Document:

<PAGE>

                                                                   EXHIBIT 10.27

February 4, 2003

Bernard Clark
10B Bayview Court
Los Gatos, CA 95030

Dear Bernie:

This letter sets forth the substance of the separation agreement (the
"Agreement") that Photon Dynamics, Inc. (the "Company") is offering to you to
aid in your employment transition.

         1.       SEPARATION. You have resigned, and the Company has accepted
your resignation, from your positions President, Flat Panel Display Division and
Vice President and Officer of the Company, effective as of today, your last day
as an employee of the Company (the "Separation Date").

         2.       ACCRUED SALARY AND PAID TIME OFF. The Company will pay you
today all accrued salary, and all accrued and unused paid time off, earned
through the Separation Date, subject to standard payroll deductions and
withholdings. You are entitled to these payments regardless of whether or not
you sign this Agreement.

         3.       SEVERANCE. Although the Company has no policy or procedure for
providing severance benefits, if you enter into and fulfill your obligations
under this Agreement and the this Agreement becomes effective as described in
Paragraph 13, below, the Company will pay you, as severance, an amount
equivalent to six (6) months of your base salary in effect as of the Separation
Date, subject to required payroll deductions and withholdings (the "Severance
Payment"). The Severance Payment will be paid to you in one (1) lump sum within
ten (10) days after the Effective Date of this Agreement, as defined in
Paragraph 13, below.

         4.       HEALTH INSURANCE. As provided by the federal COBRA law and by
the Company's current group health insurance policies, you will be eligible to
continue your health insurance benefits at your own expense. Later, you may be
able to convert to an individual policy through the provider of the Company's
health insurance, if you wish. You will be provided with a separate notice of
your COBRA rights. If you elect continued coverage under COBRA, as part of this
Agreement, the Company will pay the COBRA premiums necessary to continue your
current coverage for six (6) months after the Separation Date.

         5.       STOCK OPTIONS. As provided in your stock option agreements,
grant notices and the applicable stock option plan documents (collectively, the
"Option Documents"), your Company stock options ("Options") cease vesting and
all unvested shares terminate as of the Separation Date. You may exercise your
Options pursuant to the terms of the applicable Option Documents.

         6.       OTHER COMPENSATION OR BENEFITS. You acknowledge that, except
as expressly provided in this Agreement, you will not receive any additional
compensation, severance or benefits after the Separation Date.

<PAGE>

Bernard Clark
Page 2

         7.       EXPENSE REIMBURSEMENTS. You agree that, within ten (10) days
after the Separation Date, you will submit your final documented expense
reimbursement statement reflecting all business expenses you incurred through
the Separation Date, if any, for which you seek reimbursement. The Company will
reimburse you for these expenses pursuant to its regular business practice.

         8.       RETURN OF COMPANY PROPERTY. You agree that, within five (5)
days after the Separation Date, you will return to the Company all Company
documents (and all copies thereof) and other Company property in your possession
or control, including, but not limited to, Company files, notes, notebooks,
drawings, records, plans, forecasts, reports, proposals, studies, financial
information, sales and marketing information, research and development
information, personnel information, specifications, computer-recorded
information, tangible property and equipment (including your Company-issued
laptop computer and "blackberry" electronic communication device), credit cards,
entry cards, identification badges and keys; and any materials of any kind which
contain or embody any proprietary or confidential information of the Company
(and all reproductions thereof in whole or in part). The timely return of
Company property is a condition precedent to the Company making the Severance
Payment to you described in Paragraph 3, above.

         9.       PROPRIETARY INFORMATION OBLIGATIONS. Both during and after
your employment, you will refrain from any use or disclosure of the Company's
proprietary or confidential information or materials and you acknowledge your
continuing obligations under your Proprietary Information and Inventions
Agreement not to use or disclose any confidential or proprietary information of
the Company without prior written authorization from a duly authorized
representative of the Company. A copy of your Proprietary Information and
Inventions Agreement is attached hereto as Exhibit A.

