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                                                                   EXHIBIT 10.22

                              PHOTON DYNAMICS, INC.

                           2001 EQUITY INCENTIVE PLAN

                             ADOPTED JANUARY 8, 2001
                              AMENDED JULY 1, 2002
                              AMENDED JULY 15, 2002
                             AMENDED APRIL 14, 2003
                        STOCKHOLDER APPROVAL NOT REQUIRED

1.       PURPOSES.

         (a)      ELIGIBLE STOCK AWARD RECIPIENTS. The persons eligible to
receive Stock Awards are the Employees, Directors and Consultants of the Company
and its Affiliates.

         (b)      AVAILABLE STOCK AWARDS. The purpose of the Plan is to provide
a means by which eligible recipients of Stock Awards may be given an opportunity
to benefit from increases in value of the Common Stock through the granting of
the following Stock Awards: (i) Nonstatutory Stock Options, (ii) restricted
stock bonus awards and (iii) rights to acquire restricted stock.

         (c)      GENERAL PURPOSE. The Company, by means of the Plan, seeks to
retain the services of the group of persons eligible to receive Stock Awards, to
secure and retain the services of new members of this group and to provide
incentives for such persons to exert maximum efforts for the success of the
Company and its Affiliates.

2.       DEFINITIONS.

         (a)      "AFFILIATE" means any parent corporation or subsidiary
corporation of the Company, whether now or hereafter existing, as those terms
are defined in Sections 424(e) and (f), respectively, of the Code.

         (b)      "BOARD" means the Board of Directors of the Company.

         (c)      "CODE" means the Internal Revenue Code of 1986, as amended.

         (d)      "COMMITTEE" means a committee of one or more members of the
Board appointed by the Board in accordance with subsection 3(c).

         (e)      "COMMON STOCK" means the common stock of the Company.

         (f)      "COMPANY" means Photon Dynamics, Inc., a California
corporation.

         (g)      "CONSULTANT" means any person, including an advisor, engaged
by the Company or an Affiliate to render consulting or advisory services and who
is compensated for such

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services. However, the term "Consultant" shall not include either Directors who
are not compensated by the Company for their services as Directors or Directors
who are merely paid a director's fee by the Company for their services as
Directors.

         (h)      "CONTINUOUS SERVICE" means that the Participant's service with
the Company or an Affiliate, whether as an Employee, Director or Consultant, is
not interrupted or terminated. The Participant's Continuous Service shall not be
deemed to have terminated merely because of a change in the capacity in which
the Participant renders service to the Company or an Affiliate as an Employee,
Consultant or Director or a change in the entity for which the Participant
renders such service, provided that there is no interruption or termination of
the Participant's Continuous Service. For example, a change in status from an
Employee of the Company to a Consultant of an Affiliate or a Director will not
constitute an interruption of Continuous Service. The Board or the chief
executive officer of the Company, in that party's sole discretion, may determine
whether Continuous Service shall be considered interrupted in the case of any
leave of absence approved by that party, including sick leave, military leave or
any other personal leave.

         (i)      "DIRECTOR" means a member of the Board of Directors of the
Company.

         (j)      "DISABILITY" means the inability of a person, in the opinion
of a qualified physician acceptable to the Company, to perform the major duties
of such person's position with the Company or with an Affiliate because of the
sickness or injury of such person.

         (k)      "EMPLOYEE" means any person employed by the Company or an
Affiliate. Mere service as a Director or payment of a director's fee by the
Company or an Affiliate shall not be sufficient to constitute "employment" by
the Company or an Affiliate.

         (l)      "EXCHANGE ACT" means the Securities Exchange Act of 1934, as
amended.

         (m)      "FAIR MARKET VALUE" means, as of any date, the value of the
Common Stock determined as follows:

                  (i)      If the Common Stock is listed on any established
stock exchange or traded on the Nasdaq National Market or the Nasdaq SmallCap
Market, the Fair Market Value of a share of Common Stock shall be the closing
sales price for such stock (or the closing bid if no sales were reported) as
quoted on such exchange or market (or the exchange or market with the greatest
volume of trading in the Common Stock) on the date of grant, or if the date of
grant is not a market trading day, then the last market trading day prior to the
date of grant, as reported in The Wall Street Journal or such other source as
the Board deems reliable.

                  (ii)     In the absence of such markets for the Common Stock,
the Fair Market Value shall be determined in good faith by the Board.

         (n)      "NON-EMPLOYEE DIRECTOR" means a Director who either (i) is not
a current Employee or Officer of the Company or its parent or a subsidiary, does
not receive compensation (directly or indirectly) from the Company or its parent
or a subsidiary for services rendered as a consultant or in any capacity other
than as a Director (except for an amount as to which

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disclosure would not be required under Item 404(a) of Regulation S-K promulgated
under the federal securities laws ("Regulation S-K")), does not possess an
interest in any other transaction as to which disclosure would be required under
Item 404(a) of Regulation S-K and is not engaged in a business relationship as
to which disclosure would be required under Item 404(b) of Regulation S-K; or
(ii) is otherwise considered a "non-employee director" for purposes of Rule
16b-3.

