------------
| | Interest Income and Other, Net

|                   |  |                        |       |   |                   |  |    |      |  |   |       |   |  |        |       |   |      |  |   |   |  |   |       |  
|------------------ |  | ---------------------- | ----- | - | ----------------- |  | -- | ---- |  | - | ----- | - |  | ------ | ----- | - | ---- |  | - | - |  | - | ----- | -
|                   |  | Fiscal Year Ended      |       |   | Fiscal Year Ended | 
|                   |  | September 30,          |       |   | September 30,     | 
|                   |  |                        |       |   |                   | 
|                   |  | 2004                   |       |   | Change            |  |    | 2003 |  |   | 2003  |   |  | Change |       |   | 2002 | 
|                   |  |                        |       |   |                   |  |    |      |  |   |       |   |  |        |       |   |      | 
|                   |  | (Dollars in thousands) |      
|Income             |  | $                      | 4,802 |   |                   |  | 62 | %    |  | $ | 2,968 |   |  | $      | 2,968 |   |      |  | 2 | % |  | $ | 2,913 |  
|Percent of Revenue |  |                        | 3.4   | % |                   |  |    |      |  |   | 4.4   | % |  |        | 4.4   | % |      |  |   |   |  |   | 5.9   | %



26



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##### Table of Contents





| |                           
| | --------------------------
| | Provision for Income Taxes









Discontinued Operations






| |                                                   
| | --------------------------------------------------
| | Printed Circuit Board Assembly Inspection Business

|         |  |                   |        |   |      |   |         |      |  |   |         |  
|-------- |  | ----------------- | ------ | - | ---- | - | ------- | ---- |  | - | ------- | -
|         |  | Fiscal Year Ended |       
|         |  | September 30,     |       
|         |  |                   |       
|         |  | 2004              |        |   | 2003 |   |         | 2002 | 
|         |  |                   |        |   |      |   |         |      | 
|         |  | (In thousands)    |       
|Net Loss |  | $                 | (1,562 | ) |      | $ | (38,586 | )    |  | $ | (24,585 | )







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| |                                                                        
| | -----------------------------------------------------------------------
| | Cathode Ray Tube Display and High Quality
    Glass Inspection Business

|                  |  |                   |     |  |      |   |        |      |  |   |        |  
|----------------- |  | ----------------- | --- |  | ---- | - | ------ | ---- |  | - | ------ | -
|                  |  | Fiscal Year Ended |    
|                  |  | September 30,     |    
|                  |  |                   |    
|                  |  | 2004              |     |  | 2003 |   |        | 2002 | 
|                  |  |                   |     |  |      |   |        |      | 
|                  |  | (In thousands)    |    
|Net Income (Loss) |  | $                 | 171 |  |      | $ | (6,006 | )    |  | $ | (3,447 | )







Liquidity and Capital Resources




Operating Activities of Continuing Operations.




28



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##### Table of Contents







Investing Activities of Continuing Operations.


Financing Activities of Continuing Operations.








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| |                        
| | -----------------------
| | Contractual Obligations



Contractual Obligations


|                            |       |                             |        |        |      |   |        |        |  |   |       |       |  |      |       |       |      |   |       |            |  |   |       |       |  |   |       |       | 
|--------------------------- | ----- | --------------------------- | ------ | ------ | ---- | - | ------ | ------ |  | - | ----- | ----- |  | ---- | ----- | ----- | ---- | - | ----- | ---------- |  | - | ----- | ----- |  | - | ----- | ----- | 
|                            |       | Payments Due by Fiscal Year |       
|                            |       |                             |       
|                            |       | Total                       |        |        | 2005 |   |        | 2006   |  |   | 2007  |       |  | 2008 |       |       | 2009 |   |       | Thereafter | 
|                            |       |                             |        |        |      |   |        |        |  |   |       |       |  |      |       |       |      |   |       |            | 
|                            |       | (In thousands)              |       
|Notes payable               |       | $                           | 2,829  |        |      | $ | 1,446  |        |  | $ | 1,383 |       |  | $    |      |       |      | $ |      |            |  | $ |      |       |  | $ |      |      
|Operating lease obligations |       |                             | 18,930 |        |      |   | 3,713  |        |  |   | 3,533 |       |  |      | 3,007 |       |      |   | 2,652 |            |  |   | 2,627 |       |  |   | 3,398 |      
|Purchase obligations        |       |                             | 27,326 |        |      |   | 24,582 |        |  |   | 1,294 |       |  |      | 726   |       |      |   | 715   |            |  |   | 9     |       |  |   |      |      
|                            |       |                             |        |        |      |   |        |        |  |   |       |       |  |      |       |       |      |   |       |            | 
|                            | Total |                             | $      | 49,085 |      |   | $      | 29,741 |  |   | $     | 6,210 |  |      | $     | 3,733 |      |   | $     | 3,367      |  |   | $     | 2,636 |  |   | $     | 3,398 | 
|                            |       |                             |        |        |      |   |        |        |  |   |       |       |  |      |       |       |      |   |       |            | 





Working Capital






| |                               
| | ------------------------------
| | Off-Balance Sheet Arrangements



Operating, Investing and Financing Activities of Discontinued
Operations.


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|                                                                            |                                                                            |                                                                         |   |        |        |   |   |         |         |   |   |         |        |  
|--------------------------------------------------------------------------- | -------------------------------------------------------------------------- | ----------------------------------------------------------------------- | - | ------ | ------ | - | - | ------- | ------- | - | - | ------- | ------ | -
|                                                                            |                                                                            | Fiscal Year Ended                                                       |  
|                                                                            |                                                                            |                                                                         |  
|                                                                            |                                                                            | 2004                                                                    |   |        | 2003   |   |   | 2002    |        
|                                                                            |                                                                            |                                                                         |   |        |        |   |   |         |        
|                                                                            |                                                                            | (In thousands)                                                          |  
|Cash flows from operating activities:                                       |                                                                            |                                                                         |   |        |        |   |   |         |         |   |   |        
|                                                                            |                                                                            | Printed circuit board business                                          |   | $      | (1,387 | ) |   | $       | (10,777 | ) |   | $       | (2,709 | )
|                                                                            |                                                                            | Cathode ray tube display and high quality glass inspection
    business |   |        | (47    | ) |   |         | (1,858  | ) |   |         | (8,994 | )
|                                                                            |                                                                            |                                                                         |   |        |        |   |   |         |        
|                                                                            | Net cash used in operating activities from discontinued
    operations     |                                                                         |   | (1,434 | )      |   |   | (12,635 | )       |   |   | (11,703 | )     
|                                                                            |                                                                            |                                                                         |   |        |        |   |   |         |        
|Cash flows from investing activities:                                       |                                                                            |                                                                         |   |        |        |   |   |         |         |   |   |        
|                                                                            |                                                                            | Printed circuit board business                                          |   |        |       |   |   |         | (92     | ) |   |         | (4,133 | )
|                                                                            |                                                                            | Cathode ray tube display and high quality glass inspection
    business |   |        |       |   |   |         |        |   |   |         | 131    |  
|                                                                            |                                                                            |                                                                         |   |        |        |   |   |         |        
|                                                                            | Net cash used in investing activities from discontinued
    operations     |                                                                         |   |       |        |   |   | (92     | )       |   |   | (4,002  | )     
|                                                                            |                                                                            |                                                                         |   |        |        |   |   |         |        
|Cash flows from financing activities:                                       |                                                                            |                                                                         |   |        |        |   |   |         |         |   |   |        
|                                                                            |                                                                            | Printed circuit board business                                          |   |        |       |   |   |         |        |   |   |         |       |  
|                                                                            |                                                                            | Cathode ray tube display and high quality glass inspection
    business |   |        |       |   |   |         |        |   |   |         |       |  
|                                                                            |                                                                            |                                                                         |   |        |        |   |   |         |        
|                                                                            | Net cash provided by financing activities from discontinued
    operations |                                                                         |   |       |        |   |   |        |         |   |   |        |       
|                                                                            |                                                                            |                                                                         |   |        |        |   |   |         |        
|Net decrease in cash and cash equivalents from discontinued
    operations: |                                                                            |                                                                         |   |        |        |   |   |         |         |   |   |        
|                                                                            |                                                                            | Printed circuit board business                                          |   |        | (1,387 | ) |   |         | (10,869 | ) |   |         | (6,842 | )
|                                                                            |                                                                            | Cathode ray tube display and high quality glass inspection
    business |   |        | (47    | ) |   |         | (1,858  | ) |   |         | (8,863 | )
|                                                                            |                                                                            |                                                                         |   |        |        |   |   |         |        
|                                                                            | Net decrease in cash and cash equivalents from discontinued
    operations |                                                                         | $ | (1,434 | )      |   | $ | (12,727 | )       |   | $ | (15,705 | )     
|                                                                            |                                                                            |                                                                         |   |        |        |   |   |         |        



Impact of Accounting Pronouncements






31



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Factors Affecting Operating Results




| |                                                                      
| | ---------------------------------------------------------------------
| | We have sustained losses and we may sustain losses in the
    future.





| |                                                                                                                                             
| | --------------------------------------------------------------------------------------------------------------------------------------------
| | Our operating results are difficult to predict and may
    vary from investors expectations, which could cause our
    stock price to fall.

tm






| |   |                                                                                                                                                               
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | the timing of the receipt of orders from major customers;                                                                                                     
|
| |  | our product mix;                                                                                                                                              
|
| |  | competitive pricing pressures;                                                                                                                                
|
| |  | our ability to obtain components from our single or limited
    source suppliers in a timely manner;                                                          
|
| |  | global economic uncertainty;                                                                                                                                  
|
| |  | changing international economic conditions;                                                                                                                   
|
| |  | worldwide political instability;                                                                                                                              
|
| |  | our 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.                                                                                                          



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| |                                                                                                                    
| | -------------------------------------------------------------------------------------------------------------------
| | If our products experience performance, reliability or
    quality problems, our customers may reduce their orders.

tm tm tm




| |   |                                          
| | - | -----------------------------------------
| |  | delays in collecting accounts receivable;
|
| |  | reduced orders;                          
|
| |  | additional service expenses; and         
|
| |  | higher manufacturing costs.              







| |                                                                                                                                 
| | --------------------------------------------------------------------------------------------------------------------------------
| | Capital investment by manufacturers of flat panel display
    products can be highly cyclical and may decline in the
    future.





33



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| |                                                                                                                                                                            
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | We depend on sales to a few large customers in the flat
    panel display industry, and if we lose any of our large
    customers our revenue could decrease significantly.





| |                                                                                                                                                                       
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | We rely upon sales of a limited range of products, and if
    demand for one product decreases for any reason it could cause
    our revenue to decline significantly.





| |                                                                                                                                                                                               
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | 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.



tm tm tm






| |                                                                                                                                                                                                                                           
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | If we are not able to obtain critical components from our
    single or limited source suppliers, we may experience
    significant delays in producing our products, which could
    decrease our revenue for an extended period of time.



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| |                                                                                                                                                                             
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | All of our revenue is derived from sales to companies
    located outside the United States, which exposes us to risks
    that we would not experience with domestic sales.





| |   |                                                                                         
| | - | ----------------------------------------------------------------------------------------
| |  | political instability and the possibility of hostilities,
    terrorist attacks, or war;
|
| |  | imposition of governmental controls;                                                    
|
| |  | fluctuations in interest and currency exchange rates;                                   
|
| |  | export license requirements;                                                            
|
| |  | restrictions on the export of technology;                                               
|
| |  | limited foreign protection of intellectual property rights;                             
|
| |  | trade restrictions;                                                                     
|
| |  | periodic or local international downturns;                                              
|
| |  | changes in tariffs; and                                                                 
|
| |  | difficulties in staffing and managing international operations.                         





| |                                                                                                                                                                                                                                                                                                            
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | Compliance with new reporting requirements may strain our
    resources and we may be unable to implement in a timely manner
    additional finance and accounting systems, procedures and
    controls in the future to satisfy new reporting requirements,
    which could cause our stock price to fall.





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| |                                                                                                                                                                                                    
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | We may have difficulty integrating the businesses or
    assets we have acquired and may acquire in the future, and we
    may not realize the benefits that we expect from these
    acquisitions.





| |   |                                                                                                  
| | - | -------------------------------------------------------------------------------------------------
| |  | difficulty in the assimilation of the technologies and products
    of the acquired company;     
|
| |  | entering markets in which we have no or limited direct prior
    experience;                     
|
| |  | loss of key customers of the acquired company;                                                   
|
| |  | diversion of management resources from the business of the
    combined company;                 
|
| |  | incompatibility of business cultures or practices;                                               
|
| |  | loss of key employees of the acquired company;                                                   
|
| |  | costs and delays in implementing common systems and procedures;                                  
|
| |  | potential inefficiencies in delivering services to the customers
    of the combined company; and
|
| |  | assumption of unknown or undisclosed liabilities.                                                







| |                                                                                                                                                                                                                                        
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | Any failure of, or other problems at or with our third
    party manufacturers could delay shipments of our flat panel
    display products, harm our relationships with our customers or
    otherwise negatively impact our business.



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| |                                                                                       
| | --------------------------------------------------------------------------------------
| | If we do not compete effectively in our target markets, we
    will lose market share.





| |                                                                                                                                          
| | -----------------------------------------------------------------------------------------------------------------------------------------
| | Our success depends in large part on the strength of the
    active matrix liquid crystal display in the flat panel display
    industry.





| |                                                                                           
| | ------------------------------------------------------------------------------------------
| | 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.



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| |                                                                                                                                                         
| | --------------------------------------------------------------------------------------------------------------------------------------------------------
| | We must attract and retain key employees and our
    management team and employees must work effectively together to
    maintain and grow our business.





| |                                                                                            
| | -------------------------------------------------------------------------------------------
| | Terrorism and international political instability may
    negatively affect our operations.







| |                                                                                                                                                                                          
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | The outbreak of severe acute respiratory syndrome, or
    other infectious diseases, may impact our operations or
    adversely affect our customers and therefore harm our
    business.





| |                                                                                      
| | -------------------------------------------------------------------------------------
| | Our manufacturing facilities may be subject to disruption
    from natural disasters.



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| |                                             
| | --------------------------------------------
| | Our stock price may fluctuate significantly.





| |   |                                                                                            
| | - | -------------------------------------------------------------------------------------------
| |  | announcements of technological innovations or new products by us
    or by our competitors;
|
| |  | government regulations;                                                                    
|
| |  | developments in patent or other property rights; and                                       
|
| |  | developments in our relationships with our customers.                                      





| |                                                                            
| | ---------------------------------------------------------------------------
| | Some anti-takeover provisions may affect the price of our
    common stock.





| |                                            
| | -------------------------------------------
| | We do not anticipate paying cash dividends.





| |                                                                      
| | ---------------------------------------------------------------------
| | Future changes in accounting and taxation standards or
    practices.





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| |                                                                                                                                               
| | ----------------------------------------------------------------------------------------------------------------------------------------------
| | Recent and proposed regulations related to equity
    compensation could adversely affect our ability to attract and
    retain key personnel.



Effective Transactions with Related and Certain Other
Parties






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|        |                                            
|------- | -------------------------------------------
|Item 8. | Financial Statements and Supplementary Data

Index to Consolidated Financial Statements


|                                                                               |  |      |    | 
|------------------------------------------------------------------------------ |  | ---- | -- | 
|Description                                                                    |  | Page |   
|                                                                               |  |      |   
|Report of Ernst & Young LLP,
    Independent Registered Public Accounting Firm |  |      | 42 | 
|Consolidated Balance Sheets                                                    |  |      | 43 | 
|Consolidated Statements of Operations                                          |  |      | 44 | 
|Consolidated Statements of
    Shareholders Equity                            |  |      | 45 | 
|Consolidated Statements of Cash Flows                                          |  |      | 46 | 
|Notes to Consolidated Financial
    Statements                                 |  |      | 48 | 

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REPORT OF ERNST & YOUNG LLP,





INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
















| |                          
| | -------------------------
| | /s/     ERNST & YOUNG LLP













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PHOTON DYNAMICS, INC.





CONSOLIDATED BALANCE SHEETS


|                                     |                                                                                                                                                                            |                                            |        |          |         |  |        |          |         | 
|------------------------------------ | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------- | ------------------------------------------ | ------ | -------- | ------- |  | ------ | -------- | ------- | 
|                                     |                                                                                                                                                                            | September 30,                              |       
|                                     |                                                                                                                                                                            |                                            |       
|                                     |                                                                                                                                                                            | 2004                                       |        |          | 2003    | 
|                                     |                                                                                                                                                                            |                                            |        |          |         | 
|                                     |                                                                                                                                                                            | (Restated)                                 |        |          |        
|                                     |                                                                                                                                                                            | (In thousands except                       |       
|                                     |                                                                                                                                                                            | share data)                                |       
|ASSETS                              
|Current assets:                      |                                                                                                                                                                            |                                            |        |          |         |  |        |         
|                                     | Cash and cash equivalents                                                                                                                                                  |                                            | $      | 25,483   |         |  | $      | 18,305   |        
|                                     | Short-term investments                                                                                                                                                     |                                            |        | 58,672   |         |  |        | 98,164   |        
|                                     | Accounts receivable, net                                                                                                                                                   |                                            |        | 58,341   |         |  |        | 10,402   |        
|                                     | Inventories                                                                                                                                                                |                                            |        | 31,716   |         |  |        | 9,887    |        
|                                     | Other current assets                                                                                                                                                       |                                            |        | 4,536    |         |  |        | 6,449    |        
|                                     |                                                                                                                                                                            |                                            |        |          |         | 
|                                     |                                                                                                                                                                            | Total current assets                       |        |          | 178,748 |  |        |          | 143,207 | 
|Land, property and equipment, net    |                                                                                                                                                                            |                                            | 20,337 |          |         |  | 12,298 |         
|Other assets                         |                                                                                                                                                                            |                                            | 3,909  |          |         |  | 3,002  |         
|Intangible assets, net               |                                                                                                                                                                            |                                            | 4,753  |          |         |  | 2,894  |         
|Goodwill                             |                                                                                                                                                                            |                                            | 153    |          |         |  | 518    |         
|                                     |                                                                                                                                                                            |                                            |        |          |         | 
|                                     |                                                                                                                                                                            | Total assets                               |        | $        | 207,900 |  |        | $        | 161,919 | 
|                                     |                                                                                                                                                                            |                                            |        |          |         | 
|                                    
|LIABILITIES AND SHAREHOLDERS EQUITY
|Current liabilities:                 |                                                                                                                                                                            |                                            |        |          |         |  |        |         
|                                     | Accounts payable                                                                                                                                                           |                                            | $      | 18,485   |         |  | $      | 4,239    |        
|                                     | Warranty                                                                                                                                                                   |                                            |        | 6,194    |         |  |        | 2,363    |        
|                                     | Employee notes payable                                                                                                                                                     |                                            |        | 667      |         |  |        |         |        
|                                     | Other current liabilities                                                                                                                                                  |                                            |        | 9,564    |         |  |        | 8,242    |        
|                                     | Deferred gross margin                                                                                                                                                      |                                            |        | 11,503   |         |  |        | 2,739    |        
|                                     |                                                                                                                                                                            |                                            |        |          |         | 
|                                     |                                                                                                                                                                            | Total current liabilities                  |        |          | 46,413  |  |        |          | 17,583  | 
|Other liabilities                    |                                                                                                                                                                            |                                            | 1,528  |          |         |  | 193    |         
|Commitments and contingencies        |                                                                                                                                                                            |                                            |        |          |         |  |        |         
|Shareholders equity:                |                                                                                                                                                                            |                                            |        |          |         |  |        |         
|                                     | Preferred stock, no par value, 5,000,000 shares authorized,
    none outstanding, as of September 30, 2004 and 2003,
    respectively                                      |                                            |        |         |         |  |        |         |        
|                                     | Common stock, no par value, 30,000,000 shares authorized,
    16,859,084 and 16,389,727 shares issued and outstanding, as
    of September 30, 2004 and 2003, respectively |                                            |        | 285,790  |         |  |        | 279,417  |        
|                                     | Accumulated deficit                                                                                                                                                        |                                            |        | (126,178 | )       |  |        | (135,872 | )      
|                                     | Accumulated other comprehensive income                                                                                                                                     |                                            |        | 347      |         |  |        | 598      |        
|                                     |                                                                                                                                                                            |                                            |        |          |         | 
|                                     |                                                                                                                                                                            | Total shareholders equity                 |        |          | 159,959 |  |        |          | 144,143 | 
|                                     |                                                                                                                                                                            |                                            |        |          |         | 
|                                     |                                                                                                                                                                            | Total liabilities and shareholders equity |        | $        | 207,900 |  |        | $        | 161,919 | 
|                                     |                                                                                                                                                                            |                                            |        |          |         | 



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PHOTON DYNAMICS, INC.