         10.      CONFIDENTIALITY. The provisions of this Agreement shall be
held in strictest confidence by you and the Company and shall not be publicized
or disclosed in any manner whatsoever; provided, however, that: (a) you may
disclose this Agreement to your immediate family; (b) the parties may disclose
this Agreement in confidence to their respective attorneys, accountants,
auditors, tax preparers, and financial advisors; (c) the Company may disclose
this Agreement as necessary to fulfill standard or legally required corporate
reporting or disclosure requirements (including, without limitation, filing this
Agreement or disclosing its terms in public filings with the Securities and
Exchange Commission); and (d) the parties may disclose this Agreement insofar as
such disclosure may be necessary to enforce its terms or as otherwise required
by law. By way of example and without limitation, you agree not to disclose the
terms of this Agreement to any current or former Company employee.

11.      NONDISPARAGEMENT. Both you and the Company's officers and directors
agree not to disparage the other party, and the other party's officers,
directors, employees, shareholders and agents, in any manner likely to be
harmful to them or their business, business reputation or personal reputation;
provided that both you and the Company shall respond truthfully, accurately and
fully to any question, inquiry or request for information when required by legal
process, and the Company shall communicate truthfully, accurately and fully with
any government agency.

<PAGE>

Bernard Clark
Page 3

12.      RELEASE. In exchange for the Severance Payment, COBRA payments and
other consideration under this Agreement to which you would not otherwise be
entitled, you completely release the Company, and its affiliated, related,
parent and subsidiary corporations, and its and their present and former
directors, officers, employees, attorneys and agents from any and all claims of
any kind, known and unknown, which you may now have or have ever had against any
of them, that arise out of or are in any way related to events, acts, conduct,
or omissions occurring prior to your signing this Agreement (the "Released
Claims"). The Released Claims include, but are not limited to: (1) all claims
arising out of or in any way related to your employment with the Company or the
termination of that employment; (2) all claims related to your compensation or
benefits from the Company, including salary, bonuses, commissions, vacation pay,
expense reimbursements, severance pay, fringe benefits, stock, stock options, or
any other ownership interests in the Company; (3) all claims for breach of
contract, wrongful termination, and breach of the implied covenant of good faith
and fair dealing; (4) all tort claims, including claims for fraud, defamation,
emotional distress, and discharge in violation of public policy; and (5) all
federal, state, and local statutory claims, including claims for discrimination,
harassment, retaliation, attorneys' fees, and other claims arising under the
federal Civil Rights Act of 1964 (as amended), the federal Americans with
Disabilities Act, the federal Age Discrimination in Employment Act of 1967, as
amended (the "ADEA"), and the California Fair Employment and Housing Act (as
amended). Notwithstanding anything contained in this Agreement, nothing herein
shall release the parties' rights under this Agreement; your right (if any) to
indemnification granted by any act or agreement of the Company, state or federal
law or policy of insurance; your rights in the Company's 401K Plan; your right
to make a claim under the Workers' Compensation Act; and, if the Company makes
any claim against you, you have the right to assert as a counterclaim,
cross-complaint or cross-action any claim, charge, complaint, lien, demand,
cause of action, obligation, damage or liability otherwise released by you
pursuant to this Paragraph 12.

         13.      RELEASE OF ADEA CLAIMS. You acknowledge that you are knowingly
and voluntarily waiving and releasing any rights you may have under the ADEA and
acknowledge that the consideration given for the waiver and release in the
preceding paragraph hereof is in addition to anything of value to which you were
already entitled. You further acknowledge that you have been advised by this
writing, as required by the ADEA, that: (a) your waiver and release do not apply
to any rights or claims that may arise after the date you sign this Agreement;
(b) you should consult with an attorney prior to signing this Agreement
(although you may choose not to do so); (c) you have twenty-one (21) days to
consider this Agreement (although you may voluntarily sign this Agreement
earlier); (d) you have seven (7) days following the date you sign this Agreement
to revoke the Agreement; and (e) this Agreement shall not be effective until the
date upon which the revocation period has expired, which shall be the eighth day
after this Agreement is signed by you (the "Effective Date").