         (o)      "NONSTATUTORY STOCK OPTION" means an Option not intended to
qualify as an "incentive stock option" within the meaning of Section 422 of the
Code and the regulations promulgated thereunder.

         (p)      "OFFICER" means a person who possesses the authority of an
"officer" as that term is used in Rule 4460(i)(1)(A) of the Rules of the
National Association of Securities Dealers, Inc. For purposes of the Plan, a
person employed by the Company in the position of "Vice President" or higher
shall be classified as an "Officer" unless the Board or Committee expressly
finds that such person does not possess the authority of an "officer" as that
term is used in Rule 4460(i)(1)(A) of the Rules of the National Association of
Securities Dealers, Inc.

         (q)      "OPTION" means a Nonstatutory Stock Option granted pursuant to
the Plan.

         (r)      "OPTION AGREEMENT" means a written agreement between the
Company and an Optionholder evidencing the terms and conditions of an individual
Option grant. Each Option Agreement shall be subject to the terms and conditions
of the Plan.

         (s)      "OPTIONHOLDER" means a person to whom an Option is granted
pursuant to the Plan or, if applicable, such other person who holds an
outstanding Option.

         (t)      "PARTICIPANT" means a person to whom a Stock Award is granted
pursuant to the Plan or, if applicable, such other person who holds an
outstanding Stock Award.

         (u)      "PLAN" means this Photon Dynamics, Inc. 2001 Equity Incentive
Plan.

         (v)      "RULE 16b-3" means Rule 16b-3 promulgated under the Exchange
Act or any successor to Rule 16b-3, as in effect from time to time.

         (w)      "SECURITIES ACT" means the Securities Act of 1933, as amended.

         (x)      "STOCK AWARD" means any right granted under the Plan,
including an Option, a stock purchase award and a restricted stock bonus award.

         (y)      "STOCK AWARD AGREEMENT" means a written agreement between the
Company and a holder of a Stock Award evidencing the terms and conditions of an
individual Stock Award grant. Each Stock Award Agreement shall be subject to the
terms and conditions of the Plan.

3.       ADMINISTRATION.

         (a)      ADMINISTRATION BY BOARD. The Board shall administer the Plan
unless and until

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the Board delegates administration to a Committee, as provided in subsection
3(c).

         (b)      POWERS OF BOARD. The Board shall have the power, subject to,
and within the limitations of, the express provisions of the Plan:

                  (i)      To determine from time to time which of the persons
eligible under the Plan shall be granted Stock Awards; when and how each Stock
Award shall be granted; what type or combination of types of Stock Award shall
be granted; the provisions of each Stock Award granted, including the time or
times when a person shall be permitted to receive Common Stock pursuant to a
Stock Award; and the number of shares of Common Stock with respect to which a
Stock Award shall be granted to each such person.

                  (ii)     To construe and interpret the Plan and Stock Awards
granted under it, and to establish, amend and revoke rules and regulations for
its administration. The Board, in the exercise of this power, may correct any
defect, omission or inconsistency in the Plan or in any Stock Award Agreement,
in a manner and to the extent it shall deem necessary or expedient to make the
Plan fully effective.

                  (iii)    To amend the Plan or a Stock Award as provided in
Section 12.

                  (iv)     Generally, to exercise such powers and to perform
such acts as the Board deems necessary or expedient to promote the best
interests of the Company which are not in conflict with the provisions of the
Plan.

         (c)      DELEGATION TO COMMITTEE.

                  (i)      GENERAL. The Board may delegate administration of the
Plan to a Committee or Committees of one (1) or more members of the Board, and
the term "Committee" shall apply to any person or persons to whom such authority
has been delegated. If administration is delegated to a Committee, the Committee
shall have, in connection with the administration of the Plan, the powers
theretofore possessed by the Board, including the power to delegate to a
subcommittee any of the administrative powers the Committee is authorized to
exercise (and references in this Plan to the Board shall thereafter be to the
Committee or subcommittee), subject, however, to such resolutions, not
inconsistent with the provisions of the Plan, as may be adopted from time to
time by the Board. The Board may abolish the Committee at any time and revest in
the Board the administration of the Plan.

                  (ii)     COMMITTEE COMPOSITION WHEN COMMON STOCK IS PUBLICLY
TRADED. At such time as the Common Stock is publicly traded, in the discretion
of the Board, a Committee may consist solely of two or more Non-Employee
Directors, in accordance with Rule 16b-3. Within the scope of such authority,
the Board or the Committee may delegate to a committee of one or more members of
the Board who are not Non-Employee Directors the authority to grant Stock Awards
to eligible persons who are not then subject to Section 16 of the Exchange Act.

         (d)      EFFECT OF BOARD'S DECISION. All determinations,
interpretations and constructions made by the Board in good faith shall not be
subject to review by any person and shall be final, binding and conclusive on
all persons.

                                       4.

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4.       SHARES SUBJECT TO THE PLAN.

