THIRD AMENDMENT TO LEASE

Exhibit 10.26

THIRD AMENDMENT TO LEASE

This Third Amendment to Lease (the “Third Amendment”), is made and entered into this [12^th] day of August, 2003 by and between Mission West Properties, L.P. II, a Delaware limited partnership (“Lessor”) and Photon Dynamics, a California Corporation (“Lessee”).

RECITALS

NOW, THEREFORE, for good and valuable consideration, the receipt and sufficiency of which are acknowledged, the parties hereto agree to amend the Lease as follows:

If the Expansion Premises Commencement Date occurs after January 1, 2004, then all the dates described above shall be adjusted by adding to each date the number of days after January 1, 2004 that Lessee’s obligation to pay Rent hereunder actually commences.

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“It is the intention of the Lessee and Lessor that January 1, 2004, shall be the Expansion Premises Commencement Date. Lessor shall grant Lessee early occupancy at least fifteen (15) days before the Expansion Premises Commencement Date in order for Lessee to commence its wiring and cabling work.”

The second paragraph of Section 1 is hereby amended by the addition of a new item as follows:

“and (v) the issuance by the City of San Jose of a certificate of occupancy.”

Lessee’s Improvements: “Lessee’s Improvements” are defined as all improvements not included in Lessor Improvements. Lessee shall be solely responsible for the cost of the Lessee’s Improvements, subject to Lessor’s “not to exceed” cost shown on Exhibit B. Lessor shall construct Lessee’s Improvements pursuant to final construction plans and specifications that have been approved in writing by Lessee. Within five (5) business days following the execution of this Third Amendment, Lessor shall cause its architect to prepare and deliver to Lessee proposed construction plans and specifications for the Lessee’s and Lessor’s Improvements to be added after Lessee’s approval as Exhibit C. Within five (5) business days following delivery to Lessee of the proposed construction plans, Lessee shall approve the proposed construction plans or deliver to Lessor its written proposal for changes that must be made to said plans to conform the improvements to be constructed pursuant thereto, with respect to design, materials, quality, layout, and the like, to improvements reasonably suitable for Lessee’s intended purpose. If Lessee fails to approve or disapprove the proposed construction plans within the allowed time period, the construction plans proposed by Lessor shall be deemed to be approved by Lessee. If Lessee disapproves the proposed construction plans in any respect, the parties shall promptly meet and confer and negotiate in good faith to reach agreement on the construction plans. If Lessee’s Improvements exceed budget, Lessor will immediately notify Lessee as to amount of the overruns and the source of overruns and Lessee can reduce the cost by deleting items, agree to pay the overruns or ask Lessor to amortize the overruns or choose any combination of the above or if Lessee’s Improvements exceed $5,000,000, by written notice to Lessor, Lessee may terminate this Lease.

Lessor’s Improvements: Lessor at Lessor’s sole cost shall be responsible to complete all of the required improvements as shown below “Lessor’s Improvements”:

A, All improvements on 2^nd floor and all improvements contained within the cross hatched portion of first floor (as shown on Exhibit D) in a “turn key” condition, ready for occupancy, less the carpet allowance in Exhibit B of $141,250. The Lessor’s Improvements shall be substantially similar to the improvements in Lessor’s building at 6331 San Ignatio, San Jose, California.

B. 65% of Main Electrical Switchgear.

C. Overhead sprinklers (not including drops) in area of Lessee Improvements

D. Exterior painting and landscaping.

E. Lessor to provide 4000 amps electrical power at the transformer.

F. Insulate roof structure.

All bids and quotes will be based on division of Lessee’s and Lessor’s Improvements.

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Lessor shall be responsible for ensuring that the Lessee’s and Lessor”s Improvements conform to the approved plans and specifications, and all applicable statutes, rules, regulations, ordinances, and City of San Jose Building Department. Lessee’s approval of the plans for the Lessee’s and Lessor’s Improvements shall not relieve Lessor of its obligations under this Lease nor make Lessee liable to Lessor or its contractors. Lessor shall be responsible for paying for any improvements that are required by the City of San Jose as a condition to approving plans for Lessee’s or Lessor’s Improvements to comply with: (i) the Americans With Disabilities Act or (ii) any seismic modifications not related to or as a result of Lessee’s Improvements.