14.      RELEASE OF UNKNOWN CLAIMS. You acknowledge that you have read and
understand Section 1542 of the California Civil Code, which states:

         "A GENERAL RELEASE DOES NOT EXTEND TO CLAIMS WHICH THE CREDITOR DOES
         NOT KNOW OR SUSPECT TO EXIST IN HIS FAVOR AT THE TIME OF EXECUTING THE
         RELEASE, WHICH IF KNOWN BY

<PAGE>

Bernard Clark
Page 4

HIM MUST HAVE MATERIALLY AFFECTED HIS SETTLEMENT WITH THE DEBTOR."

         You hereby expressly waive and relinquish all rights and benefits under
that section and any law in any jurisdiction of similar effect with respect to
your release of any unknown or unsuspected claims you may have against the
Company.

         15.      MISCELLANEOUS. This Agreement, including Exhibit A,
constitutes the complete, final and exclusive embodiment of the entire agreement
between you and the Company with regard to this subject matter. It is entered
into without reliance on any promise or representation, written or oral, other
than those expressly contained herein, and it supersedes any other such
promises, warranties or representations. This Agreement may not be modified or
amended except in a writing signed by both you and a duly authorized officer of
the Company. This Agreement shall bind the heirs, personal representatives,
successors and assigns of both you and the Company, and inure to the benefit of
both you and the Company, and your and its heirs, successors and assigns. If any
provision of this Agreement is determined to be invalid or unenforceable, in
whole or in part, this determination will not affect any other provision of this
Agreement and the provision in question shall be modified by the court so as to
be rendered enforceable in a manner which is consistent with the intent of the
parties insofar as possible. This Agreement shall be deemed to have been entered
into and shall be construed and enforced in accordance with the laws of the
State of California as applied to contracts made and to be performed entirely
within California.

If this Agreement is acceptable to you, please sign below and return the
original to me.

We wish you all the best in your future endeavors.

Sincerely,

Photon Dynamics, Inc.

By: /s/ Woody Spedden
   ------------------
        Woody Spedden

Exhibit A - Proprietary Information and Inventions Agreement

UNDERSTOOD AND AGREED:

/s/ Bernard Clark
-----------------
Bernard Clark

DATED: 02/10/03

<PAGE>

                                    EXHIBIT A

                PROPRIETARY INFORMATION AND INVENTIONS AGREEMENT

                                        5.<PAGE>

                                                                   EXHIBIT 10.28

February 4, 2003

Elwood Spedden
17 Great Oaks Blvd.
San Jose, CA 95119

Dear Woody:

Photon Dynamics, Inc. (the "Company") is pleased to continue your employment in
the position of President and Chief Executive Officer ("CEO") of the Company on
the following terms:

         1. POSITION, DUTIES AND RESPONSIBILITIES. You began employment with the
Company on January 13, 2003 (the "Employment Date"). You will continue to serve
in a full-time capacity as President and CEO of the Company, reporting to the
Company's Board of Directors (the "Board"). As President and CEO, you have
overall responsibility for management of the Company, and shall continue to
perform duties customarily associated with this position and such other duties
as are assigned from time to time by the Board, consistent with the Bylaws of
the Company. In your capacity as President and CEO, you shall continue to serve
as a member of the Board, subject to shareholder approval. You shall devote your
full time and attention during normal business hours to the business affairs of
the Company, except for reasonable vacations and periods of illness or
incapacity. By signing this letter agreement, you represent and warrant to the
Company that you are under no contractual commitments inconsistent with your
obligations to the Company.

         2. COMPENSATION AND EMPLOYEE BENEFITS.

                  2.1      BASE SALARY. Your base salary is $25,000 per month
($300,000 annually), less payroll deductions and required withholdings, paid
according to the Company's regular payroll schedule and procedures. Your salary
will be subject to adjustment as determined by the Board.

                  2.2      INCENTIVE BONUS. You will be eligible to receive an
annual incentive bonus of up to $250,000 for each Company fiscal year during
which you are employed (the "Bonus Year"), based on the achievement of
performance goals and financial targets. You and the Board will establish such
goals and targets by mutual agreement, within 60 days after the Employment Date
and the end of each Bonus Year. For the first Bonus Year, which will end on
September 30, 2003, you will be eligible to receive a pro rata share of the
annual bonus amount, up to a total of $178,767, provided that you are employed
at the end of the first Bonus Year. Any bonus payment shall be subject to
payroll deductions and required withholdings.