         (a)      SHARE RESERVE. Subject to the provisions of Section 11
relating to adjustments upon changes in Common Stock, the Common Stock that may
be issued pursuant to Stock Awards shall not exceed in the aggregate six hundred
fifty thousand (650,000) shares of Common Stock.

         (b)      REVERSION OF SHARES TO THE SHARE RESERVE. If any Nonstatutory
Stock Option shall for any reason expire or otherwise terminate, in whole or in
part, without having been exercised in full, the shares of Common Stock not
acquired under such Nonstatutory Stock Option shall revert to and again become
available for issuance under the Plan.

         (c)      SOURCE OF SHARES. The shares of Common Stock subject to the
Plan may be unissued shares or reacquired shares, bought on the market or
otherwise.

5.       ELIGIBILITY.

         (a)      ELIGIBILITY FOR SPECIFIC STOCK AWARDS. Stock Awards may be
granted to Employees, Directors and Consultants.

         (b)      RESTRICTIONS ON ELIGIBILITY. Notwithstanding the foregoing,
the aggregate number of shares issued pursuant to Stock Awards granted to
Officers and Directors (i) shall not exceed forty percent (40%) of the total
number of shares reserved for issuance under the Plan as determined at the time
of each such issuance to an Officer or Director and (ii) shall not exceed forty
percent (40%) of the aggregate number of shares underlying Stock Awards granted
to all persons under the Plan as determined from the date of the adoption of the
Plan to the date of the third anniversary of such adoption and every anniversary
thereafter, except that in each case there shall be excluded from these
calculations shares issued to Officers not previously employed by the Company
pursuant to Stock Awards granted as an inducement essential to such individuals
entering into employment contracts with the Company.

         (c)      CONSULTANTS.

                  (i)      A Consultant shall not be eligible for the grant of a
Stock Award if, at the time of grant, a Form S-8 Registration Statement under
the Securities Act ("Form S-8") is not available to register either the offer or
the sale of the Company's securities to such Consultant because of the nature of
the services that the Consultant is providing to the Company, or because the
Consultant is not a natural person, or as otherwise provided by the rules
governing the use of Form S-8, unless the Company determines both (i) that such
grant (A) shall be registered in another manner under the Securities Act (e.g.,
on a Form S-3 Registration Statement) or (B) does not require registration under
the Securities Act in order to comply with the requirements of the Securities
Act, if applicable, and (ii) that such grant complies with the securities laws
of all other relevant jurisdictions.

                  (ii)     Form S-8 generally is available to consultants and
advisors only if (i) they are natural persons; (ii) they provide bona fide
services to the issuer, its parents, its majority-owned subsidiaries or
majority-owned subsidiaries of the issuer's parent; and (iii) the services are

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not in connection with the offer or sale of securities in a capital-raising
transaction, and do not directly or indirectly promote or maintain a market for
the issuer's securities.

6.       OPTION PROVISIONS.

         Each Option shall be in such form and shall contain such terms and
conditions as the Board shall deem appropriate. The provisions of separate
Options shall include (through incorporation of provisions hereof by reference
in the Option or otherwise) the substance of each of the following provisions:

         (a)      TERM. The term of an Option shall not exceed 10 years, either
at the time of grant of the Option or as the Option may be amended thereafter.

         (b)      EXERCISE PRICE OF A NONSTATUTORY STOCK OPTION. The exercise
price of each Nonstatutory Stock Option shall be not less than the Fair Market
Value of the Common Stock subject to the Option on the date the Option is
granted.

         (c)      CONSIDERATION. The purchase price of Common Stock acquired
pursuant to an Option shall be paid, to the extent permitted by applicable
statutes and regulations, either (i) in cash or by check at the time the Option
is exercised or (ii) at the discretion of the Board at the time of the grant of
the Option or at any time prior to the time of exercise in the case of a
Nonstatutory Stock Option (1) by delivery to the Company of other Common Stock,
(2) according to a deferred payment or other similar arrangement with the
Optionholder or (3) in any other form of legal consideration that may be
acceptable to the Board. Unless otherwise specifically provided in the Option,
the purchase price of Common Stock acquired pursuant to an Option that is paid
by delivery to the Company of other Common Stock acquired, directly or
indirectly from the Company, shall be paid only by shares of the Common Stock of
the Company that have been held for more than six (6) months (or such longer or
shorter period of time required to avoid a charge to earnings for financial
accounting purposes). At any time that the Company is incorporated in Delaware,
payment of the Common Stock's "par value," as defined in the Delaware General
Corporation Law, shall not be made by deferred payment.

         In the case of any deferred payment arrangement, interest shall be
compounded at least annually and shall be charged at the market rate of interest
necessary to avoid a charge to earnings for financial accounting purposes.

         (d)      TRANSFERABILITY OF A NONSTATUTORY STOCK OPTION. A Nonstatutory
Stock Option shall not be transferable except by will or by the laws of descent
and distribution and shall be exercisable during the lifetime of the
Optionholder only by the Optionholder. Notwithstanding the foregoing, the
Optionholder may, by delivering written notice to the Company, in a form
satisfactory to the Company, designate a third party who, in the event of the
death of the Optionholder, shall thereafter be entitled to exercise the Option.