CONSOLIDATED STATEMENTS OF OPERATIONS


|                                                                                             |                                              |                                       |         |        |        |   |         |        |         |   |         |        |         |  
|-------------------------------------------------------------------------------------------- | -------------------------------------------- | ------------------------------------- | ------- | ------ | ------ | - | ------- | ------ | ------- | - | ------- | ------ | ------- | -
|                                                                                             |                                              | Year Ended September 30,              |        
|                                                                                             |                                              |                                       |        
|                                                                                             |                                              | 2004                                  |         |        | 2003   |   |         | 2002   |        
|                                                                                             |                                              |                                       |         |        |        |   |         |        |        
|                                                                                             |                                              | (Restated)                            |         |        |        |   |        
|                                                                                             |                                              | (In thousands, except per share data) |        
|Revenue                                                                                      |                                              | $                                     | 141,870 |        |        | $ | 67,196  |        |         | $ | 49,342  |       
|Cost of revenue                                                                              |                                              |                                       | 83,969  |        |        |   | 44,071  |        |         |   | 25,799  |       
|                                                                                             |                                              |                                       |         |        |        |   |         |        |        
|Gross margin                                                                                 |                                              |                                       | 57,901  |        |        |   | 23,125  |        |         |   | 23,543  |       
|Operating expenses:                                                                          |                                              |                                       |         |        |        |   |         |        |         |   |         |       
|                                                                                             | Research and development                     |                                       |         | 29,701 |        |   |         | 22,786 |         |   |         | 10,878 |        
|                                                                                             | Selling, general and administrative          |                                       |         | 17,780 |        |   |         | 13,763 |         |   |         | 8,853  |        
|                                                                                             | Goodwill impairment charge                   |                                       |         | 665    |        |   |         | 10,010 |         |   |         |       |        
|                                                                                             | Impairment of purchased intangibles          |                                       |         | 2,089  |        |   |         | 3,548  |         |   |         |       |        
|                                                                                             | Impairment of fixed assets                   |                                       |         | 234    |        |   |         |       |         |   |         |       |        
|                                                                                             | Gain on sale of fixed assets                 |                                       |         | (427   | )      |   |         |       |         |   |         |       |        
|                                                                                             | Acquired in-process research and development |                                       |         | 210    |        |   |         | 2,474  |         |   |         | 410    |        
|                                                                                             | Amortization of intangible assets            |                                       |         | 789    |        |   |         | 1,236  |         |   |         |       |        
|                                                                                             |                                              |                                       |         |        |        |   |         |        |        
|                                                                                             |                                              | Total operating expenses              |         |        | 51,041 |   |         |        | 53,817  |   |         |        | 20,141  |  
|Income (loss) from operations                                                                |                                              |                                       | 6,860   |        |        |   | (30,692 | )      |         |   | 3,402   |       
|Interest income and other, net                                                               |                                              |                                       | 4,802   |        |        |   | 2,968   |        |         |   | 2,913   |       
|                                                                                             |                                              |                                       |         |        |        |   |         |        |        
|Income (loss) from continuing operations before income taxes and
    discontinued operations |                                              |                                       | 11,662  |        |        |   | (27,724 | )      |         |   | 6,315   |       
|Provision for income taxes                                                                   |                                              |                                       | 577     |        |        |   | 56      |        |         |   | 85      |       
|                                                                                             |                                              |                                       |         |        |        |   |         |        |        
|Income (loss) from continuing operations before discontinued
    operations                  |                                              |                                       | 11,085  |        |        |   | (27,780 | )      |         |   | 6,230   |       
|Loss from discontinued operations                                                            |                                              |                                       | (1,391  | )      |        |   | (44,592 | )      |         |   | (28,032 | )     
|                                                                                             |                                              |                                       |         |        |        |   |         |        |        
|                                                                                             |                                              | Net income (loss)                     |         | $      | 9,694  |   |         | $      | (72,372 | ) |         | $      | (21,802 | )
|                                                                                             |                                              |                                       |         |        |        |   |         |        |        
|Income (loss) per share from continuing operations:                                          |                                              |                                       |         |        |        |   |         |        |         |   |         |       
|                                                                                             | Basic                                        |                                       | $       | 0.67   |        |   | $       | (1.73  | )       |   | $       | 0.39   |        
|                                                                                             |                                              |                                       |         |        |        |   |         |        |        
|                                                                                             | Diluted                                      |                                       | $       | 0.65   |        |   | $       | (1.73  | )       |   | $       | 0.37   |        
|                                                                                             |                                              |                                       |         |        |        |   |         |        |        
|Loss per share from discontinued operations:                                                 |                                              |                                       |         |        |        |   |         |        |         |   |         |       
|                                                                                             | Basic                                        |                                       | $       | (0.08  | )      |   | $       | (2.77  | )       |   | $       | (1.76  | )      
|                                                                                             |                                              |                                       |         |        |        |   |         |        |        
|                                                                                             | Diluted                                      |                                       | $       | (0.08  | )      |   | $       | (2.77  | )       |   | $       | (1.67  | )      
|                                                                                             |                                              |                                       |         |        |        |   |         |        |        
|Net income (loss) per share:                                                                 |                                              |                                       |         |        |        |   |         |        |         |   |         |       
|                                                                                             | Basic                                        |                                       | $       | 0.58   |        |   | $       | (4.50  | )       |   | $       | (1.37  | )      
|                                                                                             |                                              |                                       |         |        |        |   |         |        |        
|                                                                                             | Diluted                                      |                                       | $       | 0.57   |        |   | $       | (4.50  | )       |   | $       | (1.30  | )      
|                                                                                             |                                              |                                       |         |        |        |   |         |        |        
|Weighted average number of shares:                                                           |                                              |                                       |         |        |        |   |         |        |         |   |         |       
|                                                                                             | Basic                                        |                                       |         | 16,631 |        |   |         | 16,089 |         |   |         | 15,923 |        
|                                                                                             | Diluted                                      |                                       |         | 17,087 |        |   |         | 16,089 |         |   |         | 16,791 |        



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PHOTON DYNAMICS, INC.





CONSOLIDATED STATEMENTS OF SHAREHOLDERS EQUITY


|                                               |                                             |                                       |        |       |             |                |             |               |   |   |          |         |   |       |     |      |   |   |         |         |         |  
|---------------------------------------------- | ------------------------------------------- | ------------------------------------- | ------ | ----- | ----------- | -------------- | ----------- | ------------- | - | - | -------- | ------- | - | ----- | --- | ---- | - | - | ------- | ------- | ------- | -
|                                               |                                             | Common Stock and                      |        |       |             |                |             |               |  
|                                               |                                             | Capital in Excess of                  |        |       |             |                | Accumulated |               |   |  
|                                               |                                             | Par Value                             |        |       |             |                | Other       |               |   |  
|                                               |                                             |                                       |        |       | Accumulated |                |             | Comprehensive |   |   |         
|                                               |                                             | Share                                 |        |       | Amount      |                |             | Deficit       |   |   | Income   |         |   | Total |    
|                                               |                                             |                                       |        |       |             |                |             |               |   |   |          |         |   |       |    
|                                               |                                             |                                       |        |       |             | (In thousands) |             |               |  
|Balances at September 30, 2001                 |                                             |                                       | 13,885 |       |             | $              | 184,500     |               |   | $ | (41,698  | )       |   | $     | 506 |      |   | $ | 143,308 |        
|Components of comprehensive loss:
    Net loss |                                             |                                       |       |       |             |                |            |               |   |   | (21,802  | )       |   |       |    |      |   |   | (21,802 | )      
|                                               | Change in unrealized gain on investments    |                                       |        |      |             |                |             |              |   |   |          |        |   |       |     | 289  |   |   |         | 289     |        
|                                               | Currency translation adjustments            |                                       |        |      |             |                |             |              |   |   |          |        |   |       |     | 15   |   |   |         | 15      |        
|                                               |                                             |                                       |        |       |             |                |             |               |   |   |          |         |   |       |    
|                                               |                                             | Total comprehensive loss              |        |       |             |                |             |               |   |   |          |         |   |       |     |      |   |   |         |         | (21,498 | )
|                                               |                                             |                                       |        |       |             |                |             |               |   |   |          |         |   |       |    
|                                               | Net issuance of common stock                |                                       |        | 3,236 |             |                |             | 112,384       |   |   |          |        |   |       |     |     |   |   |         | 112,384 |        
|                                               | Repurchase of common stock, net             |                                       |        | (351  | )           |                |             | (6,901        | ) |   |          |        |   |       |     |     |   |   |         | (6,901  | )      
|                                               | Cancellation of returned IRSI escrow shares |                                       |        | (53   | )           |                |             | (1,425        | ) |   |          |        |   |       |     |     |   |   |         | (1,425  | )      
|                                               | Stock ownership expense                     |                                       |        |      |             |                |             | 275           |   |   |          |        |   |       |     |     |   |   |         | 275     |        
|                                               |                                             |                                       |        |       |             |                |             |               |   |   |          |         |   |       |    
|Balances at September 30, 2002                 |                                             |                                       | 16,717 |       |             |                | 288,833     |               |   |   | (63,500  | )       |   |       | 810 |      |   |   | 226,143 |        
|Components of comprehensive loss:              |                                             |                                       |        |       |             |                |             |               |   |   |          |         |   |       |     |      |   |   |         |        
|                                               | Net loss                                    |                                       |        |      |             |                |             |              |   |   |          | (72,372 | ) |       |     |     |   |   |         | (72,372 | )      
|                                               | Change in unrealized gain on investments    |                                       |        |      |             |                |             |              |   |   |          |        |   |       |     | (206 | ) |   |         | (206    | )      
|                                               | Currency translation adjustments            |                                       |        |      |             |                |             |              |   |   |          |        |   |       |     | (6   | ) |   |         | (6      | )      
|                                               |                                             |                                       |        |       |             |                |             |               |   |   |          |         |   |       |    
|                                               |                                             | Total comprehensive loss              |        |       |             |                |             |               |   |   |          |         |   |       |     |      |   |   |         |         | (72,584 | )
|                                               |                                             |                                       |        |       |             |                |             |               |   |   |          |         |   |       |    
|                                               | Net issuance of common stock                |                                       |        | 576   |             |                |             | 7,898         |   |   |          |        |   |       |     |     |   |   |         | 7,898   |        
|                                               | Repurchase of common stock, net             |                                       |        | (903  | )           |                |             | (17,678       | ) |   |          |        |   |       |     |     |   |   |         | (17,678 | )      
|                                               | Stock ownership expense                     |                                       |        |      |             |                |             | 364           |   |   |          |        |   |       |     |     |   |   |         | 364     |        
|                                               |                                             |                                       |        |       |             |                |             |               |   |   |          |         |   |       |    
|Balances at September 30, 2003                 |                                             |                                       | 16,390 |       |             |                | 279,417     |               |   |   | (135,872 | )       |   |       | 598 |      |   |   | 144,143 |        
|Components of comprehensive loss:              |                                             |                                       |        |       |             |                |             |               |   |   |          |         |   |       |     |      |   |   |         |        
|                                               | Net income (restated)                       |                                       |        |      |             |                |             |              |   |   |          | 9,694   |   |       |     |     |   |   |         | 9,694   |        
|                                               | Change in unrealized gain on investments    |                                       |        |      |             |                |             |              |   |   |          |        |   |       |     | (377 | ) |   |         | (377    | )      
|                                               | Currency translation adjustments            |                                       |        |      |             |                |             |              |   |   |          |        |   |       |     | 126  |   |   |         | 126     |        
|                                               |                                             |                                       |        |       |             |                |             |               |   |   |          |         |   |       |    
|                                               |                                             | Total comprehensive income (restated) |        |       |             |                |             |               |   |   |          |         |   |       |     |      |   |   |         |         | 9,443   |  
|                                               |                                             |                                       |        |       |             |                |             |               |   |   |          |         |   |       |    
|                                               | Net issuance of common stock                |                                       |        | 469   |             |                |             | 6,167         |   |   |          |        |   |       |     |     |   |   |         | 6,167   |        
|                                               | Stock ownership expense                     |                                       |        |      |             |                |             | 206           |   |   |          |        |   |       |     |     |   |   |         | 206     |        
|                                               |                                             |                                       |        |       |             |                |             |               |   |   |          |         |   |       |    
|Balances at September 30, 2004 (restated)      |                                             |                                       | 16,859 |       |             | $              | 285,790     |               |   | $ | (126,178 | )       |   | $     | 347 |      |   | $ | 159,959 |        
|                                               |                                             |                                       |        |       |             |                |             |               |   |   |          |         |   |       |    



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PHOTON DYNAMICS, INC.





CONSOLIDATED STATEMENTS OF CASH FLOWS


|                                      |                                                                                                                                                    |                                                      |                           |                                                                                    |       |         |         |          |        |        |         |          |       |        |         |  
|------------------------------------- | -------------------------------------------------------------------------------------------------------------------------------------------------- | ---------------------------------------------------- | ------------------------- | ---------------------------------------------------------------------------------- | ----- | ------- | ------- | -------- | ------ | ------ | ------- | -------- | ----- | ------ | ------- | -
|                                      |                                                                                                                                                    | Year Ended September 30,                             |                          
|                                      |                                                                                                                                                    |                                                      |                          
|                                      |                                                                                                                                                    | 2004                                                 |                           |                                                                                    | 2003  |         |         | 2002     |       
|                                      |                                                                                                                                                    |                                                      |                           |                                                                                    |       |         |         |          |       
|                                      |                                                                                                                                                    | (Restated)                                           |                           |                                                                                    |       |         |        
|                                      |                                                                                                                                                    | (In thousands)                                       |                          
|Cash flows from operating activities: |                                                                                                                                                    |                                                      |                           |                                                                                    |       |         |         |          |        |        |         |         
|                                      | Net income (loss) from continuing operations                                                                                                       |                                                      | $                         | 11,085                                                                             |       |         | $       | (27,780  | )      |        | $       | 6,230    |      
|                                      | Adjustments to reconcile net income (loss) from continuing
    operations to net cash used in operating activities from
    continuing operations: |                                                      |                           |                                                                                    |       |         |         |          |        |        |         |          |      
|                                      |                                                                                                                                                    | Depreciation                                         |                           |                                                                                    | 2,898 |         |         |          | 3,119  |        |         |          | 2,058 |       
|                                      |                                                                                                                                                    | Amortization of intangible assets                    |                           |                                                                                    | 789   |         |         |          | 1,793  |        |         |          |      |       
|                                      |                                                                                                                                                    | Acquired in process research and development         |                           |                                                                                    | 210   |         |         |          | 2,474  |        |         |          | 410   |       
|                                      |                                                                                                                                                    | Impairment of goodwill                               |                           |                                                                                    | 665   |         |         |          | 10,010 |        |         |          |      |       
|                                      |                                                                                                                                                    | Impairment of purchased intangibles and fixed assets |                           |                                                                                    | 2,323 |         |         |          | 3,548  |        |         |          |      |       
|                                      |                                                                                                                                                    | Loss on disposal of equipment                        |                           |                                                                                    |      |         |         |          | 211    |        |         |          | 709   |       
|                                      |                                                                                                                                                    | Stock ownership expense                              |                           |                                                                                    | 206   |         |         |          | 364    |        |         |          | 275   |       
|                                      |                                                                                                                                                    | Gain on sale of fixed assets                         |                           |                                                                                    | (427  | )       |         |          |       |        |         |          |      |       
|                                      |                                                                                                                                                    | Accretion of non-interest bearing notes payable      |                           |                                                                                    | 17    |         |         |          |       |        |         |          |      |       
|                                      |                                                                                                                                                    | Changes in assets and liabilities:                   |                           |                                                                                    |       |         |         |          |        |        |         |          |       |       
|                                      |                                                                                                                                                    |                                                      | Accounts receivable       |                                                                                    |       | (48,074 | )       |          |        | (4     | )       |          |       | (3,603 | )      
|                                      |                                                                                                                                                    |                                                      | Inventories               |                                                                                    |       | (22,720 | )       |          |        | 993    |         |          |       | (1,762 | )      
|                                      |                                                                                                                                                    |                                                      | Other current assets      |                                                                                    |       | 1,553   |         |          |        | 1,498  |         |          |       | (4,598 | )      
|                                      |                                                                                                                                                    |                                                      | Related party receivable  |                                                                                    |       | 250     |         |          |        |       |         |          |       |       |        
|                                      |                                                                                                                                                    |                                                      | Other assets              |                                                                                    |       | (1,157  | )       |          |        | (166   | )       |          |       | (4,271 | )      
|                                      |                                                                                                                                                    |                                                      | Accounts payable          |                                                                                    |       | 14,448  |         |          |        | (4,167 | )       |          |       | 6,421  |        
|                                      |                                                                                                                                                    |                                                      | Other current liabilities |                                                                                    |       | 4,808   |         |          |        | (647   | )       |          |       | 1,883  |        
|                                      |                                                                                                                                                    |                                                      | Deferred gross margin     |                                                                                    |       | 8,764   |         |          |        | 2,717  |         |          |       | (1,477 | )      
|                                      |                                                                                                                                                    |                                                      | Other liabilities         |                                                                                    |       | (49     | )       |          |        | (684   | )       |          |       |       |        
|                                      |                                                                                                                                                    |                                                      |                           |                                                                                    |       |         |         |          |       
|                                      |                                                                                                                                                    |                                                      |                           | Net cash provided by (used in) operating activities from
    continuing operations |       |         | (24,411 | )        |        |        | (6,721  | )        |       |        | 2,275   |  
|                                      |                                                                                                                                                    |                                                      |                           | Net cash used in operating activities from discontinued
    operations             |       |         | (1,434  | )        |        |        | (12,635 | )        |       |        | (11,703 | )
|                                      |                                                                                                                                                    |                                                      |                           |                                                                                    |       |         |         |          |       
|                                      |                                                                                                                                                    |                                                      |                           | Net cash used in operating activities                                              |       |         | (25,845 | )        |        |        | (19,356 | )        |       |        | (9,428  | )
|                                      |                                                                                                                                                    |                                                      |                           |                                                                                    |       |         |         |          |       
|Cash flows from investing activities: |                                                                                                                                                    |                                                      |                           |                                                                                    |       |         |         |          |        |        |         |         
|                                      | Purchase of property and equipment                                                                                                                 |                                                      |                           | (9,803                                                                             | )     |         |         | (2,547   | )      |        |         | (2,099   | )    
|                                      | Proceeds from sale of fixed assets                                                                                                                 |                                                      |                           | 481                                                                                |       |         |         |         |        |        |         |         |      
|                                      | Acquisition of Akcron Corporation Ltd.                                                                                                             |                                                      |                           |                                                                                   |       |         |         |         |        |        |         | (2,559   | )    
|                                      | Acquisition of Rapid Thermal Processing Division from Intevac,
    Inc.                                                                            |                                                      |                           | (300                                                                               | )     |         |         | (20,000  | )      |        |         |         |      
|                                      | Acquisition of Quantum Composers, Inc.                                                                                                             |                                                      |                           | (1,000                                                                             | )     |         |         |         |        |        |         |         |      
|                                      | Acquisition of Tucson Optical Research Corporation                                                                                                 |                                                      |                           | (625                                                                               | )     |         |         |         |        |        |         |         |      
|                                      | Acquisition of Summit Imaging, Inc.                                                                                                                |                                                      |                           |                                                                                   |       |         |         | (1,676   | )      |        |         |         |      
|                                      | Acquisition of certain intangible assets upon termination of a
    distributor agreement                                                           |                                                      |                           | (1,138                                                                             | )     |         |         |         |        |        |         |         |      
|                                      | Purchase of short-term investments                                                                                                                 |                                                      |                           | (420,296                                                                           | )     |         |         | (569,566 | )      |        |         | (662,097 | )    