Lessor has prepared and Lessee has approved a budget for the completion of Lessee’s Improvements which is described on Exhibit B (“Lessee’s Improvements Costs Analysis”), including all “hard” and “soft” costs, permits and a management fee of 6% of the “hard” costs to Lessor. Lessor shall bid each major line item on the Lessee’s Improvement Costs Analysis that exceed $100,000 (the “Major Cost Line Item”) with at least three contractors acceptable to Lessee and shall provide Lessee a list of proposed contractors for Lessee’s approval prior to bidding. Prior to accepting a bid for a Major Cost Line Item, Lessor is responsible to provide a written summary of each of the Major Cost Line Item bids to Lessee. Within three (3) business days following the Lessor’s delivery to Lessee of the written summary of each of the Major Cost Line Item bids, Lessee shall approve the lowest bid to perform the work described in the bid. If Lessee fails to approve the lowest bid within the allowed time period, the lowest bid presented by the Lessor shall be deemed to be approved by Lessee. Lessor shall deliver an invoice to Lessee by the fifteenth (15^th) of each calendar month for the cost of construction (including equipment purchases) for Lessee’s Improvements and a pro rata portion of Lessor’s management fee. Lessee will wire all funds due Lessor by no later than the twenty fourth (24^th) day of the calendar month for the Lessor’s progress billing from the fifteenth (15^th) of the same calendar month.

Change Orders: No change made to the approved construction plans for the Lessee’s and Lessor’s Improvements and the Lessee’s Improvements cost statement after the final approval by the parties thereof shall be effective, unless such change is approved in writing by Lessor and Lessee, which approval shall not be unreasonably withheld. In this regard, Lessor shall not be required to approve any change that will structurally impair the Expansion Premises, or materially and adversely effect the outside appearance of the Building, interfere with the conduct of Lessee’s business, or materially detract from the inside appearance of the Expansion Premises. Change orders shall be written and shall describe the nature of the change and the reasonably determined increase or decrease in each line item of the approved cost statement for the Lessee’s Improvements occasioned by the change. If Lessee requests a change which will delay the Substantial Completion of the Lessee’s or Lessor’s Improvements beyond the Scheduled Completion Date, as hereinafter defined, the maximum amount of Lessee Delay, as hereinafter defined, that can be attributed to the change shall also be specified in the change order, including but not limited to, any Rent for any Lessee Delays that effect the Expansion Premises Commencement Date.

Inability to Obtain Materials: If Lessor notifies Lessee that any fittings, finishes or other materials specified by Lessee for the Lessee’s or Lessor’s Improvements for the Expansion Premises cannot be obtained within ten (10) days after placing an order therefore and Lessor reasonably determines that such extended delivery time will prohibit Lessor from Substantially Completing the Lessee’s Improvements by the Scheduled Completion Date, Lessor shall notify Lessee of such fact, the expected delay in the Scheduled Completion Date, and information that will permit Lessee to reasonably select an alternative fitting, finish, or material, including, without limitation any expected delays in the then Scheduled Completion Date associated with each alternative. Within three (3) business days, Lessee shall either (i) execute a change order in accordance with the foregoing requirements selecting an alternative presented by Lessor or developed by Lessee and approved by Lessor, which approval shall not be unreasonably withheld, or (ii) agree that any delay in the Substantial Completion of the Lessee’s or Lessor’s Improvements as a consequence of the inability to obtain the item will be a Lessee Delay.

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Lessor shall use its best efforts to cause the Expansion Premises Commencement Date to occur not later than January 1, 2004 (the “Scheduled Completion Date”). If the Expansion Premises Commencement Date has not occurred by the Scheduled Completion Date, Lessee shall receive one day of Rent abatement for each day (up to fifteen days) between the Scheduled Completion Date, and the Expansion Premises Commencement Date. If the Expansion Premises Commencement Date has not occurred by the fifteenth day following the Scheduled Completion Date, Lessee shall receive two days of Rent abatement for each day after the fifteenth day between the Scheduled Completion Date, and the Expansion Premises Commencement Date. Lessor and Lessee agree that having an Expansion Premises Commencement Date after the Scheduled Completion Date, will cause Lessee to incur costs not contemplated by this Lease, the exact amount of which will be extremely difficult to ascertain. Accordingly, the parties hereby agree that Lessee’s right to the abatement of Rent specified herein represents a fair and reasonable settlement for both parties and neither party shall have further liability to the other for any damages. Notwithstanding anything to the contrary herein, all dates stated herein shall be extended for the number of days Lessor is unable to Substantially Complete the Lessee’s or Lessor’s Improvements as a result of delays (i) due to failure of the City of San Jose to issue a building permit for the deck in 30 days after submission of all required documents in final form and payment of all fees, through no fault of Lessor or its contractors, (ii) due to failure of the City of San Jose to issue a building permit for the Lessor’s Improvements (except the deck) and the Lessee’s Improvements in 30 days after submission of all required documents in final form and payment of all fees, through no fault of Lessor or its contractors, (iii) due to acts of God, and (iv) due to Lessee Delays. “Lessee Delays” means a delay in Substantial Completion resulting from (a) Lessee’s failure (through no fault of Lessor or its contractors or consultants) to meet Lessee’s deadlines for approval as described in this Section 2, (b) delays due to change orders requested by Lessee, but only to the extent that the amount of the delay is set forth in a change order approved in writing by Lessee, (c) delays due to Lessee’s failure (through no fault of Lessor or its contractors or consultants) to meet the deadlines for approving any plans or change orders, and (d) delays because of the inability to obtain any product, materials, design, color, fitting, or finish pursuant to the provisions of Section 8 herein. Lessee shall have a minimum of five (5) business days to approve or disapprove any preliminary plans, change orders or any final plans. If Lessee does not disapprove any plans or change orders within the time period set forth herein in writing, Lessor may proceed on the basis that the plans or change orders are approved by Lessee. If plans or change orders are disapproved, Lessee shall state the reason for disapproval and Lessor and Lessee shall promptly meet and confer and act in good faith to resolve any issues. To the extent that the Expansion Premises Commencement Date is delayed beyond the Scheduled Completion Date, solely as a result of a Lessee Delay, then Lessee shall be responsible to pay Rent for each day of delay beyond the Scheduled Completion Date caused by such Lessee Delay.