         (e)      VESTING GENERALLY. Each Option shall be evidenced by a Stock
Award Agreement executed by the Company and the Optionholder. The total number
of shares of Common Stock subject to an Option may vest and therefore become
exercisable as set-forth in

                                       6.

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the Stock Award Agreement. The Option may be subject to such other terms and
conditions on the time or times when it may be exercised (which may be based on
performance or other criteria) as the Board may deem appropriate. The provisions
of this subsection 6(e) are subject to any Option provisions governing the
minimum number of shares of Common Stock as to which an Option may be exercised.

         (f)      TERMINATION OF CONTINUOUS SERVICE. In the event an
Optionholder's Continuous Service terminates for any reason other than upon the
Optionholder's death or Disability, the Optionholder may exercise his or her
Option (to the extent that the Optionholder was entitled to exercise such Option
as of the date of termination or as otherwise permitted by the Company) but only
within such period of time ending on the earlier of (i) the date ninety (90)
days following the termination of the Optionholder's Continuous Service, or (ii)
the expiration of the term of the Option as set forth in the Option Agreement.
If, after termination, the Optionholder does not exercise his or her Option
within the time specified in the Option Agreement, the Option shall terminate.

         (g)      EXTENSION OF TERMINATION DATE. An Optionholder's Option
Agreement may also provide that if the exercise of the Option following the
termination of the Optionholder's Continuous Service (other than upon the
Optionholder's death or Disability) would be prohibited at any time solely
because the issuance of shares of Common Stock would violate the registration
requirements under the Securities Act or similar requirements of applicable law
of another jurisdiction to which the Option is subject, then the Option shall
terminate on the earlier of (i) the expiration of the term of the Option set
forth in the Option Agreement, or (ii) the expiration of a period of three (3)
months after the termination of the Optionholder's Continuous Service during
which the exercise of the Option would not be in violation of such registration
requirements or similar requirements.

         (h)      DISABILITY OF OPTIONHOLDER. In the event that an
Optionholder's Continuous Service terminates as a result of the Optionholder's
Disability, the Optionholder may exercise his or her Option (to the extent that
the Optionholder was entitled to exercise such Option as of the date of
termination or as otherwise permitted by the Company), but only within such
period of time ending on the earlier of (i) the date three hundred sixty-five
(365) days following such termination (or such longer or shorter period
specified in the Option Agreement) or (ii) the expiration of the term of the
Option as set forth in the Option Agreement. If, after termination, the
Optionholder does not exercise his or her Option within the time specified
herein, the Option shall terminate.

         (i)      DEATH OF OPTIONHOLDER. In the event (i) an Optionholder's
Continuous Service terminates as a result of the Optionholder's death or (ii)
the Optionholder dies within the period (if any) specified in the Option
Agreement after the termination of the Optionholder's Continuous Service for a
reason other than death, then the Option may be exercised (to the extent the
Optionholder was entitled to exercise such Option as of the date of death or as
otherwise permitted by the Company) by the Optionholder's estate, by a person
who acquired the right to exercise the Option by bequest or inheritance or by a
person designated to exercise the Option upon the Optionholder's death pursuant
to subsection 6(d), but only within the period ending on the earlier of (1) the
date three hundred sixty-five (365) days following the date of death (or such

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longer or shorter period specified in the Option Agreement) or (2) the
expiration of the term of such Option as set forth in the Option Agreement. If,
after death, the Option is not exercised within the time specified herein, the
Option shall terminate.

         (j)      EARLY EXERCISE. The Option may include a provision whereby the
Optionholder may elect at any time before the Optionholder's Continuous Service
terminates to exercise the Option as to any part or all of the shares of Common
Stock subject to the Option prior to the full vesting of the Option. Any
unvested shares of Common Stock so purchased may be subject to a repurchase
option in favor of the Company or to any other restriction the Board determines
to be appropriate.

7.       PROVISIONS OF STOCK AWARDS OTHER THAN OPTIONS.

         (a)      RESTRICTED STOCK BONUS AWARDS. Each restricted stock bonus
agreement shall be in such form and shall contain such terms and conditions as
the Board shall deem appropriate. The terms and conditions of restricted stock
bonus agreements may change from time to time, and the terms and conditions of
separate restricted stock bonus agreements shall include (through incorporation
of provisions hereof by reference in the agreement or otherwise) the substance
of each of the following provisions:

                  (i)      CONSIDERATION. A restricted stock bonus award may be
awarded in consideration for past services actually rendered to the Company or
an Affiliate for its benefit.

                  (ii)     VESTING. Shares of Common Stock awarded under the
restricted stock bonus agreement may be subject to a share repurchase option in
favor of the Company in accordance with a vesting schedule to be determined by
the Board.

                  (iii)    TERMINATION OF PARTICIPANT'S CONTINUOUS SERVICE. In
the event a Participant's Continuous Service terminates, the Company shall
automatically reacquire any or all of the shares of Common Stock held by the
Participant which have not vested as of the date of termination under the terms
of the restricted stock bonus agreement.