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|                                                                           |                                                                                                                                                |                                                                                    |        |         |        |   |         |         |        |   |         |         |         |  
|-------------------------------------------------------------------------- | ---------------------------------------------------------------------------------------------------------------------------------------------- | ---------------------------------------------------------------------------------- | ------ | ------- | ------ | - | ------- | ------- | ------ | - | ------- | ------- | ------- | -
|                                                                           |                                                                                                                                                | Year Ended September 30,                                                           |       
|                                                                           |                                                                                                                                                |                                                                                    |       
|                                                                           |                                                                                                                                                | 2004                                                                               |        |         | 2003   |   |         | 2002    |       
|                                                                           |                                                                                                                                                |                                                                                    |        |         |        |   |         |         |       
|                                                                           |                                                                                                                                                | (Restated)                                                                         |        |         |        |   |        
|                                                                           |                                                                                                                                                | (In thousands)                                                                     |       
|                                                                           | Redemption of short-term investments                                                                                                           |                                                                                    |        | 459,411 |        |   |         | 615,759 |        |   |         | 583,739 |        
|                                                                           |                                                                                                                                                |                                                                                    |        |         |        |   |         |         |       
|                                                                           |                                                                                                                                                | Net cash provided by (used in) investing activities from
    continuing operations |        |         | 26,730 |   |         |         | 21,970 |   |         |         | (83,016 | )
|                                                                           |                                                                                                                                                | Net cash used in investing activities from discontinued
    operations             |        |         |       |   |         |         | (92    | ) |         |         | (4,002  | )
|                                                                           |                                                                                                                                                |                                                                                    |        |         |        |   |         |         |       
|                                                                           |                                                                                                                                                | Net cash provided by (used in) investing activities                                |        |         | 26,730 |   |         |         | 21,878 |   |         |         | (87,018 | )
|                                                                           |                                                                                                                                                |                                                                                    |        |         |        |   |         |         |       
|Cash flows from financing activities:                                      |                                                                                                                                                |                                                                                    |        |         |        |   |         |         |        |   |         |        
|                                                                           | Issuance of common stock, net                                                                                                                  |                                                                                    |        | 6,167   |        |   |         | 7,898   |        |   |         | 112,384 |        
|                                                                           | Repurchase of common stock                                                                                                                     |                                                                                    |        |        |        |   |         | (17,678 | )      |   |         | (6,901  | )      
|                                                                           | Capital lease repayments                                                                                                                       |                                                                                    |        |        |        |   |         | (11     | )      |   |         |        |        
|                                                                           |                                                                                                                                                |                                                                                    |        |         |        |   |         |         |       
|                                                                           |                                                                                                                                                | Net cash provided by (used in) financing activities from
    continuing operations |        |         | 6,167  |   |         |         | (9,791 | ) |         |         | 105,483 |  
|                                                                           |                                                                                                                                                |                                                                                    |        |         |        |   |         |         |       
|Effect of exchange rate changes on cash and cash equivalents               |                                                                                                                                                |                                                                                    | 126    |         |        |   | (6      | )       |        |   | 15      |        
|                                                                           |                                                                                                                                                |                                                                                    |        |         |        |   |         |         |       
|Net increase in cash and cash equivalents from continuing
    operations   |                                                                                                                                                |                                                                                    | 8,612  |         |        |   | 5,452   |         |        |   | 24,757  |        
|Net decrease in cash and cash equivalents from discontinued
    operations |                                                                                                                                                |                                                                                    | (1,434 | )       |        |   | (12,727 | )       |        |   | (15,705 | )      
|                                                                           |                                                                                                                                                |                                                                                    |        |         |        |   |         |         |       
|Net increase (decrease) in cash and cash equivalents                       |                                                                                                                                                |                                                                                    | 7,178  |         |        |   | (7,275  | )       |        |   | 9,052   |        
|Cash and cash equivalents at beginning of year                             |                                                                                                                                                |                                                                                    | 18,305 |         |        |   | 25,580  |         |        |   | 16,528  |        
|                                                                           |                                                                                                                                                |                                                                                    |        |         |        |   |         |         |       
|Cash and cash equivalents at end of year                                   |                                                                                                                                                | $                                                                                  | 25,483 |         |        | $ | 18,305  |         |        | $ | 25,580  |        
|                                                                           |                                                                                                                                                |                                                                                    |        |         |        |   |         |         |       
|Supplemental cash flow disclosures:                                        |                                                                                                                                                |                                                                                    |        |         |        |   |         |         |        |   |         |        
|                                                                           | Income taxes paid                                                                                                                              |                                                                                    | $      | 59      |        |   | $       | 69      |        |   | $       | 101     |        
|                                                                           | Interest paid                                                                                                                                  |                                                                                    |        | 6       |        |   |         | 21      |        |   |         | 10      |        
|Supplemental non-cash financing and investing activities
    disclosure:   |                                                                                                                                                |                                                                                    |        |         |        |   |         |         |        |   |         |        
|                                                                           | Assumed liabilities from acquisition of Infrared Screening and
    Inspection Solutions Division from Advanced Research
    Technologies, Inc. |                                                                                    |        |        |        |   |         |        |        |   |         | 260     |        
|                                                                           | Assumed liabilities from acquisition of Akcron Corporation
    Ltd.                                                                            |                                                                                    |        |        |        |   |         |        |        |   |         | 970     |        
|                                                                           | Cancellation of returned Intelligent Reasoning Systems, Inc.
    escrow shares                                                                 |                                                                                    |        |        |        |   |         |        |        |   |         | 1,425   |        
|                                                                           | Assumed liabilities from acquisition of Rapid Thermal Processing
    Division from Intevac, Inc. assets                                        |                                                                                    |        |        |        |   |         | 350     |        |   |         |        |        
|                                                                           | Assumed liabilities from acquisition of Summit Imaging, Inc.
    assets                                                                        |                                                                                    |        |        |        |   |         | 15      |        |   |         |        |        
|                                                                           | Assumed liabilities from acquisition of Quantum Composers, Inc.
    assets                                                                     |                                                                                    |        | 155     |        |   |         |        |        |   |         |        |        
|                                                                           | Note payable from acquisition of Quantum Composers, Inc. assets                                                                                |                                                                                    |        | 2,000   |        |   |         |        |        |   |         |        |        
|                                                                           | Note payable from acquisition of Tucson Optical Research
    Corporation assets                                                                |                                                                                    |        | 625     |        |   |         |        |        |   |         |        |        



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PHOTON DYNAMICS, INC.





NOTES TO CONSOLIDATED FINANCIAL STATEMENTS




|         |                                           
|-------- | ------------------------------------------
|Note 1  | Summary of Significant Accounting Policies



| |                                                                                                                                            
| | -------------------------------------------------------------------------------------------------------------------------------------------
| | Restatement of Financial Statements (financial information
    with respect to dates or periods after September 30, 2004
    are unaudited)









| |                                                                                                                                                                                                                                                                                                                                                                 
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | 1) Incomplete documentation of sales arrangements: Certain
    elements of certain sales arrangements with customers were not
    reflected in the Companys customary sales documents and,
    as a result, the Company overstated revenue for the value of the
    undelivered elements within those arrangements.                                            
|
| | 2) Unidentified elements in sales arrangements: Certain
    elements of certain sales arrangements with customers contained
    in the Companys customary sales documents were either not
    identified or not properly analyzed and, as a result, the
    Company overstated revenue for the value of the undelivered
    elements within those arrangements.
|
| | 3) Inappropriate amounts deferred: Certain undelivered
    elements within certain sales arrangements were not deferred at
    the appropriate amount and, as a result, the Company did not
    recognize the appropriate amount of revenue for the undelivered
    elements.                                                                                   



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PHOTON DYNAMICS, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)






|                                 |                                            |                               |   |          |             |  |   |             |   |  |   |          |  
|-------------------------------- | ------------------------------------------ | ----------------------------- | - | -------- | ----------- |  | - | ----------- | - |  | - | -------- | -
|                                 |                                            | Year Ended September 30, 2004 |  
|                                 |                                            |                               |  
|                                 |                                            | As Reported                   |   |          | Adjustments |  |   | As Restated |  
|                                 |                                            |                               |   |          |             |  |   |             |  
|                                 |                                            | (In thousands)                |  
|Consolidated Balance Sheet Data: |                                            |                               |   |          |             |  |   |             |   |  |   |         
|                                 | Total current assets                       |                               | $ | 178,748  |             |  | $ |            |   |  | $ | 178,748  |  
|                                 | Total assets                               |                               |   | 207,900  |             |  |   |            |   |  |   | 207,900  |  
|                                 | Other current liabilities                  |                               |   | 9,593    |             |  |   | (29         | ) |  |   | 9,564    |  
|                                 | Deferred gross margin                      |                               |   | 10,104   |             |  |   | 1,399       |   |  |   | 11,503   |  
|                                 | Total current liabilities                  |                               |   | 45,043   |             |  |   | 1,370       |   |  |   | 46,413   |  
|                                 | Accumulated deficit                        |                               |   | (124,808 | )           |  |   | (1,370      | ) |  |   | (126,178 | )
|                                 | Total liabilities and shareholders equity |                               |   | 207,900  |             |  |   |            |   |  |   | 207,900  |  

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PHOTON DYNAMICS, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)


|                                                                                      |         |                                       |         |        |             |   |        |             |   |   |         |        |  
|------------------------------------------------------------------------------------- | ------- | ------------------------------------- | ------- | ------ | ----------- | - | ------ | ----------- | - | - | ------- | ------ | -
|                                                                                      |         | Year Ended September 30, 2004         |        
|                                                                                      |         |                                       |        
|                                                                                      |         | As Reported                           |         |        | Adjustments |   |        | As Restated |  
|                                                                                      |         |                                       |         |        |             |   |        |             |  
|                                                                                      |         | (In thousands, except per share data) |        
|Consolidated Statement of Operations Data:                                            |         |                                       |         |        |             |   |        |             |   |   |         |       
|Revenue                                                                               |         | $                                     | 143,269 |        |             | $ | (1,399 | )           |   | $ | 141,870 |       
|Income (loss) from operations                                                         |         |                                       | 8,259   |        |             |   | (1,399 | )           |   |   | 6,860   |       
|Interest income and other, net                                                        |         |                                       | 4,802   |        |             |   |       |             |   |   | 4,802   |       
|                                                                                      |         |                                       |         |        |             |   |        |             |  
|Income from continuing operations before income taxes and
    discontinued operations |         |                                       | 13,061  |        |             |   | (1,399 | )           |   |   | 11,662  |       
|Provision for income taxes                                                            |         |                                       | 606     |        |             |   | (29    | )           |   |   | 577     |       
|                                                                                      |         |                                       |         |        |             |   |        |             |  
|Income from continuing operations                                                     |         |                                       | 12,455  |        |             |   | (1,370 | )           |   |   | 11,085  |       
|Loss from discontinued operations                                                     |         |                                       | (1,391  | )      |             |   |       |             |   |   | (1,391  | )     
|                                                                                      |         |                                       |         |        |             |   |        |             |  
|Net income                                                                            |         | $                                     | 11,064  |        |             | $ | (1,370 | )           |   | $ | 9,694   |       
|                                                                                      |         |                                       |         |        |             |   |        |             |  
|Net income per share from continuing operations:                                      |         |                                       |         |        |             |   |        |             |   |   |         |       
|                                                                                      | Basic   |                                       | $       | 0.75   |             |   | $      | (0.08       | ) |   | $       | 0.67   |  
|                                                                                      |         |                                       |         |        |             |   |        |             |  
|                                                                                      | Diluted |                                       | $       | 0.73   |             |   | $      | (0.08       | ) |   | $       | 0.65   |  
|                                                                                      |         |                                       |         |        |             |   |        |             |  
|Net loss per share from discontinued operations:                                      |         |                                       |         |        |             |   |        |             |   |   |         |       
|                                                                                      | Basic   |                                       | $       | (0.08  | )           |   | $      | (0.00       | ) |   | $       | (0.08  | )
|                                                                                      |         |                                       |         |        |             |   |        |             |  
|                                                                                      | Diluted |                                       | $       | (0.08  | )           |   | $      | (0.00       | ) |   | $       | (0.08  | )
|                                                                                      |         |                                       |         |        |             |   |        |             |  
|Net income (loss) per share:                                                          |         |                                       |         |        |             |   |        |             |   |   |         |       
|                                                                                      | Basic   |                                       | $       | 0.67   |             |   | $      | (0.08       | ) |   | $       | 0.58   |  
|                                                                                      |         |                                       |         |        |             |   |        |             |  
|                                                                                      | Diluted |                                       | $       | 0.65   |             |   | $      | (0.08       | ) |   | $       | 0.57   |  
|                                                                                      |         |                                       |         |        |             |   |        |             |  
|Weighted average number of shares:                                                    |         |                                       |         |        |             |   |        |             |   |   |         |       
|                                                                                      | Basic   |                                       |         | 16,631 |             |   |        | 16,631      |   |   |         | 16,631 |  
|                                                                                      | Diluted |                                       |         | 17,087 |             |   |        | 17,087      |   |   |         | 17,087 |  



Description of Operations and Principles of
Consolidation.






| |                                                                            
| | ---------------------------------------------------------------------------
| | Akcron Corporation, Ltd.                                                   
| | CR Technology, Inc.                                                        
| | Intelligent Reasoning Systems, Inc.                                        
| | Intelligent Reasoning Systems Intl KK                                      
| | Kabushiki Kaisha Photon Dynamics                                           
| | Photon Dynamics Canada Inc., formerly known as Image Processing
    Systems
| | Inc. (IPS)                                                               
| | Photon Dynamics International Trading (Shanghai) Co., Ltd.                 

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PHOTON DYNAMICS, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)




| |                                                               
| | --------------------------------------------------------------
| | Photon Dynamics Korea Inc. Photon Dynamics Nova Scotia Company
| | Photon Dynamics Technology (Beijing) Co., Ltd.                



Management Estimates.


Fair Value of Financial Instruments.


Cash Equivalents and Short-Term Investments.


Inventories.


Land, Property and Equipment.


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PHOTON DYNAMICS, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)




Goodwill and Intangible Assets.




Impairment of Long-Lived Assets.


Accumulated other comprehensive Income.


Concentration of Credit and Other Risk.






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PHOTON DYNAMICS, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)






Foreign Currency.


Derivative Financial Instruments.






Warranty.


Revenue Recognition.




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PHOTON DYNAMICS, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)










Shipping Costs.


Advertising.


Research and Development Cost.


Interest Income.


Income Taxes.


Earnings Per Share.


Stock-Based Compensation Plans.


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PHOTON DYNAMICS, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)




|                     |                                  |      |  |      |      |  |  |      |   |  |  |      |  
|-------------------- | -------------------------------- | ---- |  | ---- | ---- |  |  | ---- | - |  |  | ---- | -
|                     |                                  | 2004 |  |      | 2003 |  |  | 2002 |  
|                     |                                  |      |  |      |      |  |  |      |  
|Stock option plan:   |                                  |      |  |      |      |  |  |      |   |  |  |     
|                     | Expected stock price volatility  |      |  | 0.83 |      |  |  | 0.93 |   |  |  | 0.96 |  
|                     | Risk free interest rate          |      |  | 2.33 | %    |  |  | 2.05 | % |  |  | 3.21 | %
|                     | Expected life of options (years) |      |  | 6    |      |  |  | 5    |   |  |  | 3    |  
|Stock purchase plan: |                                  |      |  |      |      |  |  |      |   |  |  |     
|                     | Expected stock price volatility  |      |  | 0.96 |      |  |  | 0.90 |   |  |  | 0.99 |  
|                     | Risk free interest rate          |      |  | 2.13 | %    |  |  | 2.19 | % |  |  | 3.13 | %
|                     | Expected life of plan (years)    |      |  | 2    |      |  |  | 0.9  |   |  |  | 1.7  |  





|                                                  |                                                                                                                   |                                       |       |        |            |   |         |            |   |   |         |        |  
|------------------------------------------------- | ----------------------------------------------------------------------------------------------------------------- | ------------------------------------- | ----- | ------ | ---------- | - | ------- | ---------- | - | - | ------- | ------ | -
|                                                  |                                                                                                                   | Year Ended September 30,              |      
|                                                  |                                                                                                                   |                                       |      
|                                                  |                                                                                                                   | 2004                                  |       |        | 2003       |   |         | 2002       |  
|                                                  |                                                                                                                   |                                       |       |        |            |   |         |            |  
|                                                  |                                                                                                                   | (Restated)                            |       |        | (Restated) |   |         | (Restated) |  
|                                                  |                                                                                                                   | (In thousands, except per share data) |      
|Net income (loss)  as reported                   |                                                                                                                   | $                                     | 9,694 |        |            | $ | (72,372 | )          |   | $ | (21,802 | )     
|                                                  | Plus: stock based employee compensation expense included in
    reported net income                               |                                       |       |       |            |   |         | 364        |   |   |         | 275    |  
|                                                  | Less: total stock-based employee compensation expense determined
    under fair value based method for all awards |                                       |       | (7,532 | )          |   |         | (6,619     | ) |   |         | (8,895 | )
|                                                  |                                                                                                                   |                                       |       |        |            |   |         |            |  
|Net income (loss)  pro forma                     |                                                                                                                   | $                                     | 2,162 |        |            | $ | (78,627 | )          |   | $ | (30,422 | )     
|                                                  |                                                                                                                   |                                       |       |        |            |   |         |            |  
|Basic net income (loss) per share  as reported   |                                                                                                                   | $                                     | 0.58  |        |            | $ | (4.50   | )          |   | $ | (1.37   | )     
|Diluted net income (loss) per share  as reported |                                                                                                                   | $                                     | 0.57  |        |            | $ | (4.50   | )          |   | $ | (1.30   | )     
|Basic net income (loss) per share  pro forma     |                                                                                                                   | $                                     | 0.13  |        |            | $ | (4.89   | )          |   | $ | (1.91   | )     
|Diluted net income (loss) per share  pro forma   |                                                                                                                   | $                                     | 0.13  |        |            | $ | (4.89   | )          |   | $ | (1.81   | )     

Reclassifications.


55



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PHOTON DYNAMICS, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)


Recent Accounting Pronouncements.




56



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PHOTON DYNAMICS, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)




|         |                               
|-------- | ------------------------------
|Note 2  | Financial Statement Components

|              |                               |                                                 |        |   |         |        |        |   |         |        | 
|------------- | ----------------------------- | ----------------------------------------------- | ------ | - | ------- | ------ | ------ | - | ------- | ------ | 
|              |                               | September 30,                                   |       
|              |                               |                                                 |       
|              |                               | 2004                                            |        |   | 2003    |       
|              |                               |                                                 |        |   |         |       
|              |                               | (In thousands)                                  |       
|Balance Sheet |                               |                                                 |        |   |         |        |        |  
|              | Accounts receivable           |                                                 |        |   |         |        |        |   |        
|              |                               | Accounts receivable, gross                      |        | $ | 58,838  |        |        | $ | 11,128  |       
|              |                               | Allowance for doubtful accounts                 |        |   | (497    | )      |        |   | (726    | )     
|              |                               |                                                 |        |   |         |       
|              |                               |                                                 | Total  |   | $       | 58,341 |        |   | $       | 10,402 | 
|              |                               |                                                 |        |   |         |       
|              | Inventories:                  |                                                 |        |   |         |        |        |   |        
|              |                               | Raw materials                                   |        | $ | 15,529  |        |        | $ | 3,945   |       
|              |                               | Work-in-process                                 |        |   | 15,046  |        |        |   | 4,565   |       
|              |                               | Finished goods                                  |        |   | 1,141   |        |        |   | 1,377   |       
|              |                               |                                                 |        |   |         |       
|              |                               |                                                 | Total  |   | $       | 31,716 |        |   | $       | 9,887  | 
|              |                               |                                                 |        |   |         |       
|              | Land, property and equipment: |                                                 |        |   |         |        |        |   |        
|              |                               | Land and building                               |        | $ | 7,299   |        |        | $ | 7,299   |       
|              |                               | Equipment                                       |        |   | 17,647  |        |        |   | 13,751  |       
|              |                               | Office furniture and fixtures                   |        |   | 3,057   |        |        |   | 2,097   |       
|              |                               | Leasehold improvements                          |        |   | 8,934   |        |        |   | 2,619   |       
|              |                               |                                                 |        |   |         |       
|              |                               |                                                 | 36,937 |   |         |        | 25,766 |  
|              |                               | Less: accumulated depreciation and amortization |        |   | (16,600 | )      |        |   | (13,468 | )     
|              |                               |                                                 |        |   |         |       
|              |                               |                                                 | Total  |   | $       | 20,337 |        |   | $       | 12,298 | 
|              |                               |                                                 |        |   |         |       
|              | Intangible assets:            |                                                 |        |   |         |        |        |   |        
|              |                               | Core technology                                 |        | $ | 8,695   |        |        | $ | 7,997   |       
|              |                               | Developed technology                            |        |   | 6,865   |        |        |   | 4,734   |       
|              |                               | Backlog                                         |        |   | 557     |        |        |   | 557     |       
|              |                               | Non-compete agreement                           |        |   | 969     |        |        |   | 199     |       
|              |                               | Patents                                         |        |   | 123     |        |        |   | 123     |       
|              |                               | License agreement                               |        |   | 1,139   |        |        |   |        |       
|              |                               |                                                 |        |   |         |       
|              |                               |                                                 | 18,348 |   |         |        | 13,610 |  
|              |                               | Less: accumulated amortization                  |        |   | (4,059  | )      |        |   | (3,269  | )     
|              |                               | Less: accumulated impairment charges(1)         |        |   | (9,536  | )      |        |   | (7,447  | )     
|              |                               |                                                 |        |   |         |       
|              |                               |                                                 | Total  |   | $       | 4,753  |        |   | $       | 2,894  | 
|              |                               |                                                 |        |   |         |       
|              | Goodwill:                     |                                                 |        |   |         |        |        |   |        
|              |                               | Initial goodwill                                |        | $ | 37,389  |        |        | $ | 37,089  |       
|              |                               | Subsequent adjustments to goodwill              |        |   | (278    | )      |        |   | (278    | )     
|              |                               |                                                 |        |   |         |       
|              |                               |                                                 | 37,111 |   |         |        | 36,811 |  