                  2.3      STOCK OPTION GRANTS. Subject to approval of the
Board, the Company shall grant you options to purchase an aggregate of 200,000
shares of the Company's common

<PAGE>

Elwood Spedden
February 4, 2003
Page 2

stock (the "Common Stock") pursuant to the Company's stock option plans (the
"Stock Options"), consisting of an option to purchase 158,000 shares of Common
Stock under the Company's Amended and Restated 1995 Stock Option Plan and an
option to purchase 42,000 shares of Common Stock under the Company's Amended and
Restated 2001 Equity Incentive Plan. The exercise price of the Stock Options
shall be equal to the fair market value of the stock as of the date of grant as
determined by the Board. Each of the Stock Options will be subject to the
following vesting schedule during your employment: three percent (3%) of the
total number of shares underlying the Stock Options will vest (and become
exercisable) at the end of each full month during the first year of your
employment, and four percent (4%) of the total number of shares underlying the
Stock Options will vest (and become exercisable) at the end of each full month
during your second year of employment and the first four (4) months of your
third year of employment, so that the Stock Options will be fully vested and
exercisable after you complete two (2) years and four (4) months of employment
with the Company. The Stock Options will otherwise be governed by the terms and
conditions of the applicable stock option plans, stock option agreements and
grant notices.

                  2.4      EMPLOYEE BENEFITS. You are entitled to receive all
benefits, including accrual of Paid Time Off, and health and disability
benefits, for which you are eligible under the terms and conditions of the
standard Company benefit plans, which may be in effect from time to time and
provided by the Company to its senior executive level employees generally. After
termination of your employment with the Company, to the extent provided by the
federal COBRA law or, if applicable, state insurance laws, and by the Company's
then-current group health insurance policies, you will be eligible to continue
your group health insurance benefits at your own expense.

                  2.5      RELOCATION. The Company will reimburse you for actual
expenses reasonably incurred in connection with your relocation to California,
subject to the Company's general policies and procedures governing such
reimbursements (the "Relocation Reimbursement"). If any portion of the
Relocation Reimbursement paid to you by the Company is taxable, you shall be
entitled to receive from the Company an additional payment (the "Gross-Up
Payment") in an amount that shall fund the payment by you of any income and
employment taxes imposed on the Relocation Reimbursement as well as all income
and employment taxes imposed on the Gross-Up Payment.

         3. OTHER ACTIVITIES DURING EMPLOYMENT. During your employment with the
Company, you will not engage in any other gainful employment business or
activity without the prior written consent of the Board. While you are employed
by the Company, you also will not assist any person or organization in competing
with the Company, in preparing to compete with the Company or in soliciting or
hiring any employees of the Company. Nothing in this letter agreement will
prevent you from accepting speaking or presentation engagements in exchange for
honoraria, serving on boards of charitable organizations or owning no more than
one percent (1%) of the voting stock of a corporation.

<PAGE>

Elwood Spedden
February 4, 2003
Page 3

         4. COMPANY POLICIES; PROPRIETARY INFORMATION AND INVENTIONS AGREEMENT.
As a Company employee, you are expected to abide by Company policies and
procedures, and acknowledge in writing that you have read the Company's Employee
Handbook. You must also sign and comply with the enclosed Proprietary
Information and Inventions Agreement as a condition of your continuing
employment.

         5. AT-WILL EMPLOYMENT. Your employment with the Company is at-will.
Either you or the Company may terminate the employment relationship at any time,
with or without cause and with or without advance notice, provided that you may
be removed from any position that you hold as a member of the Board only in the
manner provided by the Bylaws of the Company and applicable law.