                  (iv)     TRANSFERABILITY. Rights to acquire shares of Common
Stock under the restricted stock bonus agreement shall be transferable by the
Participant only upon such terms and conditions as are set forth in the
restricted stock bonus agreement, as the Board shall determine in its
discretion, so long as Common Stock awarded under the restricted stock bonus
agreement remains subject to the terms of the restricted stock bonus agreement.

         (b)      STOCK PURCHASE AWARDS. Each stock purchase agreement shall be
in such form and shall contain such terms and conditions as the Board shall deem
appropriate. The terms and conditions of the stock purchase agreements may
change from time to time, and the terms and conditions of separate stock
purchase agreements need not be identical, but each stock purchase agreement
shall include (through incorporation of provisions hereof by reference in the
agreement or otherwise) the substance of each of the following provisions:

                  (i)      PURCHASE PRICE. The purchase price under each stock
purchase agreement shall be such amount as the Board shall determine and
designate in such stock purchase

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agreement.

                  (ii)     CONSIDERATION. The purchase price of Common Stock
acquired pursuant to the stock purchase agreement shall be paid either: (i) in
cash at the time of purchase; (ii) at the discretion of the Board, according to
a deferred payment or other similar arrangement with the Participant; or (iii)
in any other form of legal consideration that may be acceptable to the Board in
its discretion; provided, however, that at any time that the Company is
incorporated in Delaware, then payment of the Common Stock's "par value," as
defined in the Delaware General Corporation Law, shall not be made by deferred
payment.

                  (iii)    VESTING. Shares of Common Stock acquired under the
stock purchase agreement may be subject to a share repurchase option in favor of
the Company in accordance with a vesting schedule to be determined by the Board.

                  (iv)     TERMINATION OF PARTICIPANT'S CONTINUOUS SERVICE. In
the event a Participant's Continuous Service terminates, the Company may
repurchase or otherwise reacquire any or all of the shares of Common Stock held
by the Participant which have not vested as of the date of termination under the
terms of the stock purchase agreement.

                  (v)      TRANSFERABILITY. Rights to acquire shares of Common
Stock under the stock purchase agreement shall be transferable by the
Participant only upon such terms and conditions as are set forth in the stock
purchase agreement, as the Board shall determine in its discretion, so long as
Common Stock awarded under the stock purchase agreement remains subject to the
terms of the stock purchase agreement.

8.       COVENANTS OF THE COMPANY.

         (a)      AVAILABILITY OF SHARES. During the terms of the Stock Awards,
the Company shall keep available at all times the number of shares of Common
Stock required to satisfy such Stock Awards.

         (b)      SECURITIES LAW COMPLIANCE. The Company shall seek to obtain
from each regulatory commission or agency having jurisdiction over the Plan such
authority as may be required to grant Stock Awards and to issue and sell shares
of Common Stock upon exercise of the Stock Awards; provided, however, that this
undertaking shall not require the Company to register under the Securities Act
the Plan, any Stock Award or any Common Stock issued or issuable pursuant to any
such Stock Award. If, after reasonable efforts, the Company is unable to obtain
from any such regulatory commission or agency the authority which counsel for
the Company deems necessary for the lawful issuance and sale of Common Stock
under the Plan, the Company shall be relieved from any liability for failure to
grant Stock Awards in compliance with applicable law or to issue and sell Common
Stock upon exercise of such Stock Awards unless and until such authority is
obtained.

9.       USE OF PROCEEDS FROM STOCK.

         Proceeds from the sale of Common Stock pursuant to Stock Awards shall
constitute general funds of the Company.

                                       9.

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10.      MISCELLANEOUS.

         (a)      STOCKHOLDER RIGHTS. No Participant shall be deemed to be the
holder of, or to have any of the rights of a holder with respect to, any shares
of Common Stock subject to such Stock Award unless and until such Participant
has satisfied all requirements for exercise of the Stock Award pursuant to its
terms.

         (b)      NO EMPLOYMENT OR OTHER SERVICE RIGHTS. Nothing in the Plan or
any instrument executed or Stock Award granted pursuant thereto shall confer
upon any Participant any right to continue to serve the Company or an Affiliate
in the capacity in effect at the time the Stock Award was granted or shall
affect the right of the Company or an Affiliate to terminate (i) the employment
of an Employee with or without notice and with or without cause, (ii) the
service of a Consultant pursuant to the terms of such Consultant's agreement
with the Company or an Affiliate or (iii) the service of a Director pursuant to
the Bylaws of the Company or an Affiliate, and any applicable provisions of the
corporate law of the state in which the Company or the Affiliate is
incorporated, as the case may be.