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PHOTON DYNAMICS, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)


|                                                                                    |                                                                                        |                |            |         |       |   |     |         |       | 
|----------------------------------------------------------------------------------- | -------------------------------------------------------------------------------------- | -------------- | ---------- | ------- | ----- | - | --- | ------- | ----- | 
|                                                                                    |                                                                                        | September 30,  |           
|                                                                                    |                                                                                        |                |           
|                                                                                    |                                                                                        | 2004           |            |         | 2003  |  
|                                                                                    |                                                                                        |                |            |         |       |  
|                                                                                    |                                                                                        | (In thousands) |           
|                                                                                    | Less: accumulated impairment charges(1)                                                |                |            | (36,958 | )     |   |     | (36,293 | )    
|                                                                                    |                                                                                        |                |            |         |       |  
|                                                                                    |                                                                                        | Total          |            | $       | 153   |   |     | $       | 518   | 
|                                                                                    |                                                                                        |                |            |         |       |  
|                                                                                    |                                                                                        |                | (Restated) |         |       |   |     |        
|                                                                                   
|Other current liabilities:                                                          |                                                                                        |                |            |         |       |   |     |        
|                                                                                    | Compensation                                                                           |                | $          | 3,984   |       |   | $   | 2,369   |      
|                                                                                    | Commissions                                                                            |                |            | 197     |       |   |     | 1,128   |      
|                                                                                    | Due to Akcron shareholders                                                             |                |            |        |       |   |     | 1,035   |      
|                                                                                    | Obligation to a manufacturing subcontractor in connection with
    inventory purchases |                |            | 623     |       |   |     | 647     |      
|                                                                                    | Accrued closing costs associated with discontinued operations                          |                |            | 449     |       |   |     | 666     |      
|                                                                                    | Notes Payable (Note 14)                                                                |                |            | 519     |       |   |     | 576     |      
|                                                                                    | Other accrued expenses                                                                 |                |            | 3,792   |       |   |     | 1,821   |      
|                                                                                    |                                                                                        |                |            |         |       |  
|                                                                                    |                                                                                        | Total          |            | $       | 9,564 |   |     | $       | 8,242 | 
|                                                                                    |                                                                                        |                |            |         |       |  
|Accumulated other comprehensive income Foreign currency
    translation adjustments |                                                                                        | $              | 533        |         |       | $ | 407 |        
|                                                                                    | Unrealized gains (losses) on available for sale securities                             |                |            | (186    | )     |   |     | 191     |      
|                                                                                    |                                                                                        |                |            |         |       |  
|                                                                                    |                                                                                        | Total          |            | $       | 347   |   |     | $       | 598   | 
|                                                                                    |                                                                                        |                |            |         |       |  

|                         |                                                    |                              |       |       |       |       |   |       |      |       |   |       |      |       | 
|------------------------ | -------------------------------------------------- | ---------------------------- | ----- | ----- | ----- | ----- | - | ----- | ---- | ----- | - | ----- | ---- | ----- | 
|                         |                                                    | Year Ended September 30,     |      
|                         |                                                    |                              |      
|                         |                                                    | 2004                         |       |       | 2003  |       |   | 2002  |     
|                         |                                                    |                              |       |       |       |       |   |       |     
|                         |                                                    | (In thousands)               |      
|Statements of Operations |                                                    |                              |       |       |       |       |   |       |      |       |   |      
|                         | Interest income and other, net
    Interest income |                              | $     | 1,508 |       |       | $ | 2,548 |      |       | $ | 3,374 |     
|                         |                                                    | Interest expense             |       |       | (25   | )     |   |       | (11  | )     |   |       | (7   | )    
|                         |                                                    | Foreign exchange gain (loss) |       |       | (90   | )     |   |       | (425 | )     |   |       | (211 | )    
|                         |                                                    | Other(2)                     |       |       | 3,409 |       |   |       | 856  |       |   |       | (243 | )    
|                         |                                                    |                              |       |       |       |       |   |       |     
|                         |                                                    |                              | Total |       | $     | 4,802 |   |       | $    | 2,968 |   |       | $    | 2,913 | 
|                         |                                                    |                              |       |       |       |       |   |       |     






|    |                                                                                                                                                                                                                                                                                                                                                                                                                                 
|--- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(1) | In fiscal 2002, 2003 and 2004, the Company recorded impairment
    charges against certain of its goodwill and intangible assets.
    In accordance with FAS 142 and Statement of Financial
    Accounting Standards No. 144 Accounting for the
    Impairment or Disposal of Long-Lived Assets
    (FAS 144), these impairments established new
    cost bases for the related assets. See additional detail in
    Note 5.
|   
|(2) | In fiscal 2004, the Company recorded a technology license fee
    resulting from a litigation settlement in the first quarter of
    fiscal 2004, the terms of which were confidential. See
    additional detail in Note 11.                                                                                                                                                                                                   



|         |                        
|-------- | -----------------------
|Note 3  | Discontinued Operations



| |                                                   
| | --------------------------------------------------
| | Printed Circuit Board Assembly Inspection Business



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PHOTON DYNAMICS, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)






|                                  |                                                      |                          |        |       |       |   |         |        |        |   |         |        |        | 
|--------------------------------- | ---------------------------------------------------- | ------------------------ | ------ | ----- | ----- | - | ------- | ------ | ------ | - | ------- | ------ | ------ | 
|                                  |                                                      | Year Ended September 30, |       
|                                  |                                                      |                          |       
|                                  |                                                      | 2004                     |        |       | 2003  |   |         | 2002   |       
|                                  |                                                      |                          |        |       |       |   |         |        |       
|                                  |                                                      | (In thousands)           |       
|Revenue                           |                                                      | $                        | 83     |       |       | $ | 4,320   |        |        | $ | 12,366  |       
|Cost of revenue                   |                                                      |                          |       |       |       |   | 11,661  |        |        |   | 9,605   |       
|                                  |                                                      |                          |        |       |       |   |         |        |       
|Gross margin                      |                                                      |                          | 83     |       |       |   | (7,341  | )      |        |   | 2,761   |       
|                                  |                                                      |                          |        |       |       |   |         |        |       
|Operating expenses:               |                                                      |                          |        |       |       |   |         |        |        |   |         |       
|                                  | Research and development                             |                          |        | 21    |       |   |         | 3,695  |        |   |         | 4,367  |       
|                                  | Selling, general and administrative                  |                          |        | 1,624 |       |   |         | 6,827  |        |   |         | 6,925  |       
|                                  | Goodwill impairment charge                           |                          |        |      |       |   |         | 15,083 |        |   |         | 11,200 |       
|                                  | Impairment of purchased intangibles and fixed assets |                          |        |      |       |   |         | 5,445  |        |   |         | 1,017  |       
|                                  | Restructuring charges                                |                          |        |      |       |   |         |       |        |   |         | 2,551  |       
|                                  | Acquired in-process research and development         |                          |        |      |       |   |         |       |        |   |         | 244    |       
|                                  | Amortization of intangible assets                    |                          |        |      |       |   |         | 195    |        |   |         | 1,042  |       
|                                  |                                                      |                          |        |       |       |   |         |        |       
|                                  |                                                      | Total operating expenses |        |       | 1,645 |   |         |        | 31,245 |   |         |        | 27,346 | 
|                                  |                                                      |                          |        |       |       |   |         |        |       
|Loss from discontinued operations |                                                      | $                        | (1,562 | )     |       | $ | (38,586 | )      |        | $ | (24,585 | )     
|                                  |                                                      |                          |        |       |       |   |         |        |       







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PHOTON DYNAMICS, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)








|                     |                           |                           |     |     |      |  |     |       |       | 
|-------------------- | ------------------------- | ------------------------- | --- | --- | ---- |  | --- | ----- | ----- | 
|                     |                           | September 30,             |    
|                     |                           |                           |    
|                     |                           | 2004                      |     |     | 2003 | 
|                     |                           |                           |     |     |      | 
|                     |                           | (In thousands)            |    
|ASSETS              
|Current assets:      |                           |                           |     |     |      |  |     |      
|                     | Accounts receivable, net  |                           | $   |    |      |  | $   | 104   |      
|                     | Other current assets      |                           |     | 908 |      |  |     | 1,268 |      
|                     |                           |                           |     |     |      | 
|                     |                           | Total assets              |     | $   | 908  |  |     | $     | 1,372 | 
|                     |                           |                           |     |     |      | 
|LIABILITIES         
|Current liabilities: |                           |                           |     |     |      |  |     |      
|                     | Accounts payable          |                           | $   | 5   |      |  | $   | 102   |      
|                     | Other current liabilities |                           |     | 707 |      |  |     | 819   |      
|                     |                           |                           |     |     |      | 
|                     |                           | Total current liabilities |     |     | 712  |  |     |       | 921   | 
|Other liabilities    |                           |                           | 113 |     |      |  | 193 |      
|                     |                           |                           |     |     |      | 
|                     |                           | Total liabilities         |     | $   | 825  |  |     | $     | 1,114 | 
|                     |                           |                           |     |     |      | 







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PHOTON DYNAMICS, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)




|                             |                               |                |      |   |       |   |       |       |  |   |        |     | 
|---------------------------- | ----------------------------- | -------------- | ---- | - | ----- | - | ----- | ----- |  | - | ------ | --- | 
|                             |                               | One-time       |      |   |       |   |      
|                             |                               | Termination    |      |   | Other |   |       |      
|                             |                               | Benefits       |      |   | Costs |   |       | Total | 
|                             |                               |                |      |   |       |   |       |       | 
|                             |                               | (In thousands) |     
|Inception of liability       |                               | $              | 696  |   |       | $ | 1,326 |       |  | $ | 2,022  |    
|Cash expenditures            |                               |                | (614 | ) |       |   | (447  | )     |  |   | (1,061 | )  
|Adjustments to the liability |                               |                | (82  | ) |       |   | (342  | )     |  |   | (424   | )  
|                             |                               |                |      |   |       |   |       |       | 
|                             | Balance at September 30, 2003 |                |      |  |       |   |       | 537   |  |   |        | 537 | 
|Cash expenditures            |                               |                |     |   |       |   |      |       |  |   |       |    
|Adjustments to the liability |                               |                |     |   |       |   |      |       |  |   |       |    
|                             |                               |                |      |   |       |   |       |       | 
|                             | Balance at September 30, 2004 |                | $    |  |       |   | $     | 537   |  |   | $      | 537 | 
|                             |                               |                |      |   |       |   |       |       | 





| |                                                                        
| | -----------------------------------------------------------------------
| | Cathode Ray Tube Display and High Quality
    Glass Inspection Business





|                                           |                                                      |                          |     |      |      |   |        |       |       |   |        |       |       | 
|------------------------------------------ | ---------------------------------------------------- | ------------------------ | --- | ---- | ---- | - | ------ | ----- | ----- | - | ------ | ----- | ----- | 
|                                           |                                                      | Year Ended September 30, |    
|                                           |                                                      |                          |    
|                                           |                                                      | 2004                     |     |      | 2003 |   |        | 2002  |      
|                                           |                                                      |                          |     |      |      |   |        |       |      
|                                           |                                                      | (In thousands)           |    
|Revenue                                    |                                                      | $                        |    |      |      | $ | 2,412  |       |       | $ | 7,518  |      
|Cost of revenue                            |                                                      |                          |    |      |      |   | 4,393  |       |       |   | 4,626  |      
|                                           |                                                      |                          |     |      |      |   |        |       |      
|Gross margin                               |                                                      |                          |    |      |      |   | (1,981 | )     |       |   | 2,892  |      
|                                           |                                                      |                          |     |      |      |   |        |       |      
|Operating expenses:                        |                                                      |                          |     |      |      |   |        |       |       |   |        |      
|                                           | Research and development                             |                          |     |     |      |   |        | 701   |       |   |        | 3,574 |      
|                                           | Selling, general and administrative                  |                          |     | 38   |      |   |        | 2,533 |       |   |        | 2,765 |      
|                                           | Impairment of purchased intangibles and fixed assets |                          |     |      |      |   |        | 791   |       |   |        |      |      
|                                           | Gain on sale of fixed assets                         |                          |     | (209 | )    |   |        |      |       |   |        |      |      
|                                           |                                                      |                          |     |      |      |   |        |       |      
|                                           |                                                      | Total operating expenses |     |      | (171 | ) |        |       | 4,025 |   |        |       | 6,339 | 
|                                           |                                                      |                          |     |      |      |   |        |       |      
|Income (loss) from discontinued operations |                                                      | $                        | 171 |      |      | $ | (6,006 | )     |       | $ | (3,447 | )    
|                                           |                                                      |                          |     |      |      |   |        |       |      

61



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PHOTON DYNAMICS, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)






|                     |                           |                           |   |     |      |  |   |       |       | 
|-------------------- | ------------------------- | ------------------------- | - | --- | ---- |  | - | ----- | ----- | 
|                     |                           | September 30,             |  
|                     |                           |                           |  
|                     |                           | 2004                      |   |     | 2003 | 
|                     |                           |                           |   |     |      | 
|                     |                           | (In thousands)            |  
|ASSETS              
|Current assets:      |                           |                           |   |     |      |  |   |      
|                     | Accounts receivable, net  |                           | $ |    |      |  | $ | 31    |      
|                     |                           |                           |   |     |      | 
|                     |                           | Total current assets      |   | $   |     |  |   | $     | 31    | 
|                     |                           |                           |   |     |      | 
|LIABILITIES         
|Current liabilities: |                           |                           |   |     |      |  |   |      
|                     | Other current liabilities |                           | $ | 797 |      |  | $ | 1,046 |      
|                     |                           |                           |   |     |      | 
|                     |                           | Total current liabilities |   | $   | 797  |  |   | $     | 1,046 | 
|                     |                           |                           |   |     |      | 





|                             |                                            |                |        |    |             |   |      |       |  |   |       |    |  |   |        |     | 
|---------------------------- | ------------------------------------------ | -------------- | ------ | -- | ----------- | - | ---- | ----- |  | - | ----- | -- |  | - | ------ | --- | 
|                             |                                            | One-time       |        |    | Contract    |   |      |       |  |  
|                             |                                            | Termination    |        |    | Termination |   |      | Other |  |   |      
|                             |                                            | Benefits       |        |    | Costs       |   |      | Costs |  |   | Total |   
|                             |                                            |                |        |    |             |   |      |       |  |   |       |   
|                             |                                            | (In thousands) |       
|Inception of liability       |                                            | $              | 1,116  |    |             | $ | 771  |       |  | $ | 11    |    |  | $ | 1,898  |    
|Cash expenditures            |                                            |                | (1,085 | )  |             |   | (171 | )     |  |   | (26   | )  |  |   | (1,282 | )  
|Adjustments to the liability |                                            |                |       |    |             |   |     |       |  |   | 50    |    |  |   | 50     |    
|                             |                                            |                |        |    |             |   |      |       |  |   |       |   
|                             | Balance of liability at September 30, 2003 |                |        | 31 |             |   |      | 600   |  |   |       | 35 |  |   |        | 666 | 
|Cash expenditures            |                                            |                | (31    | )  |             |   | (151 | )     |  |   | (35   | )  |  |   | (217   | )  
|                             |                                            |                |        |    |             |   |      |       |  |   |       |   
|                             | Balance of liability at September 30, 2004 |                | $      |   |             |   | $    | 449   |  |   | $     |   |  |   | $      | 449 | 
|                             |                                            |                |        |    |             |   |      |       |  |   |       |   

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##### Table of Contents



PHOTON DYNAMICS, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)




|         |                              
|-------- | -----------------------------
|Note 4  | Acquisitions and Dispositions



| |                                           
| | ------------------------------------------
| | Year Ended September 30, 2004 Dispositions





| |                                           
| | ------------------------------------------
| | Year Ended September 30, 2004 Acquisitions







| |                                                        
| | -------------------------------------------------------
| | Year Ended September 30, 2003 Purchase
    Acquisitions







63



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##### Table of Contents



PHOTON DYNAMICS, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)






| |                                                        
| | -------------------------------------------------------
| | Year Ended September 30, 2002 Purchase
    Acquisitions







| |                                                    
| | ---------------------------------------------------
| | Purchase Price Allocation and Pro Forma Information







64



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##### Table of Contents



PHOTON DYNAMICS, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)




|                      |  |        |    |   |         |  |    |        |  |  |        |   |  |        |    |   |        |  |    |   |  |  |    |  
|--------------------- |  | ------ | -- | - | ------- |  | -- | ------ |  |  | ------ | - |  | ------ | -- | - | ------ |  | -- | - |  |  | -- | -
|                      |  | TORC   |    |   | Quantum |  |    | Summit |  |  | RTP    |   |  | Akcron |    |   | ISIS   | 
|                      |  | Assets |    |   | Assets  |  |    | Assets |  |  | Assets |   |  | Assets |    |   | Assets | 
|                      |  |        |    |   |         |  |    |        |  |  |        |   |  |        |    |   |        | 
|Developed technology  |  |        |   |   |         |  | 25 | %      |  |  |       |   |  |        | 15 | % |        |  | 15 | % |  |  | 15 | %
|Core technology       |  |        | 25 | % |         |  | 25 | %      |  |  | 50     | % |  |        | 20 | % |        |  | 20 | % |  |  | 20 | %
|In-process technology |  |        |   |   |         |  | 30 | %      |  |  | 60     | % |  |        | 25 | % |        |  | 25 | % |  |  | 25 | %



|                                                                       |       |                |       |       |         |   |       |        |  |   |        |       |  |        |       |        |        |   |       |       |  |   |       |       | 
|---------------------------------------------------------------------- | ----- | -------------- | ----- | ----- | ------- | - | ----- | ------ |  | - | ------ | ----- |  | ------ | ----- | ------ | ------ | - | ----- | ----- |  | - | ----- | ----- | 
|                                                                       |       | TORC           |       |       | Quantum |   |       | Summit |  |   | RTP    |       |  | Akcron |       |        | ISIS   |  
|                                                                       |       | Assets         |       |       | Assets  |   |       | Assets |  |   | Assets |       |  | Assets |       |        | Assets |  
|                                                                       |       |                |       |       |         |   |       |        |  |   |        |       |  |        |       |        |        |  
|                                                                       |       | (In thousands) |      
|Acquired core technology                                               |       | $              | 1,144 |       |         | $ | 699   |        |  | $ | 565    |       |  | $      | 3,764 |        |        | $ | 225   |       |  | $ | 196   |      
|Acquired developed technology                                          |       |                |      |       |         |   | 1,006 |        |  |   |       |       |  |        | 2,673 |        |        |   | 252   |       |  |   | 315   |      
|Patents                                                                |       |                |      |       |         |   |      |        |  |   |       |       |  |        |      |        |        |   |      |       |  |   | 123   |      
|Backlog                                                                |       |                |      |       |         |   |      |        |  |   |       |       |  |        | 557   |        |        |   |      |       |  |   |      |      
|Acquired in-process research and development                           |       |                |      |       |         |   | 210   |        |  |   | 625    |       |  |        | 1,849 |        |        |   | 410   |       |  |   | 244   |      
|Non-compete agreement                                                  |       |                |      |       |         |   | 769   |        |  |   | 199    |       |  |        |      |        |        |   |      |       |  |   |      |      
|Goodwill                                                               |       |                |      |       |         |   |      |        |  |   | 106    |       |  |        | 7,386 |        |        |   | 3,454 |       |  |   | 3,419 |      
|Net fair value of acquired tangible assets and assumed
    liabilities |       |                | 114   |       |         |   | 397   |        |  |   | 163    |       |  |        | 2,621 |        |        |   | 234   |       |  |   | 1,322 |      
|                                                                       |       |                |       |       |         |   |       |        |  |   |        |       |  |        |       |        |        |  
|                                                                       | Total |                | $     | 1,258 |         |   | $     | 3,081  |  |   | $      | 1,658 |  |        | $     | 18,850 |        |   | $     | 4,575 |  |   | $     | 5,619 | 
|                                                                       |       |                |       |       |         |   |       |        |  |   |        |       |  |        |       |        |        |  









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PHOTON DYNAMICS, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)








|                                                              |                                              |                                       |         |        |      |   |         |         |   |   |        |       |  
|------------------------------------------------------------- | -------------------------------------------- | ------------------------------------- | ------- | ------ | ---- | - | ------- | ------- | - | - | ------ | ----- | -
|                                                              |                                              | Year Ended September 30,              |        
|                                                              |                                              |                                       |        
|                                                              |                                              | 2004                                  |         |        | 2003 |   |         | 2002    |  
|                                                              |                                              |                                       |         |        |      |   |         |         |  
|                                                              |                                              | (Restated)                            |         |        |      |   |        
|                                                              |                                              | (Unaudited)                           |        
|                                                              |                                              | (In thousands, except per share data) |        
|Total revenue                                                 |                                              | $                                     | 146,412 |        |      | $ | 71,734  |         |   | $ | 56,262 |      
|Income (loss) from operations                                 |                                              |                                       | 8,095   |        |      |   | (26,922 | )       |   |   | (117   | )    
|                                                              | Net income (loss) from continuing operations |                                       |         | 12,320 |      |   |         | (24,010 | ) |   |        | 2,188 |  
|Pro forma income (loss) per share from operations:            |                                              |                                       |         |        |      |   |         |         |   |   |        |      
|                                                              | Basic                                        |                                       | $       | 0.49   |      |   | $       | (1.67   | ) |   | $      | (0.01 | )
|                                                              | Diluted                                      |                                       | $       | 0.47   |      |   | $       | (1.67   | ) |   | $      | (0.01 | )
|Pro forma income (loss) per share from continuing operations: |                                              |                                       |         |        |      |   |         |         |   |   |        |      
|                                                              | Basic                                        |                                       | $       | 0.74   |      |   | $       | (1.49   | ) |   | $      | 0.14  |  
|                                                              | Diluted                                      |                                       | $       | 0.72   |      |   | $       | (1.49   | ) |   | $      | 0.13  |  

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PHOTON DYNAMICS, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)