During the first ninety (90) days following the Expansion Premises Commencement Date, Lessor at Lessor’s sole cost and expense shall be responsible to repair or replace any defects in Lessee’s or Lessor’s Improvements that are not caused by Lessee’s negligence. Lessee is responsible to notify Lessor in writing immediately upon the discovery of a defect in the Lessee’s or Lessor’s Improvements. Lessor is responsible to commence repairs or to replace any defect in the Lessee’s or Lessor’s Improvements immediately upon receipt of written notification from Lessee during the first ninety (90) days following Expansion Premises Commencement Date. Notwithstanding the foregoing, Lessor shall not be responsible for any failure of equipment that is moved from the Original Premises to the Expansion Premises. Lessor will assign to Lessee all construction warranties with regard to the Expansion Premises.

Lessor agrees to improve the Expansion Premises as described on Exhibits B, C and D by January 1, 2004, subject to receipt of an executed Third Amendment by August 8, 2003.

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“Notwithstanding the foregoing, any non-structural alteration or addition to the interior of the Expansion Premises with a total cost of less than $25,000 shall not require the written approval of the Lessor. However, Lessee will be required to notify Lessor in writing and be responsible to provide Lessor with all drawings and permits required in connection with the non-structural alteration or addition with a total cost less than $25,000.”

In section 4, add the following sentence after the fifth sentence: “Notwithstanding any provision in this Lease, Lessee shall have no obligation to remove at the end of the Term any Lessee Improvements for the Expansion Premises described on Exhibit C or any Lessor Improvements.”

Assignment and Subletting: Lessee shall not assign this Lease, or any interest therein, and shall not sublet the said Expansion Premises or any part thereof, or any right or privilege appurtenant thereto, or cause any other person or entity, to occupy or use the Expansion Premises, or any portion thereof, without the advance written consent of Lessor, which consent shall not be unreasonably withheld and shall be given or withheld within ten (10) days following Lessee’s request for such consent and delivery of the items required by this Section to be delivered to Lessor. Notwithstanding the above, Lessee may, without the consent of Lessor and without application of any of the other rights granted to the Lessor under this Section 20, assign this Lease or sublet all or any part of the Expansion Premises to (A) a bona fide subsidiary or affiliate of Lessee (provided the Lessee remains liable on the Lease as a surety or guarantor), (B) an entity in which or with which Lessee merges (provided the net worth of the resulting entity is not less than the net worth of the Lessee immediately prior to such transaction), or (C) an entity which acquires all or substantially all of the assets of Lessee located at the Expansion Premises (provided the Lessee remains liable on the Lease as a surety or guarantor) (in any such case an “Excepted Party”). Any such assignment or subletting requiring Lessor’s consent made without Lessor’s consent shall be void, and shall, at the option of the Lessor, terminate this Lease. This Lease shall not, nor shall any interest herein, be assignable, as to the interest of Lessee, by operation of law, without the written consent of Lessor, except to an Excepted Party. The sale of Lessee’s capital stock through a public exchange shall not be deemed a conveyance of this Lease, the Expansion Premises or any portion thereof or interest therein.