         (c)      INVESTMENT ASSURANCES. The Company may require a Participant,
as a condition of exercising or acquiring Common Stock under any Stock Award,
(i) to give written assurances satisfactory to the Company as to the
Participant's knowledge and experience in financial and business matters and/or
to employ a purchaser representative reasonably satisfactory to the Company who
is knowledgeable and experienced in financial and business matters and that he
or she is capable of evaluating, alone or together with the purchaser
representative, the merits and risks of exercising the Stock Award; and (ii) to
give written assurances satisfactory to the Company stating that the Participant
is acquiring Common Stock subject to the Stock Award for the Participant's own
account and not with any present intention of selling or otherwise distributing
the Common Stock. The foregoing requirements, and any assurances given pursuant
to such requirements, shall be inoperative if (1) the issuance of the shares of
Common Stock upon the exercise or acquisition of Common Stock under the Stock
Award has been registered under a then currently effective registration
statement under the Securities Act or (2) as to any particular requirement, a
determination is made by counsel for the Company that such requirement need not
be met in the circumstances under the then applicable securities laws. The
Company may, upon advice of counsel to the Company, place legends on stock
certificates issued under the Plan as such counsel deems necessary or
appropriate in order to comply with applicable securities laws, including, but
not limited to, legends restricting the transfer of the Common Stock.

         (d)      WITHHOLDING OBLIGATIONS. To the extent provided by the terms
of a Stock Award Agreement, the Participant may satisfy any federal, state or
local tax withholding obligation relating to the exercise or acquisition of
Common Stock under a Stock Award by any of the following means (in addition to
the Company's right to withhold from any compensation paid to the Participant by
the Company) or by a combination of such means: (i) tendering a cash payment;
(ii) authorizing the Company to withhold shares of Common Stock from the shares
of Common Stock otherwise issuable to the Participant as a result of the
exercise or acquisition of

                                       10.

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Common Stock under the Stock Award, provided, however, that no shares of Common
Stock are withheld with a value exceeding the minimum amount of tax required to
be withheld by law; or (iii) delivering to the Company owned and unencumbered
shares of Common Stock.

11.      ADJUSTMENTS UPON CHANGES IN STOCK.

         (a)      CAPITALIZATION ADJUSTMENTS. If any change is made in the
Common Stock subject to the Plan, or subject to any Stock Award, without the
receipt of consideration by the Company (through merger, consolidation,
reorganization, recapitalization, reincorporation, stock dividend, dividend in
property other than cash, stock split, liquidating dividend, combination of
shares, exchange of shares, change in corporate structure or other transaction
not involving the receipt of consideration by the Company), the Plan will be
appropriately adjusted in the type, class(es) and maximum number of securities
subject to the Plan pursuant to subsection 4(a), and the outstanding Stock
Awards will be appropriately adjusted in the type, class(es) and number of
securities and price per share of securities subject to such outstanding Stock
Awards. The Board shall make such adjustments, and its determination shall be
final, binding and conclusive. (The conversion of any convertible securities of
the Company shall not be treated as a transaction "without receipt of
consideration" by the Company.)

         (b)      DISSOLUTION OR LIQUIDATION. In the event of a dissolution or
liquidation of the Company, then all outstanding Stock Awards shall terminate
immediately prior to such event.

         (c)      ASSET SALE, MERGER, CONSOLIDATION OR REVERSE MERGER. In the
event of (i) a sale, exchange, lease or other disposition of all or
substantially all of the assets of the Company, (ii) a merger or consolidation
in which the Company is not the surviving corporation or (iii) a reverse merger
in which the Company is the surviving corporation but the shares of Common Stock
outstanding immediately preceding the merger are converted by virtue of the
merger into other property, whether in the form of securities, cash or otherwise
(individually, a "Corporate Transaction"), then any surviving corporation or
acquiring corporation shall assume or continue any Stock Awards outstanding
under the Plan or shall substitute similar stock awards (including an award to
acquire the same consideration paid to the stockholders in the Corporate
Transaction for those outstanding under the Plan). In the event any surviving
corporation or acquiring corporation refuses to assume or continue such Stock
Awards or to substitute similar stock awards for those outstanding under the
Plan, then with respect to Stock Awards held by Participants whose Continuous
Service has not terminated, the vesting of such Stock Awards (and, if
applicable, the time during which such Stock Awards may be exercised) shall be
accelerated in full, and the Stock Awards shall terminate if not exercised (if
applicable) at or prior to the Corporate Transaction. With respect to any other
Stock Awards outstanding under the Plan, such Stock Awards shall terminate if
not exercised (if applicable) prior to the Corporate Transaction.

12.      AMENDMENT OF THE PLAN AND STOCK AWARDS.

         (a)      AMENDMENT OF PLAN. The Board at any time, and from time to
time, may amend the Plan. However, except as provided in Section 11 relating to
adjustments upon changes in stock, no amendment shall be effective unless
approved by the stockholders of the Company to

                                       11.

<PAGE>

the extent stockholder approval is necessary for the Plan to satisfy any Nasdaq
or securities exchange listing requirements. The Board may in its sole
discretion submit such amendment to the Plan for stockholder approval.

         (b)      NO IMPAIRMENT OF RIGHTS. Rights under any Stock Award granted
before amendment of the Plan shall not be materially impaired by any amendment
of the Plan unless (i) the Company requests the consent of the Participant and
(ii) the Participant consents in writing.