Note 5  Goodwill and Other Purchased
Intangible Assets




| |         
| | --------
| | Goodwill



|                                 |                                                 |                |       |         |              |   |        |         |   |   |        |         |  
|-------------------------------- | ----------------------------------------------- | -------------- | ----- | ------- | ------------ | - | ------ | ------- | - | - | ------ | ------- | -
|                                 |                                                 | Flat Panel     |       |         | Discontinued |   |        |        
|                                 |                                                 | Display        |       |         | Operations   |   |        | Total   |  
|                                 |                                                 |                |       |         |              |   |        |         |  
|                                 |                                                 | (In thousands) |      
|Balance as of September 30, 2002 |                                                 | $              | 3,454 |         |              | $ | 15,083 |         |   | $ | 18,537 |        
|                                 | Goodwill on businesses acquired during the year |                |       | 7,492   |              |   |        |        |   |   |        | 7,492   |  
|                                 | Adjustments to goodwill, net                    |                |       | (418    | )            |   |        |        |   |   |        | (418    | )
|                                 | Goodwill impairment charge                      |                |       | (10,010 | )            |   |        | (15,083 | ) |   |        | (25,093 | )
|                                 |                                                 |                |       |         |              |   |        |         |  
|Balance as of September 30, 2003 |                                                 |                | 518   |         |              |   |       |         |   |   | 518    |        
|                                 | Adjustments to goodwill, net                    |                |       | 300     |              |   |        |        |   |   |        | 300     |  
|                                 | Goodwill impairment charge                      |                |       | (665    | )            |   |        |        |   |   |        | (665    | )
|                                 |                                                 |                |       |         |              |   |        |         |  
|Balance as of September 30, 2004 |                                                 | $              | 153   |         |              | $ |       |         |   | $ | 153    |        
|                                 |                                                 |                |       |         |              |   |        |         |  











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PHOTON DYNAMICS, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)










| |                  
| | -----------------
| | Intangible Assets



|                                                                                          |  |                |        |   |            |   |        |         |  |         |           |   |             |          |       |   |         |   |      |       |  |   |      |   |  |   |        |  
|----------------------------------------------------------------------------------------- |  | -------------- | ------ | - | ---------- | - | ------ | ------- |  | ------- | --------- | - | ----------- | -------- | ----- | - | ------- | - | ---- | ----- |  | - | ---- | - |  | - | ------ | -
|                                                                                          |  | Developed      |        |   | Core       |   |        |         |  | License |           |   | Non Compete |          |       |   |         |  
|                                                                                          |  | Technology     |        |   | Technology |   |        | Patents |  |         | Agreement |   |             | Contract |       |   | Backlog |   |      | Total | 
|                                                                                          |  |                |        |   |            |   |        |         |  |         |           |   |             |          |       |   |         |   |      |       | 
|                                                                                          |  | (In thousands) |       
|Balance as of September 30, 2002                                                          |  | $              | 557    |   |            | $ | 2,878  |         |  | $       | 119       |   |             | $        |      |   |         | $ |     |       |  | $ |     |   |  | $ | 3,554  |  
|Acquired during the period                                                                |  |                | 2,673  |   |            |   | 4,329  |         |  |         |          |   |             |          |      |   |         |   | 199  |       |  |   | 557  |   |  |   | 7,758  |  
|Amortization during the period included in continuing operations                          |  |                | (552   | ) |            |   | (639   | )       |  |         | (3        | ) |             |          |      |   |         |   | (42  | )     |  |   |     |   |  |   | (1,236 | )
|Amortization during the period included in discontinued
    operations                    |  |                | (16    | ) |            |   | (173   | )       |  |         | (6        | ) |             |          |      |   |         |   |     |       |  |   |     |   |  |   | (195   | )
|Amortization of backlog to cost of revenue in continuing
    operations during the period |  |                |       |   |            |   |       |         |  |         |          |   |             |          |      |   |         |   |     |       |  |   | (557 | ) |  |   | (557   | )
|Impairment of purchased intangibles included in continuing
    operations                 |  |                | (1,537 | ) |            |   | (1,981 | )       |  |         | (30       | ) |             |          |      |   |         |   |     |       |  |   |     |   |  |   | (3,548 | )
|Impairment of purchased intangibles included in discontinued
    operations               |  |                | (470   | ) |            |   | (2,332 | )       |  |         | (80       | ) |             |          |      |   |         |   |     |       |  |   |     |   |  |   | (2,882 | )
|                                                                                          |  |                |        |   |            |   |        |         |  |         |           |   |             |          |       |   |         |   |      |       | 
|Balance as of September 30, 2003                                                          |  |                | 655    |   |            |   | 2,082  |         |  |         |          |   |             |          |      |   |         |   | 157  |       |  |   |     |   |  |   | 2,894  |  
|Acquired during the period                                                                |  |                | 987    |   |            |   | 1,843  |         |  |         |          |   |             |          | 1,138 |   |         |   | 770  |       |  |   |     |   |  |   | 4,737  |  
|Amortization during the period included in continuing operations                          |  |                | (221   | ) |            |   | (219   | )       |  |         |          |   |             |          | (190  | ) |         |   | (160 | )     |  |   |     |   |  |   | (789   | )
|Impairment of purchased intangibles included in continuing
    operations                 |  |                | (589   | ) |            |   | (1,500 | )       |  |         |          |   |             |          |      |   |         |   |     |       |  |   |     |   |  |   | (2,089 | )
|                                                                                          |  |                |        |   |            |   |        |         |  |         |           |   |             |          |       |   |         |   |      |       | 
|Balance as of September 30, 2004                                                          |  | $              | 832    |   |            | $ | 2,206  |         |  | $       |          |   |             | $        | 948   |   |         | $ | 767  |       |  | $ |     |   |  | $ | 4,753  |  
|                                                                                          |  |                |        |   |            |   |        |         |  |         |           |   |             |          |       |   |         |   |      |       | 



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PHOTON DYNAMICS, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)


















|         |                      
|-------- | ---------------------
|Note 6  | Restructuring Charges



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PHOTON DYNAMICS, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)




Note 7  Financial Instruments




|                   |                                                |                                            |   |        |            |  |       |            |   |  |            |      |      |   |   |        |        | 
|------------------ | ---------------------------------------------- | ------------------------------------------ | - | ------ | ---------- |  | ----- | ---------- | - |  | ---------- | ---- | ---- | - | - | ------ | ------ | 
|                   |                                                |                                            |   | Gross  |            |  | Gross |            |   | 
|                   |                                                | Amortized                                  |   |        | Unrealized |  |       | Unrealized |   |  |           
|                   |                                                | Cost                                       |   |        | Gains      |  |       | Losses     |   |  | Fair Value |     
|                   |                                                |                                            |   |        |            |  |       |            |   |  |            |     
|                   |                                                | (In thousands)                             |  
|September 30, 2004 |                                                |                                            |   |        |            |  |       |            |   |  |            |      |      |   |   |       
|                   | Auction rate preferred securities              |                                            | $ | 24,370 |            |  | $     |           |   |  | $          |     |      |   | $ | 24,370 |       
|                   | Commercial paper and corporate debt securities |                                            |   | 34,488 |            |  |       |           |   |  |            | (186 | )    |   |   | 34,302 |       
|                   |                                                |                                            |   |        |            |  |       |            |   |  |            |     
|                   |                                                | Amounts included in short-term investments |   | $      | 58,858     |  |       | $          |  |  |            | $    | (186 | ) |   | $      | 58,672 | 
|                   |                                                |                                            |   |        |            |  |       |            |   |  |            |     
|September 30, 2003 |                                                |                                            |   |        |            |  |       |            |   |  |            |      |      |   |   |       
|                   | Auction rate preferred securities              |                                            | $ | 53,750 |            |  | $     |           |   |  | $          |     |      |   | $ | 53,750 |       
|                   | Commercial paper and corporate debt securities |                                            |   | 44,224 |            |  |       | 208        |   |  |            | (18  | )    |   |   | 44,414 |       
|                   |                                                |                                            |   |        |            |  |       |            |   |  |            |     
|                   | Amounts included in short-term investments     |                                            | $ | 97,974 |            |  | $     | 208        |   |  | $          | (18  | )    |   | $ | 98,164 |       
|                   |                                                |                                            |   |        |            |  |       |            |   |  |            |     





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PHOTON DYNAMICS, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)




|                 |       |                 |        |            |        |   |     |      |  
|---------------- | ----- | --------------- | ------ | ---------- | ------ | - | --- | ---- | -
|                 |       | Total in a Loss |       
|                 |       | Position(1)     |       
|                 |       |                 |       
|                 |       |                 |        | Gross      |       
|                 |       |                 |        | Unrealized |       
|                 |       | FMV             |        |            | Losses |  
|                 |       |                 |        |            |        |  
|                 |       | (In thousands)  |       
|Corporate equity |       | $               | 14,789 |            |        | $ | (93 | )   
|Municipal bonds  |       |                 | 15,907 |            |        |   | (93 | )   
|                 |       |                 |        |            |        |  
|                 | Total |                 | $      | 30,696     |        |   | $   | (186 | )
|                 |       |                 |        |            |        |  






|    |                                                                                                                                                                                                                                    
|--- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(1) | Of the total gross unrealized losses, approximately $28,000 of
    gross unrealized losses relates primarily to corporate equity
    with a fair value of $4.6 million that have been in a loss
    position for 12 months or more.



|                                     |                                      |                |        |           |            |   |        |        | 
|------------------------------------ | ------------------------------------ | -------------- | ------ | --------- | ---------- | - | ------ | ------ | 
|                                     |                                      |                |        | Estimated |           
|                                     |                                      | Cost           |        |           | Fair Value |  
|                                     |                                      |                |        |           |            |  
|                                     |                                      | (In thousands) |       
|Due within one year                  |                                      | $              | 24,370 |           |            | $ | 24,370 |       
|Due after one year through two years |                                      |                | 27,988 |           |            |   | 27,802 |       
|Due after two years                  |                                      |                | 6,500  |           |            |   | 6,500  |       
|                                     |                                      |                |        |           |            |  
|                                     | Total cost and estimated fair values |                | $      | 58,858    |            |   | $      | 58,672 | 
|                                     |                                      |                |        |           |            |  



| |                                 
| | --------------------------------
| | Derivative Financial Instruments







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PHOTON DYNAMICS, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)




Note 8  Income Taxes




|          |         |                            |   |     |      |  |   |      |    |  |   |    |    | 
|--------- | ------- | -------------------------- | - | --- | ---- |  | - | ---- | -- |  | - | -- | -- | 
|          |         | Year Ended                 |  
|          |         | September 30,              |  
|          |         |                            |  
|          |         | 2004                       |   |     | 2003 |  |   | 2002 |   
|          |         |                            |   |     |      |  |   |      |   
|          |         | (Restated)                 |   |     |      |  |  
|          |         | (In thousands)             |  
|Current:  |         |                            |   |     |      |  |   |      |    |  |   |   
|          | Federal |                            | $ | 164 |      |  | $ |     |    |  | $ |   |   
|          | State   |                            |   | 3   |      |  |   |     |    |  |   |   |   
|          | Foreign |                            |   | 410 |      |  |   | 56   |    |  |   | 85 |   
|Deferred: |         |                            |   |     |      |  |   |      |    |  |   |   
|          | Federal |                            |   |    |      |  |   |     |    |  |   |   |   
|          |         |                            |   |     |      |  |   |      |   
|          |         | Provision for income taxes |   | $   | 577  |  |   | $    | 56 |  |   | $  | 85 | 
|          |         |                            |   |     |      |  |   |      |   



|                                  |  |                          |        |   |      |   |         |      |  |   |       | 
|--------------------------------- |  | ------------------------ | ------ | - | ---- | - | ------- | ---- |  | - | ----- | 
|                                  |  | Year Ended September 30, |       
|                                  |  |                          |       
|                                  |  | 2004                     |        |   | 2003 |   |         | 2002 | 
|                                  |  |                          |        |   |      |   |         |      | 
|                                  |  | (Restated)               |        |   |      |   |        
|                                  |  | (In thousands)           |       
|Domestic                          |  | $                        | 17,490 |   |      | $ | (17,848 | )    |  | $ | 5,683 | 
|Foreign                           |  |                          | (5,828 | ) |      |   | (9,876  | )    |  |   | 632   | 
|                                  |  |                          |        |   |      |   |         |      | 
|Income (loss) before income taxes |  | $                        | 11,662 |   |      | $ | (27,724 | )    |  | $ | 6,315 | 
|                                  |  |                          |        |   |      |   |         |      | 

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PHOTON DYNAMICS, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)




|                         |                                                |                               |         |        |        |  |         |        |        | 
|------------------------ | ---------------------------------------------- | ----------------------------- | ------- | ------ | ------ |  | ------- | ------ | ------ | 
|                         |                                                | September 30,                 |        
|                         |                                                |                               |        
|                         |                                                | 2004                          |         |        | 2003   | 
|                         |                                                |                               |         |        |        | 
|                         |                                                | (Restated)                    |         |        |       
|                         |                                                | (In thousands)                |        
|Deferred tax assets:     |                                                |                               |         |        |        |  |         |       
|                         | Net operating loss carryforwards               |                               | $       | 32,385 |        |  | $       | 26,334 |       
|                         | Research credit carryforwards                  |                               |         | 9,805  |        |  |         | 8,225  |       
|                         | Canadian research and development expenditures |                               |         | 3,722  |        |  |         | 2,826  |       
|                         | Purchased intangibles                          |                               |         | 696    |        |  |         | 17,280 |       
|                         | Inventory write-downs                          |                               |         | 3,244  |        |  |         | 3,003  |       
|                         | Depreciation                                   |                               |         | 1,572  |        |  |         | 837    |       
|                         | Allowance for doubtful accounts                |                               |         | 202    |        |  |         | 204    |       
|                         | Expenses not currently deductible              |                               |         | 5,374  |        |  |         | 3,255  |       
|                         | Deferred revenue                               |                               |         | 7,173  |        |  |         | 1,852  |       
|                         |                                                |                               |         |        |        | 
|                         |                                                | Total deferred tax assets     |         |        | 64,173 |  |         |        | 63,816 | 
|Valuation allowance      |                                                |                               | (64,173 | )      |        |  | (63,816 | )     
|                         |                                                |                               |         |        |        | 
|Net deferred tax assets  |                                                |                               |        |        |        |  |        |       
|Deferred tax liabilities |                                                |                               |        |        |        |  |        |       
|                         |                                                |                               |         |        |        | 
|                         |                                                | Total net deferred tax assets |         | $      |       |  |         | $      |       | 
|                         |                                                |                               |         |        |        | 











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PHOTON DYNAMICS, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)






|                                                               |  |                          |        |   |      |   |         |      |  |   |         |  
|-------------------------------------------------------------- |  | ------------------------ | ------ | - | ---- | - | ------- | ---- |  | - | ------- | -
|                                                               |  | Year Ended September 30, |       
|                                                               |  |                          |       
|                                                               |  | 2004                     |        |   | 2003 |   |         | 2002 | 
|                                                               |  |                          |        |   |      |   |         |      | 
|                                                               |  | (Restated)               |        |   |      |   |        
|                                                               |  | (In thousands)           |       
|Expected provision (benefit) at federal statutory rate         |  | $                        | 3,594  |   |      | $ | (9,723  | )    |  | $ | 2,181   |  
|Foreign income taxes                                           |  |                          | 410    |   |      |   | 56      |      |  |   | 85      |  
|Election to treat subsidiary stock purchase as asset purchase  |  |                          |       |   |      |   |        |      |  |   | 11,906  |  
|Losses (benefited)/not benefited  Discontinued
    operations |  |                          |       |   |      |   | (18,171 | )    |  |   | (11,423 | )
|Losses (benefited)/not benefited                               |  |                          | (3,428 | ) |      |   | 26,993  |      |  |   | (2,868  | )
|Other individually immaterial items                            |  |                          | 1      |   |      |   | 901     |      |  |   | 204     |  
|                                                               |  |                          |        |   |      |   |         |      | 
|                                                               |  | $                        | 577    |   |      | $ | 56      |      |  | $ | 85      |  
|                                                               |  |                          |        |   |      |   |         |      | 

Note 9  Shareholders Equity and
Employee Benefits


Common Stock.


Warrants.


Stock Option Plans.




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PHOTON DYNAMICS, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)






|                               |  |           |          |   |             |  |           |                  |  |   |       | 
|------------------------------ |  | --------- | -------- | - | ----------- |  | --------- | ---------------- |  | - | ----- | 
|                               |  | Available |          |   | Options     |  |           | Weighted-Average | 
|                               |  | for Grant |          |   | Outstanding |  |           | Exercise Price   | 
|                               |  |           |          |   |             |  |           |                  | 
|Balances at September 30, 2001 |  |           | 360,032  |   |             |  | 1,961,809 |                  |  | $ | 19.74 | 
|Additional shares reserved     |  |           | 650,000  |   |             |  |          |                  |  |   |      | 
|Options granted                |  |           | (667,107 | ) |             |  | 667,107   |                  |  |   | 29.38 | 
|Options canceled/expired       |  |           | 559      |   |             |  | (114,089  | )                |  |   | 26.09 | 
|Options exercised              |  |           |         |   |             |  | (288,004  | )                |  |   | 13.33 | 
|                               |  |           |          |   |             |  |           |                  | 
|Balances at September 30, 2002 |  |           | 343,484  |   |             |  | 2,226,823 |                  |  |   | 23.11 | 
|Additional shares reserved     |  |           | 400,000  |   |             |  |          |                  |  |   |      | 
|Options granted                |  |           | (789,083 | ) |             |  | 789,083   |                  |  |   | 21.20 | 
|Options canceled/expired       |  |           | 770,746  |   |             |  | (786,231  | )                |  |   | 14.25 | 
|Options exercised              |  |           |         |   |             |  | (479,037  | )                |  |   | 28.73 | 
|                               |  |           |          |   |             |  |           |                  | 
|Balances at September 30, 2003 |  |           | 725,147  |   |             |  | 1,750,638 |                  |  |   | 22.14 | 
|Additional shares reserved     |  |           | 400,000  |   |             |  |          |                  |  |   |      | 
|Options granted                |  |           | (618,550 | ) |             |  | 618,550   |                  |  |   | 31.72 | 
|Options canceled/expired       |  |           | 352,407  |   |             |  | (352,407  | )                |  |   | 13.27 | 
|Options exercised              |  |           |         |   |             |  | (384,572  | )                |  |   | 22.74 | 
|                               |  |           |          |   |             |  |           |                  | 
|Balances at September 30, 2004 |  |           | 859,004  |   |             |  | 1,632,209 |                  |  | $ | 27.73 | 
|                               |  |           |          |   |             |  |           |                  | 



|                        |  |                     |           |  |                                |  |      |                   |  |   |             |  |                  |                   |         |  |  |   |       | 
|----------------------- |  | ------------------- | --------- |  | ------------------------------ |  | ---- | ----------------- |  | - | ----------- |  | ---------------- | ----------------- | ------- |  |  | - | ----- | 
|                        |  | Options Outstanding |           |  | Options Vested and Exercisable | 
|                        |  |                     |           |  |                                | 
|                        |  | Number of Shares    |           |  | Weighted-Average               |  |      | Weighted-Average  |  |   |             |  | Weighted-Average |                  
|                        |  | Outstanding at      |           |  | Remaining                      |  |      | Exercise Price at |  |   | Number      |  |                  | Exercise Price at |        
|                        |  | September 30,       |           |  | Contract Life                  |  |      | September 30,     |  |   | Vested and  |  |                  | September 30,     |        
|Range of Exercise Price |  | 2004                |           |  | (In years)                     |  |      | 2004              |  |   | Exercisable |  |                  | 2004              |        
|                        |  |                     |           |  |                                |  |      |                   |  |   |             |  |                  |                   |        
|$ 3.00 - $ 6.13         |  |                     | 49,176    |  |                                |  | 4.08 |                   |  | $ | 4.76        |  |                  |                   | 49,176  |  |  | $ | 4.76  | 
|10.63 -  16.88          |  |                     | 143,983   |  |                                |  | 6.18 |                   |  |   | 14.90       |  |                  |                   | 133,291 |  |  |   | 14.75 | 
|17.75 -  23.63          |  |                     | 219,325   |  |                                |  | 7.01 |                   |  |   | 19.18       |  |                  |                   | 139,179 |  |  |   | 19.47 | 
|24.43 -  26.24          |  |                     | 274,260   |  |                                |  | 7.94 |                   |  |   | 25.51       |  |                  |                   | 131,624 |  |  |   | 25.64 | 
|27.58 -  29.31          |  |                     | 370,926   |  |                                |  | 9.01 |                   |  |   | 28.36       |  |                  |                   | 73,266  |  |  |   | 28.73 | 
|29.69 -  47.31          |  |                     | 561,289   |  |                                |  | 8.51 |                   |  |   | 36.31       |  |                  |                   | 238,841 |  |  |   | 39.82 | 
|59.00 -  59.00          |  |                     | 13,250    |  |                                |  | 5.74 |                   |  |   | 59.00       |  |                  |                   | 13,250  |  |  |   | 59.00 | 
|                        |  |                     |           |  |                                |  |      |                   |  |   |             |  |                  |                   |        
|$ 3.00 - $59.00         |  |                     | 1,632,209 |  |                                |  | 7.97 |                   |  | $ | 27.73       |  |                  |                   | 778,627 |  |  | $ | 26.56 | 
|                        |  |                     |           |  |                                |  |      |                   |  |   |             |  |                  |                   |        



Employee Purchase Plan.