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If Lessee desires to assign its rights under this Lease or to sublet all or any part of the Expansion Premises to a party other than an Excepted Party for less than the remaining term of the Lease, Lessee and Lessor shall split (50/50) the Bonus Rent actually received by the Lessee in connection with such transaction. As used herein “Bonus Rent” shall mean the consideration received by the Lessee for the subleasing of the sublet premises or the assignment of this Lease, less the amounts that remain payable by the Lessee under this Lease with respect to the affected portions of the Expansion Premises, less reasonable broker and attorney costs associated with the transaction, and less the cost that Lessee is required to incur to perform its obligations under such sublease or assignment, including without limitation, any improvement costs.

If Lessee desires to assign its rights under this Lease or to sublet all of the Expansion Premises for the remainder of the Lease Term or for a period including the last year of the Lease Term (other than to an Excepted Party), Lessee shall first notify Lessor of the proposed terms and conditions of such assignment or subletting. Lessor, at its sole option, shall have the right to terminate the Lease and relieve Lessee of all Lease obligations occurring after the termination of the Lease. Whether or not Lessor’s consent to a sublease or assignment is required, in the event of any sublease or assignment, Lessee shall be and shall remain primarily liable for the performance of all conditions, covenants, and obligations of Lessee hereunder and, in the event of a default by an assignee or sublessee, Lessor may proceed directly against the original Lessee hereunder and/or any other predecessor of such assignee or sublessee without the necessity of exhausting remedies against said assignee or sublessee.

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(30) days prior to the Expansion Premises Commencement Date, Lessor will amortize the cost of the Partition Furniture in excess of the Lessor’s Partition Furniture Allowance over the initial term of the Lease at zero interest cost. Upon the Lease termination, Lessee shall leave the Partition Furniture in its then condition “As Is” “Where Is” with clear title free of any liens or encumbrances. Lessee may designate furniture other than 175 partitions (such as for instance conference room furniture) to be acquired by Lessor so long as the total cost to Lessor does not exceed Lessor’s Partition Furniture Allowance. At Lessee’s option, Lessee may elect to locate the Partition Furniture in which case Lessor shall acquire the Lessee located Partition Furniture provided Lessor shall be obligated to pay not more than Lessor’s Partition Furniture Allowance (with Lessee to pay any excess as described above).

Each party represents and warrants to the other party that it has not utilized or contacted a real estate broker or finder with respect to this Third Amendment other than Colliers International (“Colliers”) and each party agrees to indemnify and hold each other harmless against any claim, cost, liability or cause of action asserted by any broker or finder claiming through either party other than Colliers. Lessor and Lessee agree that Lessor shall be responsible for a commission owed to Colliers in accordance with Lessor’s commission agreement with Colliers International dated June 13, 2003. In addition, Lessor and Lessee agree that Lessor shall not be responsible for the payment of any other consulting fees, finder’s fees or any other fees or commissions arising out of the negotiation and execution of this Third Amendment. Lessor may adjust commission based on June 13, 2003 agreement to reflect any changes in base rent as a result of this Amendment.

“Lessor hereby grants to Lessee two (2) options to extend the Lease Term for five (5) year periods, on the following terms and conditions:”

B. Extended Term Rent – Option Period: The first sentence in the Lease Section 35B is hereby deleted and shall read as follows:

“The monthly rent for the Building during the extended term shall equal ninety-five percent (95%) of the fair market monthly rent for the Building as of the commencement date of the extended term.”

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The fourth sentence in Section 35B, that reads “Annual base rent increases during the extended term shall be three percent (3%) per year”, is hereby deleted. The following is hereby added in its place: “Rent increases shall be at then “market” as agreed by the parties, or as determined by appraisal.”

Add the following sentence to the end of B. Extended Term Rent – Option Period:

“Notwithstanding the foregoing, the Appraisers shall value the Building based on it being a standard Research and Development (R&D) and a manufacturing building (and without considering the increase, or decrease, in rental value resulting from the installation of the Lessee’s Improvements or any other Lessee Additions or Alterations installed during the Lease Term or any extensions thereof). Appraiser may use the allocation of

the cost of Lessor’s and Lessee’s Improvements set forth herein in determining what items should be included in rental value and shall not include in the rental value that portion related to the cost of Lessee’s Improvement in evaluating the Premises. The appraiser shall determine the rental value as though the Lessee’s Improvements were absent from the Premises (without any replacement).

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IN WITNESS WHEREOF, the parties have executed this Third Amendment, by their duly authorized signatories, as of the day first above written.

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Exhibit D

Exhibit E

Photon Dynamics