         (c)      AMENDMENT OF STOCK AWARDS. The Board at any time, and from
time to time, may amend the terms of any one or more Stock Awards; provided,
however, that the rights under any Stock Award shall not be materially impaired
by any such amendment unless (i) the Company requests the consent of the
Participant and (ii) the Participant consents in writing.

13.      TERMINATION OR SUSPENSION OF THE PLAN.

         (a)      PLAN TERM. The Board may suspend or terminate the Plan at any
time. No Stock Awards may be granted under the Plan while the Plan is suspended
or after it is terminated.

         (b)      NO IMPAIRMENT OF RIGHTS. Suspension or termination of the Plan
shall not impair rights and obligations under any Stock Award granted while the
Plan is in effect except with the written consent of the Participant.

14.      EFFECTIVE DATE OF PLAN.

         The Plan shall become effective immediately upon its adoption by the
Board.

15.      CHOICE OF LAW.

         The law of the State of California shall govern all questions
concerning the construction, validity and interpretation of this Plan, without
regard to such state's conflict of laws rules.

                                       12.<PAGE>

                                                                   EXHIBIT 10.26

January 28, 2003

Vincent F. Sollitto, Jr.
c/o Photon Dynamics, Inc.
5325 San Ignacio Avenue
San Jose, CA 95119-1202

Dear Vincent:

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 from your position as President
and Chief Executive Officer of the Company, and your position as a Director of
the Company, effective as of January 28, 2003. The Company has accepted your
resignation from these positions. Your last day as an employee of the Company
will be February 1, 2003 (the "Separation Date"). Between January 28, 2003, and
the Separation Date, you will continue as an employee of the Company and will
provide transition assistance to the new President and Chief Executive Officer.

         2.       ACCRUED SALARY AND PAID TIME OFF. On the Separation Date, the
Company will pay you 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.       CONSULTING AGREEMENT. The Company agrees to retain you, and
you agree to make yourself available and to perform, as a consultant under the
terms specified below.

                  (a)      CONSULTING PERIOD. The Company will engage you as a
consultant commencing on the Separation Date and continuing through May 31, 2003
(the "Consulting Period"). During the Consulting Period, the Company only may
terminate the Consulting Period for Cause. For purposes of this Section 3(a),
"Cause" shall mean: (i) your failure to perform (other than due to mental or
physical disability or death) the consulting duties to the reasonable
satisfaction of the Company's Board of Directors or the Chief Executive Officer
after receipt of a written warning and reasonable opportunity to cure; (ii) any
act of dishonesty taken in connection with your responsibilities as a Consultant
that is intended to result in your substantial personal enrichment; (iii) your
conviction or plea of no contest to a crime that negatively reflects on your
fitness to perform your duties or demonstrably harms the Company's reputation or
business; (iv) willful misconduct by you that is demonstrably injurious to the
Company's reputation or business; or (v) your willful violation of a material
Company policy. For purposes of determining whether "Cause" exists, an act or
failure to act will be deemed "willful" only if effected not in good faith or
without reasonable belief that the action or failure to act was in the best
interests of the Company.

<PAGE>

Vincent F. Sollitto, Jr.
Page 2

                  (b)      CONSULTING SERVICES. During the Consulting Period,
you will make yourself available, by telephone or in person, for up to forty
(40) hours per week to provide consulting services to the Company in any area of
your expertise as requested by the Company. The Company anticipates that it will
require your services to: (i) transition your current duties and
responsibilities; (ii) take steps to retain key employees; (iii) assisting
Company management in revising a strategic plan for the Company; and (iv) sell
certain assets of the Company. You agree to exercise the highest degree of
professionalism and utilize your expertise and creative talents in performing
these services. You agree not to represent or purport to represent the Company
in any manner whatsoever to any third party during the Consulting Period unless
authorized by the Company in writing to do so.

                  (c)      CONSULTING FEES. During the Consulting Period, the
Company agrees to pay you consulting fees in the amount of $24,811 per month
("Consulting Fees"). As a consultant, the Company will not withhold from the
Consulting Fees any amount for taxes (including income and employment taxes) or
other payroll deductions. The Company will issue you an IRS 1099 Form with
respect to your Consulting Fees. You acknowledge that you will be entirely
responsible for payment of any taxes which may be due with regard to the
Consulting Fees, and you hereby indemnify and save harmless the Company from any
liability for any taxes, penalties or interest that may be assessed by any
taxing authority with respect to the Consulting Fees, with the exception of the
employer's share of social security and employer's liability for tax treatment
of your consultancy, if any. The Company will reimburse you for documented
business expenses incurred during the Consulting Period, provided that these
expenses have been pre-approved by the Company in writing.

                  (d)      OTHER WORK ACTIVITIES. During the Consulting Period,
you may engage in employment, consulting or other work relationships in addition
to your work for the Company EXCEPT work activity of any type that is
competitive with the Company. If you engage in such competitive activity without
the Company's express written consent, the Company's obligations to pay you
Consulting Fees throughout the Consulting Period, to pay your health insurance
premiums under Section 5, and to allow the continued vesting of your stock
options under Section 4 will cease immediately and the Consulting Period will
end immediately.