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PHOTON DYNAMICS, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)




Other Employee Benefits Plans.




Shares Reserved.


|                                        |       |               |           |           | 
|--------------------------------------- | ----- | ------------- | --------- | --------- | 
|                                        |       | September 30, |          
|                                        |       | 2004          |          
|                                        |       |               |          
|Stock options outstanding               |       |               | 1,632,209 |          
|Stock options, available for grant      |       |               | 859,004   |          
|Shares for employee stock purchase plan |       |               | 846,868   |          
|Warrants                                |       |               | 28,766    |          
|                                        |       |               |          
|                                        | Total |               |           | 3,366,847 | 
|                                        |       |               |          

Note 10  Net Income (Loss) Per Share




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PHOTON DYNAMICS, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)




|                    |                                                                                     |                                              |   |        |       |      |   |         |       |   |   |         |       |     
|------------------- | ----------------------------------------------------------------------------------- | -------------------------------------------- | - | ------ | ----- | ---- | - | ------- | ----- | - | - | ------- | ----- | ----
|                    |                                                                                     | Year Ended September 30,                     |  
|                    |                                                                                     |                                              |  
|                    |                                                                                     | 2004                                         |   |        | 2003  |      |   | 2002    |      
|                    |                                                                                     |                                              |   |        |       |      |   |         |      
|                    |                                                                                     | (Restated)                                   |   |        |       |      |  
|                    |                                                                                     | (In thousand, except per share data)         |  
|Numerator:          |                                                                                     |                                              |   |        |       |      |   |         |       |   |   |        
|                    | Net income (loss) from continuing operations before discontinued
    operations     |                                              | $ | 11,085 |       |      | $ | (27,780 | )     |   | $ | 6,230   |      
|                    | Net loss from discontinued operations                                               |                                              |   | (1,391 | )     |      |   | (44,592 | )     |   |   | (28,032 | )    
|                    |                                                                                     |                                              |   |        |       |      |   |         |      
|                    | Net income (loss)                                                                   |                                              | $ | 9,694  |       |      | $ | (72,372 | )     |   | $ | (21,802 | )    
|                    |                                                                                     |                                              |   |        |       |      |   |         |      
|Denominator:        |                                                                                     |                                              |   |        |       |      |   |         |       |   |   |        
|                    | Weighted average shares for basic net income (loss) per share                       |                                              |   | 16,631 |       |      |   | 16,089  |       |   |   | 15,923  |      
|                    | Effect of dilutive securities: Employee stock options                               |                                              |   | 456    |       |      |   |        |       |   |   | 868     |      
|                    |                                                                                     |                                              |   |        |       |      |   |         |      
|                    | Weighted average shares for diluted net income per share                            |                                              |   | 17,087 |       |      |   | 16,089  | (1)   |   |   | 16,791  |      
|                    |                                                                                     |                                              |   |        |       |      |   |         |      
|Earnings per share: |                                                                                     |                                              |   |        |       |      |   |         |       |   |   |        
|                    | Basic net income (loss) per share:
    Net income (loss) from continuing operations |                                              | $ | 0.67   |       |      | $ | (1.73   | )     |   | $ | 0.39    |      
|                    |                                                                                     | Net loss from discontinued operations        |   |        | (0.08 | )    |   |         | (2.77 | ) |   |         | (1.76 | )   
|                    |                                                                                     |                                              |   |        |       |      |   |         |      
|                    |                                                                                     | Net income (loss) per share                  |   | $      | 0.58  |      |   | $       | (4.50 | ) |   | $       | (1.37 | )   
|                    |                                                                                     |                                              |   |        |       |      |   |         |      
|                    | Diluted net income (loss) per share:                                                |                                              |   |        |       |      |   |         |       |   |   |         |      
|                    |                                                                                     | Net income (loss) from continuing operations |   | $      | 0.65  |      |   | $       | (1.73 | ) |   | $       | 0.37  |     
|                    |                                                                                     | Net loss from discontinued operations        |   |        | (0.08 | )(2) |   |         | (2.77 | ) |   |         | (1.67 | )(2)
|                    |                                                                                     |                                              |   |        |       |      |   |         |      
|                    |                                                                                     | Net income (loss) per share                  |   | $      | 0.57  |      |   | $       | (4.50 | ) |   | $       | (1.30 | )   
|                    |                                                                                     |                                              |   |        |       |      |   |         |      






|    |                                                                                                                                                                                                                                                                                                                                               
|--- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(1) | The effect of dilutive securities from employee stock options
    and warrants to purchase 479,000 shares at
    September 30, 2003, was not included in the computation of
    diluted earnings per share as the effect is antidilutive due to
    net losses.                                                                               
|   
|(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 and warrants to purchase 456,000 and
    868,000 shares in its calculation of 2004 and 2002 diluted
    net loss from discontinued operations, respectively.



Note 11  Commitments and Contingencies




| |           
| | ----------
| | Facilities



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PHOTON DYNAMICS, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)










| |               
| | --------------
| | Line of Credit





| |                    
| | -------------------
| | Purchase Agreements





| |                
| | ---------------
| | Retention Bonus









| |                     
| | --------------------
| | Warranty Obligations



78



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PHOTON DYNAMICS, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)






|                  |                                                                             |                |       |        |        |   |       |        |  
|----------------- | --------------------------------------------------------------------------- | -------------- | ----- | ------ | ------ | - | ----- | ------ | -
|                  |                                                                             | Fiscal         |       |        | Fiscal |  
|                  |                                                                             | 2004           |       |        | 2003   |  
|                  |                                                                             |                |       |        |        |  
|                  |                                                                             | (In thousands) |      
|Beginning balance |                                                                             | $              | 2,363 |        |        | $ | 2,383 |       
|                  | Estimated warranty cost of new shipments during the period                  |                |       | 6,744  |        |   |       | 2,883  |  
|                  | Warranty charges during the period                                          |                |       | (4,588 | )      |   |       | (2,523 | )
|                  | Changes in liability for pre-existing warranties, including
    expirations |                |       | 1,675  |        |   |       | (530   | )
|                  | Liability assumed as a result of the acquisition of the RTP
    Assets      |                |       |       |        |   |       | 150    |  
|                  |                                                                             |                |       |        |        |  
|Ending balance    |                                                                             | $              | 6,194 |        |        | $ | 2,363 |       
|                  |                                                                             |                |       |        |        |  



| |                  
| | -----------------
| | Legal Proceedings





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PHOTON DYNAMICS, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)












|          |                                             
|--------- | --------------------------------------------
|Note 12  | Segment Reporting and Geographic Information





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PHOTON DYNAMICS, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)






|         |        |                          |   |        |         |  |   |        |        |  |   |        |        | 
|-------- | ------ | ------------------------ | - | ------ | ------- |  | - | ------ | ------ |  | - | ------ | ------ | 
|         |        | Year Ended September 30, |  
|         |        |                          |  
|         |        | 2004                     |   |        | 2003    |  |   | 2002   |       
|         |        |                          |   |        |         |  |   |        |       
|         |        | (Restated)               |   |        |         |  |  
|         |        | (In thousands)           |  
|Revenue: |        |                          |   |        |         |  |   |        |        |  |   |       
|         | Korea  |                          | $ | 68,450 |         |  | $ | 47,024 |        |  | $ | 28,132 |       
|         | Taiwan |                          |   | 60,793 |         |  |   | 19,125 |        |  |   | 16,546 |       
|         | Japan  |                          |   | 11,017 |         |  |   | 1,047  |        |  |   | 4,664  |       
|         | China  |                          |   | 1,610  |         |  |   |       |        |  |   |       |       
|         |        |                          |   |        |         |  |   |        |       
|         |        | Total                    |   | $      | 141,870 |  |   | $      | 67,196 |  |   | $      | 49,342 | 
|         |        |                          |   |        |         |  |   |        |       



|         |                  |                          |  |     |      |  |  |      |      |  |  |     |      | 
|-------- | ---------------- | ------------------------ |  | --- | ---- |  |  | ---- | ---- |  |  | --- | ---- | 
|         |                  | Year Ended September 30, | 
|         |                  |                          | 
|         |                  | 2004                     |  |     | 2003 |  |  | 2002 |     
|         |                  |                          |  |     |      |  |  |      |     
|         |                  | (Restated)               |  |     |      |  | 
|Revenue: |                  |                          |  |     |      |  |  |      |      |  |  |    
|         | ArrayCheckertm   |                          |  | 75% |      |  |  | 81%  |      |  |  | 72% |     
|         | ArraySavertm     |                          |  | 19% |      |  |  | 4%   |      |  |  | 15% |     
|         | RTP systems      |                          |  | 1%  |      |  |  | 6%   |      |  |  | 0%  |     
|         | Spares and other |                          |  | 5%  |      |  |  | 9%   |      |  |  | 13% |     
|         |                  |                          |  |     |      |  |  |      |     
|         |                  | Total                    |  |     | 100% |  |  |      | 100% |  |  |     | 100% | 
|         |                  |                          |  |     |      |  |  |      |     



|           |  |                          |    |   |      |  |    |      |  |  |    |  
|---------- |  | ------------------------ | -- | - | ---- |  | -- | ---- |  |  | -- | -
|           |  | Year Ended September 30, |   
|           |  |                          |   
|           |  | 2004                     |    |   | 2003 |  |    | 2002 | 
|           |  |                          |    |   |      |  |    |      | 
|           |  | (Restated)               |    |   |      |  |   
|           |  | (Percent of revenue)     |   
|Customer A |  |                          | 39 | % |      |  | 43 | %    |  |  | 48 | %
|Customer B |  |                          | *  |   |      |  | 23 | %    |  |  | *  |  
|Customer C |  |                          | 13 | % |      |  | *  |      |  |  | *  |  
|Customer E |  |                          | *  |   |      |  | 13 | %    |  |  | 13 | %
|Customer F |  |                          | 10 | % |      |  | *  |      |  |  | *  |  
|Customer H |  |                          | 10 | % |      |  | *  |      |  |  | *  |  






|  |                                                                          
|- | -------------------------------------------------------------------------
|* | Customer accounted for less than 10% of total revenue for the
    period.

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PHOTON DYNAMICS, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)




|           |  |                |    |   |      |  |    |  
|---------- |  | -------------- | -- | - | ---- |  | -- | -
|           |  | September 30,  |   
|           |  |                |   
|           |  | 2004           |    |   | 2003 | 
|           |  |                |    |   |      | 
|           |  | (Percent of    |   
|           |  | gross accounts |   
|           |  | receivable)    |   
|Customer A |  |                | 29 | % |      |  | 25 | %
|Customer C |  |                | 16 | % |      |  | *  |  
|Customer D |  |                | 13 | % |      |  | *  |  
|Customer F |  |                | 12 | % |      |  | *  |  
|Customer H |  |                | *  |   |      |  | 58 | %






|  |                                                                                            
|- | -------------------------------------------------------------------------------------------
|* | Customer accounted for less than 10% of total gross accounts
    receivable for the period.



|              |       |                |        |        |      |   |        |        | 
|------------- | ----- | -------------- | ------ | ------ | ---- | - | ------ | ------ | 
|              |       | Year Ended     |       
|              |       | September 30,  |       
|              |       |                |       
|              |       | 2004           |        |        | 2003 |  
|              |       |                |        |        |      |  
|              |       | (In thousands) |       
|United States |       | $              | 22,889 |        |      | $ | 13,709 |       
|Canada        |       |                | 1,947  |        |      |   | 1,815  |       
|Other         |       |                | 407    |        |      |   | 186    |       
|              |       |                |        |        |      |  
|              | Total |                | $      | 25,243 |      |   | $      | 15,710 | 
|              |       |                |        |        |      |  

Note 13  Related Party Transactions








|          |              
|--------- | -------------
|Note 14  | Notes Payable



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PHOTON DYNAMICS, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)










|              |  |                             |       |  |      |   |       |      |  |   |       |  |      |   |   |      |  |            |   |  |  |   |   |  |  |   |   | 
|------------- |  | --------------------------- | ----- |  | ---- | - | ----- | ---- |  | - | ----- |  | ---- | - | - | ---- |  | ---------- | - |  |  | - | - |  |  | - | - | 
|              |  | Payments Due by Fiscal Year
|              |  |                            
|              |  | Total                       |       |  | 2005 |   |       | 2006 |  |   | 2007  |  | 2008 |   |   | 2009 |  | Thereafter
|              |  |                             |       |  |      |   |       |      |  |   |       |  |      |   |   |      |  |           
|Notes payable |  | $                           | 2,829 |  |      | $ | 1,446 |      |  | $ | 1,383 |  |      | $ |  |      |  | $          |  |  |  | $ |  |  |  | $ |  | 

83



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PHOTON DYNAMICS, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)




|          |                                                         
|--------- | --------------------------------------------------------
|Note 15  | Quarterly Consolidated Results of Operations (Unaudited)



|                                                          |                                              |                                       |        |        |            |   |        |            |        |   |               |        |        |   |        |        |        | 
|--------------------------------------------------------- | -------------------------------------------- | ------------------------------------- | ------ | ------ | ---------- | - | ------ | ---------- | ------ | - | ------------- | ------ | ------ | - | ------ | ------ | ------ | 
|                                                          |                                              | Three Months Ended                    |       
|                                                          |                                              |                                       |       
|                                                          |                                              | December 31,                          |        |        | March 31,  |   |        | June 30,   |        |   | September 30, |       
|                                                          |                                              | 2003                                  |        |        | 2004       |   |        | 2004       |        |   | 2004          |       
|                                                          |                                              |                                       |        |        |            |   |        |            |        |   |               |       
|                                                          |                                              | (Restated)                            |        |        | (Restated) |   |        | (Restated) |        |   | (Restated)    |       
|                                                          |                                              | (In thousands, except per share data) |       
|Revenue                                                   |                                              | $                                     | 24,375 |        |            | $ | 26,182 |            |        | $ | 38,522        |        |        | $ | 52,791 |       
|Cost of revenue                                           |                                              |                                       | 13,412 |        |            |   | 14,183 |            |        |   | 20,711        |        |        |   | 35,663 |       
|                                                          |                                              |                                       |        |        |            |   |        |            |        |   |               |       
|Gross margin                                              |                                              |                                       | 10,963 |        |            |   | 11,999 |            |        |   | 17,811        |        |        |   | 17,128 |       
|Operating expenses:                                       |                                              |                                       |        |        |            |   |        |            |        |   |               |        |        |   |        |       
|                                                          | Research and development                     |                                       |        | 5,810  |            |   |        | 6,144      |        |   |               | 8,031  |        |   |        | 9,716  |       
|                                                          | Selling, general and administrative          |                                       |        | 4,598  |            |   |        | 3,966      |        |   |               | 4,594  |        |   |        | 4,622  |       
|                                                          | Goodwill impairment charge                   |                                       |        | 665    |            |   |        |           |        |   |               |       |        |   |        |       |       
|                                                          | Impairment of purchased intangibles          |                                       |        | 2,089  |            |   |        |           |        |   |               |       |        |   |        |       |       
|                                                          | Impairment of fixed assets                   |                                       |        | 234    |            |   |        |           |        |   |               |       |        |   |        |       |       
|                                                          | (Gain) loss on sale of fixed assets          |                                       |        | (10    | )          |   |        | (20        | )      |   |               | (419   | )      |   |        | 22     |       
|                                                          | Acquired in-process research and development |                                       |        |       |            |   |        |           |        |   |               | 210    |        |   |        |       |       
|                                                          | Amortization of intangible assets            |                                       |        | 201    |            |   |        | 60         |        |   |               | 155    |        |   |        | 373    |       
|                                                          |                                              |                                       |        |        |            |   |        |            |        |   |               |       
|                                                          |                                              | Total operating expenses              |        |        | 13,587     |   |        |            | 10,150 |   |               |        | 12,571 |   |        |        | 14,733 | 
|Income (loss) from operations                             |                                              |                                       | (2,624 | )      |            |   | 1,849  |            |        |   | 5,240         |        |        |   | 2,395  |       
|Interest income and other, net                            |                                              |                                       | 3,771  |        |            |   | 334    |            |        |   | 389           |        |        |   | 308    |       
|                                                          |                                              |                                       |        |        |            |   |        |            |        |   |               |       
|Income before income taxes                                |                                              |                                       | 1,147  |        |            |   | 2,183  |            |        |   | 5,629         |        |        |   | 2,703  |       
|Provision for income taxes                                |                                              |                                       | 362    |        |            |   | 64     |            |        |   | 134           |        |        |   | 17     |       
|                                                          |                                              |                                       |        |        |            |   |        |            |        |   |               |       
|Income from continuing operations                         |                                              |                                       | 785    |        |            |   | 2,119  |            |        |   | 5,495         |        |        |   | 2,686  |       
|Income (loss) from discontinued operations                |                                              |                                       | 47     |        |            |   | (1,276 | )          |        |   | (265          | )      |        |   | 103    |       
|                                                          |                                              |                                       |        |        |            |   |        |            |        |   |               |       
|Net income                                                |                                              | $                                     | 832    |        |            | $ | 843    |            |        | $ | 5,230         |        |        | $ | 2,789  |       
|                                                          |                                              |                                       |        |        |            |   |        |            |        |   |               |       
|Net income per share from continuing operations:          |                                              |                                       |        |        |            |   |        |            |        |   |               |        |        |   |        |       
|                                                          | Basic                                        |                                       | $      | 0.05   |            |   | $      | 0.13       |        |   | $             | 0.33   |        |   | $      | 0.16   |       
|                                                          |                                              |                                       |        |        |            |   |        |            |        |   |               |       
|                                                          | Diluted                                      |                                       | $      | 0.05   |            |   | $      | 0.12       |        |   | $             | 0.32   |        |   | $      | 0.16   |       
|                                                          |                                              |                                       |        |        |            |   |        |            |        |   |               |       
|Net income (loss) per share from discontinued operations: |                                              |                                       |        |        |            |   |        |            |        |   |               |        |        |   |        |       
|                                                          | Basic                                        |                                       | $      | 0.00   |            |   | $      | (0.08      | )      |   | $             | (0.02  | )      |   | $      | 0.01   |       
|                                                          |                                              |                                       |        |        |            |   |        |            |        |   |               |       
|                                                          | Diluted                                      |                                       | $      | 0.00   |            |   | $      | (0.07      | )      |   | $             | (0.02  | )      |   | $      | 0.01   |       
|                                                          |                                              |                                       |        |        |            |   |        |            |        |   |               |       
|Net income per share:                                     |                                              |                                       |        |        |            |   |        |            |        |   |               |        |        |   |        |       
|                                                          | Basic                                        |                                       | $      | 0.05   |            |   | $      | 0.05       |        |   | $             | 0.31   |        |   | $      | 0.17   |       
|                                                          |                                              |                                       |        |        |            |   |        |            |        |   |               |       
|                                                          | Diluted                                      |                                       | $      | 0.05   |            |   | $      | 0.05       |        |   | $             | 0.31   |        |   | $      | 0.16   |       
|                                                          |                                              |                                       |        |        |            |   |        |            |        |   |               |       
|Weighted average number of shares:                        |                                              |                                       |        |        |            |   |        |            |        |   |               |        |        |   |        |       
|                                                          | Basic                                        |                                       |        | 16,461 |            |   |        | 16,572     |        |   |               | 16,663 |        |   |        | 16,826 |       
|                                                          | Diluted                                      |                                       |        | 17,174 |            |   |        | 17,172     |        |   |               | 17,071 |        |   |        | 16,977 |       