         6. CHANGE IN CONTROL.

                  6.1      DEFINITION. For purposes of this Agreement, "Change
in Control" means the occurrence in a single transaction or in a series of
related transactions of any one or more of the following events:

                           (a)      any person (within the meaning of Section
13(d) or 14(d) of the Securities Exchange Act of 1934, as amended) becomes the
owner, directly or indirectly, of securities of the Company representing more
than fifty percent (50%) of the combined voting power of the Company's then
outstanding securities other than by virtue of a merger, consolidation or
similar transaction;

                           (b)      there is consummated a merger, consolidation
or similar transaction involving (directly or indirectly) the Company and,
immediately after the consummation of such merger, consolidation or similar
transaction, the stockholders of the Company immediately prior thereto do not
own, directly or indirectly, outstanding voting securities representing more
than fifty percent (50%) of the combined outstanding voting power of the
surviving entity in such merger, consolidation or similar transaction or more
than fifty percent (50%) of the combined outstanding voting power of the parent
of the surviving entity in such merger, consolidation or similar transaction; or

                           (c)      there is consummated a sale, lease, license
or other disposition of all or substantially all of the consolidated assets of
the Company and its subsidiaries, other than a sale, lease, license or other
disposition of all or substantially all of the consolidated assets of the
Company and its subsidiaries to an entity, more than fifty percent (50%) of the
combined voting power of the voting securities of which are owned by
stockholders of the Company in substantially the same proportions as their
ownership of the Company immediately prior to such sale, lease, license or other
disposition.

                  6.2      TERMINATION AFTER A CHANGE IN CONTROL. In the event
that within twelve (12) months following a Change in Control, the Company
terminates your employment without Cause (as defined below) or you resign for
Good Reason (as defined below) (a Change in Control

<PAGE>

Elwood Spedden
February 4, 2003
Page 4

Termination), all stock options held by you shall have their vesting accelerated
such that all options are fully vested and exercisable as of the date of the
Change in Control Termination (the "Acceleration"). As a precondition of
receiving the Acceleration, you must first sign and allow to become effective a
general release of claims in favor of the Company in a form acceptable to the
Company.

                  6.3      DEFINITION OF "CAUSE." For purposes of this
Agreement, "Cause" shall mean the occurrence of one or more of the following:
(a) your indictment or conviction of any felony or crime involving moral
turpitude or dishonesty; (b) your participation in any fraud against the Company
or its successor; (c) breach of your duties to the Company or its successor,
including, without limitation, persistent unsatisfactory performance of job
duties; (d) intentional damage to any property of the Company or its successor;
(e) willful conduct that is demonstrably injurious to the Company or its
successor, monetarily or otherwise; (f) breach of any agreement with the Company
or its successor, including your Proprietary Information and Inventions
Agreement; or (g) conduct by you that in the good faith and reasonable
determination of the Board demonstrates gross unfitness to serve. Physical or
mental disability or death shall not constitute Cause hereunder.

                  6.4      DEFINITION OF "GOOD REASON." For purposes of this
Agreement, your voluntary termination of employment with the Company will be
considered a termination for "Good Reason" if you resign your employment because
one of the following events occurs without your consent: (a) a reduction of your
then-existing annual base salary by more than ten percent (10%), unless the
then-existing base salaries of other executive officers of the Company are
accordingly reduced; (b) a material reduction in the package of benefits and
incentives, taken as a whole, provided to you (not including raising of employee
contributions to the extent of any cost increases imposed by third parties),
except to the extent that such benefits and incentives of other executive
officers of the Company are similarly reduced; (c) assignment to you of any
duties or any limitation of your responsibilities substantially inconsistent
with your position, duties, responsibilities and status with the Company
immediately prior to the date of the Change in Control; or (d) relocation of the
principal place of your employment to a location that is more than fifty (50)
miles from your principal place of employment immediately prior to the date of
the Change in Control.

                  6.5      LIMITATION ON PAYMENTS. If any payment or benefit you
would receive pursuant to a Change in Control from the Company or otherwise
("Payment") would (i) constitute a "parachute payment" within the meaning of
Section 280G of the Code, and (ii) but for this sentence, be subject to the
excise tax imposed by Section 4999 of the Code (the "Excise Tax"), then such
Payment shall be equal to the Reduced Amount. The "Reduced Amount" shall be
either (x) the largest portion of the Payment that would result in no portion of
the Payment being subject to the Excise Tax or (y) the largest portion, up to
and including the total, of the Payment, whichever amount, after taking into
account all applicable federal, state and local employment taxes, income taxes,
and the Excise Tax (all computed at the highest applicable marginal rate),
results in your receipt, on an after-tax basis, of the greater amount of the
Payment

