1002663--1/24/2008--PHOTON_DYNAMICS

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{stock, price, operating}

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{system, service, information}

{property, intellectual, protect}

{financial, litigation, operation}

{acquisition, growth, future}

{operation, natural, condition}

{personnel, key, retain}

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Our operating results are difficult to predict and may vary from investors expectations, which could cause our stock price to fall. We have experienced significant employee turnover, including in several key financial positions. If we are unable to attract and retain key employees, it may disrupt our ability to improve our financial controls, meet our reporting obligations and effectively manage our business. We have exposure to various foreign and domestic regulatory risks. Our failure to comply with governmental regulations could subject us to liability and additional expense. If our flat panel display products experience performance, reliability or quality problems, our customers may reduce their orders. Capital investment by manufacturers of flat panel display products can be highly cyclical and may decline in the future. We depend on sales to a few large customers in the flat panel display industry, and if we lose any of our large customers our revenue could decrease significantly. We rely upon sales of a limited range of flat panel display products, and if demand for one product decreases for any reason it could cause our revenue to decline significantly. 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. If we are not able to receive sufficient parts to meet our production requirements, we may experience significant delays in producing our products, which could decrease our revenue for an extended period of time. Substantially all of our revenue from flat panel display products is derived from sales to companies located outside the United States, which exposes us to risks that we would not experience with domestic sales. Our customer qualification and sales cycle is lengthy and unpredictable and requires us to incur substantial costs to make a sale, and if we fail to make a sale, our increased expenses may lead to lower profit margins. Our ability to efficiently and effectively implement our strategy of using both domestic and outsourced offshore manufacturing may impact our profitability. Any failure of, or other problems at or with, our third party manufacturers could delay shipments of our products, harm our relationships with our customers or otherwise negatively impact our business. If we do not compete effectively in our target markets, we will lose market share. Our success depends in large part on the strength of active matrix liquid crystal display technology in the flat panel display industry. We may have difficulty integrating businesses or assets that we have acquired or developed in new ventures and may acquire or develop in the future, and we may not realize the benefits that we expect from these acquisitions and new ventures. We may never achieve or sustain profitability in our High-Performance Digital Imaging business segment. If the products developed within our High-Performance Digital Imaging segment become successful, we may derive a significant portion of our revenue from customers that receive their funding for our products from U.S. government contracts, which are subject to unique risks. 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. Our corporate offices and manufacturing facilities and our customers manufacturing facilities may be subject to disruption from natural disasters. We rely upon certain critical information systems for our daily business operation. Our inability to use or access these information systems at critical points in time could unfavorably impact the timeliness and efficiency of our business operation. We may experience difficulties with our enterprise resource planning ( ERP ) system and other IT systems. System failure or malfunctioning may result in disruption of operations and the inability to process transactions, and this could adversely affect our financial results. RISKS RELATING TO OWNING OUR COMMON STOCK Our stock price may fluctuate significantly. Some anti-takeover provisions may affect the price of our common stock. We do not anticipate paying cash dividends. RISKS RELATING TO OUR RESTATEMENTS AND RELATED MATTERS Our current restatement of our consolidated financial statements and related events, as well as possible future restatements, may have a material adverse effect on our business. If we do not comply with the requirements of NASDAQ, our common stock may be delisted from the NASDAQ National Market.

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1002663--1/24/2008--PHOTON_DYNAMICS_INC