         4.       STOCK OPTIONS. As provided in your stock option agreements and
the applicable stock option plan documents (the "Option Documents"), your
Company stock options ("Options") will continue to vest during the Consulting
Period. The Options will continue to be governed in all respects by the
applicable Option Documents. Notwithstanding the Option Documents, you may
exercise the Options for the vested shares, pursuant to the terms in the
applicable Option Documents, on or before October 31, 2003; provided, however,
the shares received upon exercise may not be entitled to incentive stock option
tax treatment. You may wish to consult with your tax advisor about the tax
treatment of your Option shares.

         5.       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

<PAGE>

Vincent F. Sollitto, Jr.
Page 3

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 through the Consulting
Period.

         6.       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 execute and return the Supplemental Release Agreement
(attached hereto as Exhibit A) to the Company on or after the last day of the
Consulting Period, the Company will pay you, as severance, an amount equivalent
to eight (8) 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 the Supplemental Release Agreement, as
defined in Exhibit A.

         7.       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. You further
acknowledge and agree that you are not entitled to any compensation or benefits
pursuant to the Agreement Regarding Change of Control, dated July 1, 1996,
between you and the Company (the "Change of Control Agreement") and that the
Change of Control Agreement shall have no further force or effect after the
Separation Date.

         8.       EXPENSE REIMBURSEMENTS. You agree that, within ten (10) days
of 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.

         9.       RETURN OF COMPANY PROPERTY. You agree that, within ten (10)
days of 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, 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); provided that you shall be entitled
to retain any such property necessary to complete your consulting duties.

         9.       PROPRIETARY INFORMATION OBLIGATIONS. You acknowledge your
continuing obligations to refrain from any use or disclosure of the Company's
confidential or proprietary information or materials, unless expressly
authorized by the Company.

You further agree to maintain in confidence and not to use or disclose any
confidential or proprietary information or materials of the Company that you may
obtain or develop during the Consulting Period, except as expressly authorized
by the Company, and you hereby assign and transfer to the Company your entire
right, title, and interest in and to all inventions, including,

<PAGE>

Vincent F. Sollitto, Jr.
Page 4

but not limited to, ideas, improvements, designs, and discoveries, whether or
not patentable or reduced to practice, that you make or conceive in the course
of performing consulting services for the Company hereunder. You also agree to
return all Company property to the Company upon the completion of the Consulting
Period.

         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.

12.      RELEASE. In exchange for the consulting agreement, COBRA payments,
Severance Payment 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

<PAGE>

Vincent F. Sollitto, Jr.
Page 5

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 execution date of this
Agreement; (b) you should consult with an attorney prior to executing 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 execute this
Agreement earlier); (d) you have seven (7) days following the execution of this
Agreement by the parties 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 executed 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 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; provided, however, that the Indemnification
Agreement dated January 10, 2000 between you and the Company, and any
confidentiality agreements between you and the Company, shall remain in full
force and effect. 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, their 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.

<PAGE>

Vincent F. Sollitto, Jr.
Page 6

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 - Supplemental Release Agreement

UNDERSTOOD AND AGREED:

 /s/ Vincent F. Sollitto, Jr.
-----------------------------
Vincent F. Sollitto, Jr.

DATED:        1/28/03

<PAGE>

                                    EXHIBIT A

                         SUPPLEMENTAL RELEASE AGREEMENT

    (TO BE SIGNED AND RETURNED TO THE COMPANY ON OR AFTER THE LAST DAY OF THE
                               CONSULTING PERIOD)

I agree to the terms in the foregoing Agreement.

In consideration for the consulting agreement, COBRA payments, Extended Exercise
Period, Severance Payment and other consideration provided to me in the
Agreement to which I would not otherwise be entitled, I 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 I 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 my 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 my employment
with the Company or the termination of that employment; (2) all claims related
to my 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.

I acknowledge that I am knowingly and voluntarily waiving and releasing any
rights I 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 I was already entitled. I further acknowledge that I
have been advised by this writing, as required by the ADEA, that: (a) my waiver
and release do not apply to any rights or claims that may arise after the
execution date of this Agreement; (b) I should consult with an attorney prior to
executing this Agreement (although I may choose not to do so); (c) I have
twenty-one (21) days to consider this Agreement (although I may voluntarily
execute this Agreement earlier); (d) I have seven (7) days following the
execution of 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

                                       7.

<PAGE>

day after this Agreement is executed by me (the "Effective Date").

I UNDERSTAND THAT THIS RELEASE INCLUDES A RELEASE OF ALL KNOWN AND UNKNOWN
CLAIMS. In giving this release, which includes claims which may be unknown to me
at present, I acknowledge that I have read and understand Section 1542 of the
California Civil Code which reads as follows: "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 HIM MUST HAVE MATERIALLY
AFFECTED HIS SETTLEMENT WITH THE DEBTOR." I hereby expressly waive and
relinquish all rights and benefits under that section and any law of any other
jurisdiction of similar effect with respect to my release of any unknown or
unsuspected claims I may have against the Company.

By:                                         Date:
         Vincent F. Sollitto, Jr.

                                       8.

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