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PHOTON DYNAMICS, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)


|                                                          |                                              |                                       |        |         |           |   |        |          |       |   |               |        |        |   |         |         |        | 
|--------------------------------------------------------- | -------------------------------------------- | ------------------------------------- | ------ | ------- | --------- | - | ------ | -------- | ----- | - | ------------- | ------ | ------ | - | ------- | ------- | ------ | 
|                                                          |                                              | Three Months Ended                    |       
|                                                          |                                              |                                       |       
|                                                          |                                              | December 31,                          |        |         | March 31, |   |        | June 30, |       |   | September 30, |       
|                                                          |                                              | 2002                                  |        |         | 2003      |   |        | 2003     |       |   | 2003          |       
|                                                          |                                              |                                       |        |         |           |   |        |          |       |   |               |       
|                                                          |                                              | (In thousands, except per share data) |       
|Revenue                                                   |                                              | $                                     | 19,162 |         |           | $ | 9,058  |          |       | $ | 17,996        |        |        | $ | 20,980  |        
|Cost of revenue                                           |                                              |                                       | 11,569 |         |           |   | 7,909  |          |       |   | 11,789        |        |        |   | 12,804  |        
|                                                          |                                              |                                       |        |         |           |   |        |          |       |   |               |       
|Gross margin                                              |                                              |                                       | 7,593  |         |           |   | 1,149  |          |       |   | 6,207         |        |        |   | 8,176   |        
|Operating expenses:                                       |                                              |                                       |        |         |           |   |        |          |       |   |               |        |        |   |         |        
|                                                          | Research and development                     |                                       |        | 4,487   |           |   |        | 5,419    |       |   |               | 6,313  |        |   |         | 6,567   |       
|                                                          | Selling, general and administrative          |                                       |        | 3,068   |           |   |        | 3,776    |       |   |               | 3,176  |        |   |         | 3,743   |       
|                                                          | Goodwill impairment charge                   |                                       |        |        |           |   |        |         |       |   |               |       |        |   |         | 10,010  |       
|                                                          | Impairment of purchased intangibles          |                                       |        |        |           |   |        |         |       |   |               |       |        |   |         | 3,548   |       
|                                                          | Acquired in-process research and development |                                       |        | 1,849   |           |   |        |         |       |   |               | 625    |        |   |         |        |       
|                                                          | Amortization of intangible assets            |                                       |        | 260     |           |   |        | 367      |       |   |               | 408    |        |   |         | 201     |       
|                                                          |                                              |                                       |        |         |           |   |        |          |       |   |               |       
|                                                          |                                              | Total operating expenses              |        |         | 9,664     |   |        |          | 9,562 |   |               |        | 10,522 |   |         |         | 24,069 | 
|Loss from operations                                      |                                              |                                       | (2,071 | )       |           |   | (8,413 | )        |       |   | (4,315        | )      |        |   | (15,893 | )      
|Interest income and other, net                            |                                              |                                       | 824    |         |           |   | 717    |          |       |   | 955           |        |        |   | 472     |        
|                                                          |                                              |                                       |        |         |           |   |        |          |       |   |               |       
|Loss before income taxes                                  |                                              |                                       | (1,247 | )       |           |   | (7,696 | )        |       |   | (3,360        | )      |        |   | (15,421 | )      
|Provision for income taxes                                |                                              |                                       | 11     |         |           |   | 37     |          |       |   | 3             |        |        |   | 5       |        
|                                                          |                                              |                                       |        |         |           |   |        |          |       |   |               |       
|Loss from continuing operations                           |                                              |                                       | (1,258 | )       |           |   | (7,733 | )        |       |   | (3,363        | )      |        |   | (15,426 | )      
|                                                          | Income (loss) from discontinued operations   |                                       |        | (23,760 | )         |   |        | (15,280  | )     |   |               | (5,607 | )      |   |         | 55      |       
|                                                          |                                              |                                       |        |         |           |   |        |          |       |   |               |       
|                                                          | Net loss                                     |                                       | $      | (25,018 | )         |   | $      | (23,013  | )     |   | $             | (8,970 | )      |   | $       | (15,371 | )     
|                                                          |                                              |                                       |        |         |           |   |        |          |       |   |               |       
|Net loss per share from continuing operations:            |                                              |                                       |        |         |           |   |        |          |       |   |               |        |        |   |         |        
|                                                          | Basic                                        |                                       | $      | (0.08   | )         |   | $      | (0.49    | )     |   | $             | (0.21  | )      |   | $       | (0.95   | )     
|                                                          |                                              |                                       |        |         |           |   |        |          |       |   |               |       
|                                                          | Diluted                                      |                                       | $      | (0.08   | )         |   | $      | (0.49    | )     |   | $             | (0.21  | )      |   | $       | (0.95   | )     
|                                                          |                                              |                                       |        |         |           |   |        |          |       |   |               |       
|Net income (loss) per share from discontinued operations: |                                              |                                       |        |         |           |   |        |          |       |   |               |        |        |   |         |        
|                                                          | Basic                                        |                                       | $      | (1.47   | )         |   | $      | (0.96    | )     |   | $             | (0.35  | )      |   | $       | 0.00    |       
|                                                          |                                              |                                       |        |         |           |   |        |          |       |   |               |       
|                                                          | Diluted                                      |                                       | $      | (1.47   | )         |   | $      | (0.96    | )     |   | $             | (0.35  | )      |   | $       | 0.00    |       
|                                                          |                                              |                                       |        |         |           |   |        |          |       |   |               |       
|Net loss per share:                                       |                                              |                                       |        |         |           |   |        |          |       |   |               |        |        |   |         |        
|                                                          | Basic                                        |                                       | $      | (1.55   | )         |   | $      | (1.44    | )     |   | $             | (0.56  | )      |   | $       | (0.95   | )     
|                                                          |                                              |                                       |        |         |           |   |        |          |       |   |               |       
|                                                          | Diluted                                      |                                       | $      | (1.55   | )         |   | $      | (1.44    | )     |   | $             | (0.56  | )      |   | $       | (0.95   | )     
|                                                          |                                              |                                       |        |         |           |   |        |          |       |   |               |       
|Weighted average number of shares:                        |                                              |                                       |        |         |           |   |        |          |       |   |               |        |        |   |         |        
|                                                          | Basic                                        |                                       |        | 16,156  |           |   |        | 15,944   |       |   |               | 16,003 |        |   |         | 16,176  |       
|                                                          | Diluted                                      |                                       |        | 16,156  |           |   |        | 15,944   |       |   |               | 16,003 |        |   |         | 16,176  |       

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PHOTON DYNAMICS, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)




|                                                   |         |                                       |        |        |             |   |      |             |   |   |        |        | 
|-------------------------------------------------- | ------- | ------------------------------------- | ------ | ------ | ----------- | - | ---- | ----------- | - | - | ------ | ------ | 
|                                                   |         | Three Months Ended December 31, 2003  |       
|                                                   |         |                                       |       
|                                                   |         | As Reported                           |        |        | Adjustments |   |      | As Restated |  
|                                                   |         |                                       |        |        |             |   |      |             |  
|                                                   |         | (In thousands, except per share data) |       
|Revenue                                            |         | $                                     | 24,499 |        |             | $ | (124 | )           |   | $ | 24,375 |       
|Loss from operations                               |         |                                       | (2,500 | )      |             |   | (124 | )           |   |   | (2,624 | )     
|Interest income and other, net                     |         |                                       | 3,771  |        |             |   |     |             |   |   | 3,771  |       
|                                                   |         |                                       |        |        |             |   |      |             |  
|Income before income taxes                         |         |                                       | 1,271  |        |             |   | (124 | )           |   |   | 1,147  |       
|Provision for income taxes                         |         |                                       | 362    |        |             |   |     |             |   |   | 362    |       
|                                                   |         |                                       |        |        |             |   |      |             |  
|Income from continuing operations                  |         |                                       | 909    |        |             |   | (124 | )           |   |   | 785    |       
|Income from discontinued operations                |         |                                       | 47     |        |             |   |     |             |   |   | 47     |       
|                                                   |         |                                       |        |        |             |   |      |             |  
|Net income                                         |         | $                                     | 956    |        |             | $ | (124 | )           |   | $ | 832    |       
|                                                   |         |                                       |        |        |             |   |      |             |  
|Net income per share from continuing operations:   |         |                                       |        |        |             |   |      |             |   |   |        |       
|                                                   | Basic   |                                       | $      | 0.06   |             |   | $    | (0.01       | ) |   | $      | 0.05   | 
|                                                   |         |                                       |        |        |             |   |      |             |  
|                                                   | Diluted |                                       | $      | 0.05   |             |   | $    | (0.01       | ) |   | $      | 0.05   | 
|                                                   |         |                                       |        |        |             |   |      |             |  
|Net income per share from discontinued operations: |         |                                       |        |        |             |   |      |             |   |   |        |       
|                                                   | Basic   |                                       | $      | 0.00   |             |   | $    | 0.00        |   |   | $      | 0.00   | 
|                                                   |         |                                       |        |        |             |   |      |             |  
|                                                   | Diluted |                                       | $      | 0.00   |             |   | $    | 0.00        |   |   | $      | 0.00   | 
|                                                   |         |                                       |        |        |             |   |      |             |  
|Net income per share:                              |         |                                       |        |        |             |   |      |             |   |   |        |       
|                                                   | Basic   |                                       | $      | 0.06   |             |   | $    | (0.01       | ) |   | $      | 0.05   | 
|                                                   |         |                                       |        |        |             |   |      |             |  
|                                                   | Diluted |                                       | $      | 0.06   |             |   | $    | (0.01       | ) |   | $      | 0.05   | 
|                                                   |         |                                       |        |        |             |   |      |             |  
|Weighted average number of shares:                 |         |                                       |        |        |             |   |      |             |   |   |        |       
|                                                   | Basic   |                                       |        | 16,461 |             |   |      | 16,461      |   |   |        | 16,461 | 
|                                                   | Diluted |                                       |        | 17,174 |             |   |      | 17,174      |   |   |        | 17,174 | 

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PHOTON DYNAMICS, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)


|                                                 |         |                                       |        |        |             |   |      |             |   |   |        |        |  
|------------------------------------------------ | ------- | ------------------------------------- | ------ | ------ | ----------- | - | ---- | ----------- | - | - | ------ | ------ | -
|                                                 |         | Three Months Ended March 31, 2004     |       
|                                                 |         |                                       |       
|                                                 |         | As Reported                           |        |        | Adjustments |   |      | As Restated |  
|                                                 |         |                                       |        |        |             |   |      |             |  
|                                                 |         | (In thousands, except per share data) |       
|Revenue                                          |         | $                                     | 26,478 |        |             | $ | (296 | )           |   | $ | 26,182 |       
|Income from operations                           |         |                                       | 2,145  |        |             |   | (296 | )           |   |   | 1,849  |       
|Interest income and other, net                   |         |                                       | 334    |        |             |   |     |             |   |   | 334    |       
|                                                 |         |                                       |        |        |             |   |      |             |  
|Income before income taxes                       |         |                                       | 2,479  |        |             |   | (296 | )           |   |   | 2,183  |       
|Provision for income taxes                       |         |                                       | 64     |        |             |   |     |             |   |   | 64     |       
|                                                 |         |                                       |        |        |             |   |      |             |  
|Income from continuing operations                |         |                                       | 2,415  |        |             |   | (296 | )           |   |   | 2,119  |       
|Loss from discontinued operations                |         |                                       | (1,276 | )      |             |   |     |             |   |   | (1,276 | )     
|                                                 |         |                                       |        |        |             |   |      |             |  
|Net income                                       |         | $                                     | 1,139  |        |             | $ | (296 | )           |   | $ | 843    |       
|                                                 |         |                                       |        |        |             |   |      |             |  
|Net income per share from continuing operations: |         |                                       |        |        |             |   |      |             |   |   |        |       
|                                                 | Basic   |                                       | $      | 0.15   |             |   | $    | (0.02       | ) |   | $      | 0.13   |  
|                                                 |         |                                       |        |        |             |   |      |             |  
|                                                 | Diluted |                                       | $      | 0.14   |             |   | $    | (0.02       | ) |   | $      | 0.12   |  
|                                                 |         |                                       |        |        |             |   |      |             |  
|Net loss per share from discontinued operations: |         |                                       |        |        |             |   |      |             |   |   |        |       
|                                                 | Basic   |                                       | $      | (0.08  | )           |   | $    | 0.00        |   |   | $      | (0.08  | )
|                                                 |         |                                       |        |        |             |   |      |             |  
|                                                 | Diluted |                                       | $      | (0.07  | )           |   | $    | 0.00        |   |   | $      | (0.07  | )
|                                                 |         |                                       |        |        |             |   |      |             |  
|Net income per share:                            |         |                                       |        |        |             |   |      |             |   |   |        |       
|                                                 | Basic   |                                       | $      | 0.07   |             |   | $    | (0.02       | ) |   | $      | 0.05   |  
|                                                 |         |                                       |        |        |             |   |      |             |  
|                                                 | Diluted |                                       | $      | 0.07   |             |   | $    | (0.02       | ) |   | $      | 0.05   |  
|                                                 |         |                                       |        |        |             |   |      |             |  
|Weighted average number of shares:               |         |                                       |        |        |             |   |      |             |   |   |        |       
|                                                 | Basic   |                                       |        | 16,572 |             |   |      | 16,572      |   |   |        | 16,572 |  
|                                                 | Diluted |                                       |        | 17,172 |             |   |      | 17,172      |   |   |        | 17,172 |  

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PHOTON DYNAMICS, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)


|                                                 |         |                                       |        |        |             |   |    |             |  |   |        |        |  
|------------------------------------------------ | ------- | ------------------------------------- | ------ | ------ | ----------- | - | -- | ----------- |  | - | ------ | ------ | -
|                                                 |         | Three Months Ended June 30, 2004      |       
|                                                 |         |                                       |       
|                                                 |         | As Reported                           |        |        | Adjustments |   |    | As Restated | 
|                                                 |         |                                       |        |        |             |   |    |             | 
|                                                 |         | (In thousands, except per share data) |       
|Revenue                                          |         | $                                     | 38,452 |        |             | $ | 70 |             |  | $ | 38,522 |       
|Income from operations                           |         |                                       | 5,170  |        |             |   | 70 |             |  |   | 5,240  |       
|Interest income and other, net                   |         |                                       | 389    |        |             |   |   |             |  |   | 389    |       
|                                                 |         |                                       |        |        |             |   |    |             | 
|Income before income taxes                       |         |                                       | 5,559  |        |             |   | 70 |             |  |   | 5,629  |       
|Provision for income taxes                       |         |                                       | 134    |        |             |   |   |             |  |   | 134    |       
|                                                 |         |                                       |        |        |             |   |    |             | 
|Income from continuing operations                |         |                                       | 5,425  |        |             |   | 70 |             |  |   | 5,495  |       
|Loss from discontinued operations                |         |                                       | (265   | )      |             |   |   |             |  |   | (265   | )     
|                                                 |         |                                       |        |        |             |   |    |             | 
|Net income                                       |         | $                                     | 5,160  |        |             | $ | 70 |             |  | $ | 5,230  |       
|                                                 |         |                                       |        |        |             |   |    |             | 
|Net income per share from continuing operations: |         |                                       |        |        |             |   |    |             |  |   |        |       
|                                                 | Basic   |                                       | $      | 0.33   |             |   | $  | 0.00        |  |   | $      | 0.33   |  
|                                                 |         |                                       |        |        |             |   |    |             | 
|                                                 | Diluted |                                       | $      | 0.32   |             |   | $  | 0.00        |  |   | $      | 0.32   |  
|                                                 |         |                                       |        |        |             |   |    |             | 
|Net loss per share from discontinued operations: |         |                                       |        |        |             |   |    |             |  |   |        |       
|                                                 | Basic   |                                       | $      | (0.02  | )           |   | $  | 0.00        |  |   | $      | (0.02  | )
|                                                 |         |                                       |        |        |             |   |    |             | 
|                                                 | Diluted |                                       | $      | (0.02  | )           |   | $  | 0.00        |  |   | $      | (0.02  | )
|                                                 |         |                                       |        |        |             |   |    |             | 
|Net income per share:                            |         |                                       |        |        |             |   |    |             |  |   |        |       
|                                                 | Basic   |                                       | $      | 0.31   |             |   | $  | 0.00        |  |   | $      | 0.31   |  
|                                                 |         |                                       |        |        |             |   |    |             | 
|                                                 | Diluted |                                       | $      | 0.30   |             |   | $  | 0.00        |  |   | $      | 0.31   |  
|                                                 |         |                                       |        |        |             |   |    |             | 
|Weighted average number of shares:               |         |                                       |        |        |             |   |    |             |  |   |        |       
|                                                 | Basic   |                                       |        | 16,663 |             |   |    | 16,663      |  |   |        | 16,663 |  
|                                                 | Diluted |                                       |        | 17,071 |             |   |    | 17,071      |  |   |        | 17,071 |  

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PHOTON DYNAMICS, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)


|                                                   |         |                                       |        |        |             |   |        |             |   |   |        |        | 
|-------------------------------------------------- | ------- | ------------------------------------- | ------ | ------ | ----------- | - | ------ | ----------- | - | - | ------ | ------ | 
|                                                   |         | Three Months Ended September 30, 2004 |       
|                                                   |         |                                       |       
|                                                   |         | As Reported                           |        |        | Adjustments |   |        | As Restated |  
|                                                   |         |                                       |        |        |             |   |        |             |  
|                                                   |         | (In thousands, except per share data) |       
|Revenue                                            |         | $                                     | 53,840 |        |             | $ | (1,049 | )           |   | $ | 52,791 |       
|Income from operations,                            |         |                                       | 3,444  |        |             |   | (1,049 | )           |   |   | 2,395  |       
|Interest income and other, net                     |         |                                       | 308    |        |             |   |       |             |   |   | 308    |       
|                                                   |         |                                       |        |        |             |   |        |             |  
|Income before income taxes                         |         |                                       | 3,752  |        |             |   | (1,049 | )           |   |   | 2,703  |       
|Provision for income taxes                         |         |                                       | 46     |        |             |   | (29    | )           |   |   | 17     |       
|                                                   |         |                                       |        |        |             |   |        |             |  
|Income from continuing operations                  |         |                                       | 3,706  |        |             |   | (1,020 | )           |   |   | 2,686  |       
|Income from discontinued operations                |         |                                       | 103    |        |             |   |       |             |   |   | 103    |       
|                                                   |         |                                       |        |        |             |   |        |             |  
|Net income                                         |         | $                                     | 3,809  |        |             | $ | (1,020 | )           |   | $ | 2,789  |       
|                                                   |         |                                       |        |        |             |   |        |             |  
|Net income per share from continuing operations:   |         |                                       |        |        |             |   |        |             |   |   |        |       
|                                                   | Basic   |                                       | $      | 0.22   |             |   | $      | (0.06       | ) |   | $      | 0.16   | 
|                                                   |         |                                       |        |        |             |   |        |             |  
|                                                   | Diluted |                                       | $      | 0.22   |             |   | $      | (0.06       | ) |   | $      | 0.16   | 
|                                                   |         |                                       |        |        |             |   |        |             |  
|Net income per share from discontinued operations: |         |                                       |        |        |             |   |        |             |   |   |        |       
|                                                   | Basic   |                                       | $      | 0.01   |             |   | $      | 0.00        |   |   | $      | 0.01   | 
|                                                   |         |                                       |        |        |             |   |        |             |  
|                                                   | Diluted |                                       | $      | 0.01   |             |   | $      | 0.00        |   |   | $      | 0.01   | 
|                                                   |         |                                       |        |        |             |   |        |             |  
|Net income per share:                              |         |                                       |        |        |             |   |        |             |   |   |        |       
|                                                   | Basic   |                                       | $      | 0.23   |             |   | $      | (0.06       | ) |   | $      | 0.17   | 
|                                                   |         |                                       |        |        |             |   |        |             |  
|                                                   | Diluted |                                       | $      | 0.22   |             |   | $      | (0.06       | ) |   | $      | 0.16   | 
|                                                   |         |                                       |        |        |             |   |        |             |  
|Weighted average number of shares:                 |         |                                       |        |        |             |   |        |             |   |   |        |       
|                                                   | Basic   |                                       |        | 16,826 |             |   |        | 16,826      |   |   |        | 16,826 | 
|                                                   | Diluted |                                       |        | 16,977 |             |   |        | 16,977      |   |   |        | 16,977 | 

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|         |                        
|-------- | -----------------------
|Item 9A. | Controls and Procedures

Evaluation of Disclosure Controls and Procedures.


Identification of Material Weaknesses.




| |   |                                                                                                                                                                                                                                                                        
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | an appropriate level of review of those significant financial
    statement accounts requiring a higher degree of judgment and
    estimates, in part due to the need for more personnel as well as
    more highly skilled and trained personnel in certain positions;
|
| |  | a formal review process of the financial statements and
    supporting schedules of our international subsidiaries; and                                                                                                                                                
|
| |  | consistent processes and controls over revenue transactions
    entered into and recorded by our Japanese subsidiary with those
    processes and controls in place in the U.S.                                                                                        







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| |                                                                                                  
| | -------------------------------------------------------------------------------------------------
| | Changes in Internal Control Over Financial Reporting
    During the Fourth Quarter of Fiscal 2004





| |                                                                                   
| | ----------------------------------------------------------------------------------
| | Changes in Internal Control Over Financial Reporting
    Subsequent to Fiscal 2004





91



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| |   |                                                                                                                                                                                                                                        
| | - | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | We hired a new Chief Financial Officer, as of May 31, 2005.                                                                                                                                                                            
|
| |  | We hired a new Vice President of Finance and a new Corporate
    Controller, each of whom began employment with us in
    July 2005.                                                                                                   
|
| |  | We improved our sales certification program to ensure
    completeness of all documentation relating to complex financial
    transactions, as well as requiring a review of all material
    transactions by senior finance personnel.
|
| |  | We enhanced controls around the close process and consolidation
    to ensure timely reconciliations and reviews of all subsidiary
    and consolidated financial statements.                                                          
|
| |  | We performed additional training for key personnel in the proper
    methodology of revenue allocation for undelivered elements and
    other technical revenue recognition concepts.                                                  
|
| |  | We implemented a revised signature authorization policy to
    ensure that all contractual commitments made by the company are
    properly authorized and accounted for.                                                              
|
| |  | We strengthened our Disclosure Committee process to ensure that
    filings are properly reviewed and reflect all known material
    information required.                                                                             
|
| |  | We hired a new Asia Pacific controller in Korea to oversee Asia
    accounting personnel and ensure policies and procedures are
    followed.                                                                                          
|
| |  | We improved our reviews of all accounting estimates, ;
    specifically, excess and obsolete inventory, warranty and other
    reserves and accruals.                                                                                  

Limitations on the Effectiveness of Disclosure Controls and
Procedures.