<PAGE>

Elwood Spedden
February 4, 2003
Page 5

notwithstanding that all or some portion of the Payment may be subject to the
Excise Tax. If a reduction in payments or benefits constituting "parachute
payments" is necessary so that the Payment equals the Reduced Amount, reduction
shall occur in the following order unless you elect in writing a different order
(provided, however, that such election shall be subject to Board approval if
made on or after the effective date of the event that triggers the Payment):
reduction of cash payments; cancellation of Acceleration; reduction of employee
benefits. In the event that Acceleration is to be reduced, it shall be cancelled
in the reverse order of the date of grant of your Options (i.e., earliest
granted Option cancelled last) unless you elect in writing a different order for
cancellation.

The accounting firm engaged by the Company for general audit purposes as of the
day prior to the effective date of the Change in Control shall perform the
foregoing calculations. If the accounting firm so engaged by the Company is
serving as accountant or auditor for the individual, entity or group effecting
the Change in Control, the Company shall appoint a nationally recognized
accounting firm to make the determinations required hereunder. The Company shall
bear all expenses with respect to the determinations by such accounting firm
required to be made hereunder.

The accounting firm engaged to make the determinations hereunder shall provide
its calculations, together with detailed supporting documentation, to you and
the Company within fifteen (15) calendar days after the date on which your right
to a Payment is triggered (if requested at that time by you or the Company) or
such other time as requested by you or the Company. If the accounting firm
determines that no Excise Tax is payable with respect to a Payment, either
before or after the application of the Reduced Amount, it shall furnish you and
the Company with an opinion reasonably acceptable to you that no Excise Tax will
be imposed with respect to such Payment. Any good faith determinations of the
accounting firm made hereunder shall be final, binding and conclusive upon you
and the Company.

         7. GENERAL PROVISIONS.

                  7.1      SEVERABILITY. Whenever possible, each provision of
this Agreement will be interpreted in such manner as to be effective and valid
under applicable law, but if any provision of this Agreement is held to be
invalid, illegal or unenforceable in any respect under any applicable law or
rule in any jurisdiction, such invalidity, illegality or unenforceability will
not affect any other provision or any other jurisdiction, but such invalid,
illegal or unenforceable provision will be reformed, construed and enforced in
such jurisdiction so as to render it valid, legal, and enforceable consistent
with the intent of the parties insofar as possible.

                  7.2      ENTIRE AGREEMENT. This Agreement, together with the
Proprietary Information and Inventions Agreement, constitutes the entire and
exclusive agreement between you and the Company, and it supersedes any prior
agreement, promise, representation, or statement, written or otherwise, between
you and the Company with regard to this subject matter. It is entered into
without reliance on any promise, representation, statement or agreement other
than those expressly contained or incorporated herein, and it cannot be modified
or amended

<PAGE>

Elwood Spedden
February 4, 2003
Page 6

except in a writing signed by you and a duly authorized officer of the Company.

                  7.3      SUCCESSORS AND ASSIGNS. This Agreement is intended to
bind and inure to the benefit of and be enforceable by you, the Company and your
and its respective successors, assigns, heirs, executors and administrators,
except that you may not assign any of your duties hereunder and you may not
assign any of your rights hereunder without the written consent of the Company,
which shall not be withheld unreasonably.

                  7.4      GOVERNING LAW. All questions concerning the
construction, validity and interpretation of this Agreement will be governed by
the law of the State of California as applied to contracts made and to be
performed entirely within California.

To indicate your acceptance of the Company's offer of continued employment,
please sign and date this Agreement and the enclosed Proprietary Information and
Inventions Agreement and return the signed documents to me.

Sincerely,

PHOTON DYNAMICS, INC.

BY:   /s/ E. Floyd Kvamme
    --------------------------
       E. Floyd Kvamme
       Chairman of the Board

ACCEPTED AND AGREED:

  /s/ Elwood Spedden                02-05-03
---------------------------       DATE
ELWOOD SPEDDEN

Enclosure - Proprietary Information and Inventions Agreement

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