PART IV







|         |                                           
|-------- | ------------------------------------------
|Item 15. | Exhibits and Financial Statement Schedules

|                                                                                                                                                                                                                                                                                                                 |  |     |  |    |  |                              
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | --- |  | -- |  | -----------------------------
|                                                                                                                                                                                                                                                                                                                 |  | (a) |  | 1. |  | Financial Statements         
|See Index to Consolidated Financial Statements in Item 8 of
    this Annual Report on Form 10-K/ A, which is incorporated
    herein by reference.                                                                                                                                                              
|                                                                                                                                                                                                                                                                                                                 |  |     |  | 2. |  | Financial Statement Schedules
|The following financial statement schedule is filed as part of
    this annual report on Form 10-K. All other financial
    statement schedules have been omitted because they are either
    not applicable or the required information is shown in the
    consolidated financial statements or notes thereto.

92



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##### Table of Contents



SCHEDULE II


PHOTON DYNAMICS, INC.


VALUATION AND QUALIFYING ACCOUNT


|                                 |      |                          |   |       |            |  |            |          |     |  |            |            |        |        |  |       |     |  |   |       | 
|-------------------------------- | ---- | ------------------------ | - | ----- | ---------- |  | ---------- | -------- | --- |  | ---------- | ---------- | ------ | ------ |  | ----- | --- |  | - | ----- | 
|                                 |      | Year Ended September 30, |  
|                                 |      |                          |  
|                                 |      | Balance at               |   |       |            |  | Charged to |          |     |  |            | Balance at |       
|                                 |      | Beginning                |   |       | Charged to |  |            | Other    |     |  |            |            | End of |       
|                                 |      | of Period                |   |       | Expense    |  |            | Accounts |     |  | Deductions |            |        | Period | 
|                                 |      |                          |   |       |            |  |            |          |     |  |            |            |        |        | 
|                                 |      | (In thousands)           |  
|Allowance for doubtful accounts: |      |                          |   |       |            |  |            |          |     |  |            |            |        |        |  |       |     |  |   |      
|                                 | 2004 |                          | $ | 726   |            |  |            |         | (1) |  |            |           |        |        |  | 229   | (2) |  | $ | 497   | 
|                                 | 2003 |                          | $ | 1,466 |            |  |            | 3,132    | (1) |  |            |           |        |        |  | 3,872 | (2) |  | $ | 726   | 
|                                 | 2002 |                          | $ | 1,897 |            |  |            | 111      | (1) |  |            |           |        |        |  | 542   | (2) |  | $ | 1,466 | 






|    |                                                                                                                                                                  
|--- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------
|(1) | Includes charges to expense from discontinued operations of
    approximately $0, $2.9 million and $34,000 in fiscal 2004,
    2003 and 2002, respectively.      
|   
|(2) | Includes write-offs of uncollectible accounts from discontinued
    operations of approximately $0, $3.9 million and $0 in
    2004, 2003 and 2002, respectively.

93



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##### Table of Contents





|   |         
|-- | --------
|3. | Exhibits

|       |    |          |  |                                                                                                                                                                                                                                                                                                      
|------ | -- | -------- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Number |    | Exhibit 
|       |    |         
|       | 2  | .3(E)    |  | Agreement and Plan of Merger, dated as of July 6, 2001, by
    and among the Registrant; Iris Acquisition, LLC, a Texas limited
    liability company; Intelligent Reasoning Systems, Inc., a Texas
    corporation; and Clinton Bybee (as the Shareholders
    Agent), as amended on July 12, 2001.
|       | 3  | .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(A)*   |  | Form of Indemnification Agreement between the Registrant and
    each of its executive officers and directors.                                                                                                                                                                                       
|       | 10 | .2(A)*   |  | 1987 Stock Option Plan and Form of Stock Option Agreement.                                                                                                                                                                                                                                           
|       | 10 | .3.1(B)  |  | Lease agreement between Berg & Berg Developers and the
    Registrant dated August 6, 1996.                                                                                                                                                                                                          
|       | 10 | .3.2(H)  |  | First Amendment to Lease between Mission West Properties,
    L.P. II and the Registrant dated December 7, 2001.                                                                                                                                                                                     
|       | 10 | .8(M)*   |  | Offer Letter between the Registrant and Elwood Spedden dated
    February 4, 2003.                                                                                                                                                                                                                   
|       | 10 | .9(D)*   |  | Agreement Regarding Change of Control between the Registrant and
    Jeffrey Hawthorne dated October 15, 1995.                                                                                                                                                                                       
|       | 10 | .10(P)   |  | Lease Agreement between Corridor Park Pointe II, L.P. and
    Intelligent Reasoning Systems, Inc., dated May 21, 1999.                                                                                                                                                                               
|       | 10 | .11(P)   |  | First Amendment to Lease Agreement between Corridor Park
    Pointe II, L.P. and Intelligent Reasoning Systems, Inc.
    dated November 9, 1999.                                                                                                                                                     
|       | 10 | .12(P)   |  | Second Amendment to Lease Agreement between Corridor Park
    Pointe II, L.P. and Intelligent Reasoning Systems, Inc.
    dated March 15, 2000.                                                                                                                                                      
|       | 10 | .13(F)   |  | Agreement for Purchase and Sale of Commercial Property between
    the Registrant and Integrated Power Chip Corporation dated
    February 12, 2001.                                                                                                                                                 
|       | 10 | .15(G)   |  | Image Processing Systems Inc. Amended Share Incentive Plan.                                                                                                                                                                                                                                          
|       | 10 | .16(P)   |  | Series E Stock Purchase Warrant for Leader Technologies
    LTD, dated March 1, 2000.                                                                                                                                                                                                                
|       | 10 | .17(I)   |  | Manufacturing Services Agreement, dated as of December 10,
    2001 by and between the Registrant and Sanmina-SCI Corporation.                                                                                                                                                                       
|       | 10 | .18(H)   |  | Real Estate Sublease by and between the Registrant and
    Sanmina-SCI Corporation dated December 10, 2001.                                                                                                                                                                                          
|       | 10 | .19(H)   |  | Amended and Restated Agreement for Purchase of Inventory by and
    between the Registrant and Sanmina-SCI Corporation dated
    January 29, 2002.                                                                                                                                                   
|       | 10 | .20(L)*  |  | Amended and Restated 1995 Stock Option Plan, as amended.                                                                                                                                                                                                                                             
|       | 10 | .20.1(W) |  | Form of Stock Option Agreement under 1995 Stock Option Plan, as
    amended.                                                                                                                                                                                                                         
|       | 10 | .21(L)*  |  | 1995 Employee Stock Purchase Plan, as amended.                                                                                                                                                                                                                                                       
|       | 10 | .22(M)*  |  | 2001 Equity Incentive Plan, as amended.                                                                                                                                                                                                                                                              
|       | 10 | .22.1(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 | .26(V)   |  | Third Amendment to Lease Agreement between the Registrant and
    Mission West Properties L.P. II dated as of August 2003.                                                                                                                                                                           
|       | 10 | .29(R)*  |  | Offer Letter between the Registrant and Richard Okumoto dated
    April 21, 2003.                                                                                                                                                                                                                    
|       | 10 | .30(V)*  |  | Consulting Agreement between the Registrant and Malcolm Thompson
    dated July 28, 2003.                                                                                                                                                                                                            

94



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##### Table of Contents



|       |    |         |  |                                                                                                                                                                               
|------ | -- | ------- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Number |    | Exhibit
|       |    |        
|       | 10 | .31(V)* |  | Amendment to Consulting Agreement between the Registrant and
    Malcolm Thompson dated September 1, 2003.                                                                    
|       | 10 | .33(S)* |  | Separation Agreement, dated December 4, 2003, between
    Elwood Spedden and Photon Dynamics, Inc.                                                                            
|       | 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(T)* |  | Consulting Agreement, dated March 18, 2004, between the
    Registrant and Malcolm Thompson.                                                                                  
|       | 10 | .36(T)  |  | Termination and Assignment Agreement, dated February 27,
    2004, between Photon Dynamics, Inc. and Ishikawajima-Harima
    Heavy Industries Co. Ltd.                        
|       | 10 | .37(U)  |  | Confidential Mutual Settlement Agreement and Mutual General
    Release of All Claims, dated April 22, 2004, between Photon
    Dynamics, Inc. and Robert L. Thomason, et. al.
|       | 10 | .38(W)* |  | Offer Letter between the Registrant and Mark Merrill dated
    April 27, 2004.                                                                                                
|       | 10 | .39(W)* |  | Executive Officer Bonus Compensation Plan.                                                                                                                                    
|       | 10 | .40(X)* |  | Outside Director Cash Compensation Arrangement.                                                                                                                               
|       | 21 | .1(W)   |  | Subsidiaries of the Registrant.                                                                                                                                               
|       | 23 | .1      |  | Consent of Ernst & Young LLP, Independent Registered
    Public Accounting Firm.                                                                                              
|       | 24 | .1(W)   |  | 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 on the Registrants Registration Statement
    on Form SB-2 (Commission File No. 33-98232-LA) as
    filed with the Securities and Exchange Commission (the
    SEC) on November 15, 1995 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 Annual
    Report on Form 10-KSB for the fiscal year ended
    September 30, 1998 as filed with the SEC on
    December 18, 1998, and incorporated herein by reference.                                    
|   
|(D) |  | Previously filed as an exhibit to the Registrants Annual
    Report on Form 10-KSB for the fiscal year ended
    September 30, 1999 as filed with the SEC on
    October 27, 1999, and incorporated herein by reference.                                     
|   
|(E) |  | Previously filed as an exhibit to the Registrants Current
    Report on Form 8-K 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 on Form 10-Q for the quarter ended
    March 31, 2001 as filed with the SEC on May 4, 2001,
    and incorporated herein by reference.                                                 
|   
|(G) |  | Previously filed as an exhibit to the Registrants
    Registration Statement on Form S-8 as filed with the SEC on
    January 24, 2001, and incorporated herein by reference.                                                                                
|   
|(H) |  | Previously filed as an exhibit to the Registrants
    Registration Statement on Form S-1 (Commission File
    No. 333-76650) as filed with the SEC on January 14,
    2002, as amended, and incorporated by reference herein.                                

95



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##### Table of Contents





|    |  |                                                                                                                                                                                                                                                                                                   
|--- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(I) |  | Previously filed as an exhibit to the Registrants Current
    Report on Form 8-K as filed with the SEC on January 7,
    2002, and incorporated herein by reference. Confidential
    treatment has been granted for portions of this exhibit.                                                   
|   
|(K) |  | Previously filed as an exhibit to the Registrants Current
    Report on Form 8-K/ A 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 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 appendix to the Registrants
    Definitive Proxy Statement as filed with the SEC on
    November 8, 1999 and incorporated herein by reference.                                                                                                                            
|   
|(O) |  | Previously filed as an exhibit to the Registrants
    Registration Statement on Form S-3 as filed with the SEC on
    November 7, 2000 and incorporated herein by reference.                                                                                                                     
|   
|(P) |  | Previously filed as an exhibit to the Registrants Annual
    Report on Form 10-K for the fiscal year ended
    September 30, 2001 as filed with the SEC on
    December 6, 2001, and incorporated here 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 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 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 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 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
    Quarterly Report Form on Form 10-Q for the quarter ended
    June 30, 2004 as filed with SEC on August 16, 2004,
    and incorporated herein by reference. Confidential treatment has
    been requested for portions of this exhibit.     
|   
|(V) |  | Previously filed as an exhibit to the Registrants Annual
    Report on Form 10-K for the fiscal year ended
    September 30, 2003 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 as filed with the SEC on
    December 14, 2004, and incorporated here by reference.                                                                            
|   
|(X) |  | Previously filed as an exhibit to the Registrants Annual
    Report on Form 10-K/ A, Amendment No. 1, for the
    fiscal year ended September 30, 2004 as filed with the SEC
    on December 22, 2004, and incorporated here 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.

Exhibits




Financial Statement Schedules




96



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##### Table of Contents






SIGNATURES






| |                      
| | ---------------------
| | PHOTON DYNAMICS, INC.



| |     |                         
| | --- | ------------------------
| | By: | /s/ JEFFREY A. HAWTHORNE

| |                                      
| | -------------------------------------
| |                                      
| | Jeffrey A. Hawthorne                 
| | President and Chief Executive Officer



97



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##### Table of Contents



EXHIBIT INDEX


|       |    |          |  |                                                                                                                                                                                                                                                                                                      
|------ | -- | -------- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Number |    | Exhibit 
|       |    |         
|       | 2  | .3(E)    |  | Agreement and Plan of Merger, dated as of July 6, 2001, by
    and among the Registrant; Iris Acquisition, LLC, a Texas limited
    liability company; Intelligent Reasoning Systems, Inc., a Texas
    corporation; and Clinton Bybee (as the Shareholders
    Agent), as amended on July 12, 2001.
|       | 3  | .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(A)*   |  | Form of Indemnification Agreement between the Registrant and
    each of its executive officers and directors.                                                                                                                                                                                       
|       | 10 | .2(A)*   |  | 1987 Stock Option Plan and Form of Stock Option Agreement.                                                                                                                                                                                                                                           
|       | 10 | .3.1(B)  |  | Lease agreement between Berg & Berg Developers and the
    Registrant dated August 6, 1996.                                                                                                                                                                                                          
|       | 10 | .3.2(H)  |  | First Amendment to Lease between Mission West Properties,
    L.P. II and the Registrant dated December 7, 2001.                                                                                                                                                                                     
|       | 10 | .8(M)*   |  | Offer Letter between the Registrant and Elwood Spedden dated
    February 4, 2003.                                                                                                                                                                                                                   
|       | 10 | .9(D)*   |  | Agreement Regarding Change of Control between the Registrant and
    Jeffrey Hawthorne dated October 15, 1995.                                                                                                                                                                                       
|       | 10 | .10(P)   |  | Lease Agreement between Corridor Park Pointe II, L.P. and
    Intelligent Reasoning Systems, Inc., dated May 21, 1999.                                                                                                                                                                               
|       | 10 | .11(P)   |  | First Amendment to Lease Agreement between Corridor Park
    Pointe II, L.P. and Intelligent Reasoning Systems, Inc.
    dated November 9, 1999.                                                                                                                                                     
|       | 10 | .12(P)   |  | Second Amendment to Lease Agreement between Corridor Park
    Pointe II, L.P. and Intelligent Reasoning Systems, Inc.
    dated March 15, 2000.                                                                                                                                                      
|       | 10 | .13(F)   |  | Agreement for Purchase and Sale of Commercial Property between
    the Registrant and Integrated Power Chip Corporation dated
    February 12, 2001.                                                                                                                                                 
|       | 10 | .15(G)   |  | Image Processing Systems Inc. Amended Share Incentive Plan.                                                                                                                                                                                                                                          
|       | 10 | .16(P)   |  | Series E Stock Purchase Warrant for Leader Technologies
    LTD, dated March 1, 2000.                                                                                                                                                                                                                
|       | 10 | .17(I)   |  | Manufacturing Services Agreement, dated as of December 10,
    2001 by and between the Registrant and Sanmina-SCI Corporation.                                                                                                                                                                       
|       | 10 | .18(H)   |  | Real Estate Sublease by and between the Registrant and
    Sanmina-SCI Corporation dated December 10, 2001.                                                                                                                                                                                          
|       | 10 | .19(H)   |  | Amended and Restated Agreement for Purchase of Inventory by and
    between the Registrant and Sanmina-SCI Corporation dated
    January 29, 2002.                                                                                                                                                   
|       | 10 | .20(L)*  |  | Amended and Restated 1995 Stock Option Plan, as amended.                                                                                                                                                                                                                                             
|       | 10 | .20.1(W) |  | Form of Stock Option Agreement under 1995 Stock Option Plan, as
    amended.                                                                                                                                                                                                                         
|       | 10 | .21(L)*  |  | 1995 Employee Stock Purchase Plan, as amended.                                                                                                                                                                                                                                                       
|       | 10 | .22(M)*  |  | 2001 Equity Incentive Plan, as amended.                                                                                                                                                                                                                                                              
|       | 10 | .22.1(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 | .26(V)   |  | Third Amendment to Lease Agreement between the Registrant and
    Mission West Properties L.P. II dated as of August 2003.                                                                                                                                                                           
|       | 10 | .29(R)*  |  | Offer Letter between the Registrant and Richard Okumoto dated
    April 21, 2003.                                                                                                                                                                                                                    
|       | 10 | .30(V)*  |  | Consulting Agreement between the Registrant and Malcolm Thompson
    dated July 28, 2003.                                                                                                                                                                                                            
|       | 10 | .31(V)*  |  | Amendment to Consulting Agreement between the Registrant and
    Malcolm Thompson dated September 1, 2003.                                                                                                                                                                                           



---



##### Table of Contents



|       |    |         |  |                                                                                                                                                                               
|------ | -- | ------- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Number |    | Exhibit
|       |    |        
|       | 10 | .33(S)* |  | Separation Agreement, dated December 4, 2003, between
    Elwood Spedden and Photon Dynamics, Inc.                                                                            
|       | 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(T)* |  | Consulting Agreement, dated March 18, 2004, between the
    Registrant and Malcolm Thompson.                                                                                  
|       | 10 | .36(T)  |  | Termination and Assignment Agreement, dated February 27,
    2004, between Photon Dynamics, Inc. and Ishikawajima-Harima
    Heavy Industries Co. Ltd.                        
|       | 10 | .37(U)  |  | Confidential Mutual Settlement Agreement and Mutual General
    Release of All Claims, dated April 22, 2004, between Photon
    Dynamics, Inc. and Robert L. Thomason, et. al.
|       | 10 | .38(W)* |  | Offer Letter between the Registrant and Mark Merrill dated
    April 27, 2004.                                                                                                
|       | 10 | .39(W)* |  | Executive Officer Bonus Compensation Plan.                                                                                                                                    
|       | 10 | .40(X)* |  | Outside Director Cash Compensation Arrangement.                                                                                                                               
|       | 21 | .1(W)   |  | Subsidiaries of the Registrant.                                                                                                                                               
|       | 23 | .1      |  | Consent of Ernst & Young LLP, Independent Registered
    Public Accounting Firm.                                                                                              
|       | 24 | .1(W)   |  | 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 on the Registrants Registration Statement
    on Form SB-2 (Commission File No. 33-98232-LA) as
    filed with the Securities and Exchange Commission (the
    SEC) on November 15, 1995 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 Annual
    Report on Form 10-KSB for the fiscal year ended
    September 30, 1998 as filed with the SEC on
    December 18, 1998, and incorporated herein by reference.                                    
|   
|(D) |  | Previously filed as an exhibit to the Registrants Annual
    Report on Form 10-KSB for the fiscal year ended
    September 30, 1999 as filed with the SEC on
    October 27, 1999, and incorporated herein by reference.                                     
|   
|(E) |  | Previously filed as an exhibit to the Registrants Current
    Report on Form 8-K 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 on Form 10-Q for the quarter ended
    March 31, 2001 as filed with the SEC on May 4, 2001,
    and incorporated herein by reference.                                                 
|   
|(G) |  | Previously filed as an exhibit to the Registrants
    Registration Statement on Form S-8 as filed with the SEC on
    January 24, 2001, and incorporated herein by reference.                                                                                
|   
|(H) |  | Previously filed as an exhibit to the Registrants
    Registration Statement on Form S-1 (Commission File
    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 as filed with the SEC on January 7,
    2002, and incorporated herein by reference. Confidential
    treatment has been granted for portions of this exhibit.               
|   
|(K) |  | Previously filed as an exhibit to the Registrants Current
    Report on Form 8-K/ A as filed with the SEC on
    July 29, 2002, and incorporated herein by reference.                                                                                        



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##### Table of Contents





|    |  |                                                                                                                                                                                                                                                                                                   
|--- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(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 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 appendix to the Registrants
    Definitive Proxy Statement as filed with the SEC on
    November 8, 1999 and incorporated herein by reference.                                                                                                                            
|   
|(O) |  | Previously filed as an exhibit to the Registrants
    Registration Statement on Form S-3 as filed with the SEC on
    November 7, 2000 and incorporated herein by reference.                                                                                                                     
|   
|(P) |  | Previously filed as an exhibit to the Registrants Annual
    Report on Form 10-K for the fiscal year ended
    September 30, 2001 as filed with the SEC on
    December 6, 2001, and incorporated here 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 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 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 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 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
    Quarterly Report Form on Form 10-Q for the quarter ended
    June 30, 2004 as filed with SEC on August 16, 2004,
    and incorporated herein by reference. Confidential treatment has
    been requested for portions of this exhibit.     
|   
|(V) |  | Previously filed as an exhibit to the Registrants Annual
    Report on Form 10-K for the fiscal year ended
    September 30, 2003 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 as filed with the SEC on
    December 14, 2004, and incorporated here by reference.                                                                            
|   
|(X) |  | Previously filed as an exhibit to the Registrants Annual
    Report on Form 10-K/ A, Amendment No. 1, for the
    fiscal year ended September 30, 2004 as filed with the SEC
    on December 22, 2004, and incorporated here 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.