PowerPoint presentation

Meeting Objectives

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Understand

–

The §

409A issue

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What KLA-Tencor is doing for the affected options

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Your choices

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Review your next steps

Why are we here today?

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KLA-Tencor has determined that you hold certain

stock options that may be negatively affected by a

recent law change.

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KLA-Tencor has developed a solution that eliminates

the problem, but which requires your participation

and permission to implement.

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If you do not participate, you may have adverse tax

consequences.

Tax Law Change: §409A

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409A is a set of operating rules for items

considered to be deferred compensation.

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Certain stock options are now considered to

be deferred compensation.

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What are the consequences of §

409A?

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Potential income taxation prior to exercise

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40% additional tax (20% federal & 20% CA)

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Interest penalty

Which options are affected?

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Options granted at a price below the stock’s fair

market value (FMV) on the actual grant date

(“Discount Options”).

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Only options that vest AFTER 12/31/04.

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Thus, options granted prior to 409A’s enactment could be

affected by this new law if they vested 1/1/05 and later.

Example:

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Option granted on Jan 1, 2003 –

10,000 shares

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Option price = $32.50, but fair market value at grant date =

$35.75

Vesting: 2,500 options vest on Jan 1, 2004

2,500 options vest on a monthly basis during 2004

2,500 options vest on a monthly basis during 2005

2,500 options vest on a monthly basis during 2006

CONCLUSION:

The 5,000 options that vested prior to 1/1/05 are NOT subject to

§409A.

The 5,000 options that vest after 12/31/04 are subject to §409A

because they were granted at a discount.

Example: (continued)

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Assume that the fair market value of the option shares on the

applicable tax date is $52 and no options were exercised.

§409A Estimated Impact

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W-2 Income Inclusion: $97,500

(= 5,000 options subject to §409A x $19.50 ($52 FMV -

$32.50

Option Price))

Fed Ordinary Income

$34,125

(35%)

CA Ordinary Income

$ 9,067

(9.3%)

Normal Stock Gain Rate

$43,192

44.3%

§409A Tax

(Fed/CA)

$39,000

(40%)

§409A Interest

$ 8,775

(9%)

Tax Rate w/§409A

$90,967

93.3%

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This will occur until exercise or expiration of the option.

KLA-Tencor’s Program 1: 2006 W-2

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W-2 Reporting of 2006 exercises of

discounted options in Box 12 (Code Z)

AND

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Provide a cash payment in 2007 to cover

additional tax(es) on the exercises

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Affected employees will pay 20% federal & 20%

CA tax(es); these are not withheld

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Payment is compensation and will be grossed-up

for income/payroll taxes

Program 2: Tender Offer for Unexercised

Options

KLA-Tencor expects to commence a formal

tender offer for certain outstanding stock

options held by its employees. We will notify

you when that tender offer commences. We

advise you to read the tender statement

when it is available because it will contain

important information relating to your stock

options. We will deliver the actual tender

offer documents to all affected employees by

via electronic website when the tender offer

commences, and those documents will also

be available for free at the Securities and

Exchange Commission's public website.

Program 2: Tender Offer for Unexercised

Options

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Amend option to potentially increase option

price, AND

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Provide a cash payment

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Only options issued below market and that

vest after 12/31/04 will be subject to the

tender offer.

KLA-Tencor’s Solution: Tender Offer

Example:

–

Orig. Option Price: $30

–

Adjusted Option Price: $32

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FMV at Tender Offer close: $50

Example:

–

Orig. Option Price: $48

–

Adjusted Option Price: $58

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FMV at Tender Offer close: $50

Example:

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Orig. Option Price: $30

–

Adjusted Option Price: $32

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FMV at Tender Offer close: $28

KLA-Tencor’s Solution: Tender Offer

Amend options to potentially increase the

option price

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Option price will be the lower of:

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Fair market value on the actual grant date, or

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Closing price of KLA-Tencor stock the day after the tender

offer closes

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Option price will never be lower than current exercise

price

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All other terms will remain the same (including the

number of shares, vesting schedule and expiration

date)

KLA-Tencor’s Solution: Tender Offer

Cash Bonus payment

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Equal to the difference (if any) between the

adjusted option price and original option price

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Will be made in January 2008 per IRS

requirement

Example

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Option for 8,000 shares granted on 1/1/03 with price

= $32.50, but FMV = $35.75

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Vesting:

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2,000 vest on 1/1/04 –

not subject to §409A

–

2,000 vest monthly in 2004–

not subject to §409A

–

2,000 vest monthly in 2005 –

subject to §409A

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2,000 vest monthly in 2006 –

subject to §409A

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Option Amendment:

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4,000 options vested on 12/31/04 –

NO CHANGE

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4,000 options vesting 2005-2006 -

amended price = $35.75

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No change to expiration date or vesting schedule

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Cash Payment:

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Employee receives cash payment of $13,000 = 4,000 options x ($35.75 -

$32.50), (less bonus withholdings), paid in January 2008.

Eligibility

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Must be an employee at the close of the

Tender Offer and subject to US income

taxation.

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Offer covers unexercised options that were

granted at a discount and vest after

12/31/04.

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You can select which of your affected grants

to tender (i.e., participate with), but once

selected, the entire unexercised portion must

be tendered.

What if I do nothing?

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Tax Impact:

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Income taxation before exercise

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20% additional federal tax on income amount

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20% additional California tax on income amount

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Potentially other state additional taxes

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Interest penalty on income amount

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Will occur until exercise or expiration of the

discounted options.

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Tender offer is a one-time offer to prevent future

adverse tax consequences.

Tender Offer Expected Timeline

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Tender Offer Begins: February 5, 2007

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Tender Offer Ends: March 6, 2007

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All elections MUST be received by 11:59PM Pacific

Time on the expiration date

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Late submissions will not be accepted

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Option Amendment: March 7, 2006

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How to submit your election: E-mail with web

based instructions will be sent to you.

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Confirming e-mail will be sent to you upon

completion of your acceptance of the Offer.

What Information Have You Received?

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Email that includes:

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Description of Programs

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Meeting announcements

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Mailed Stock Option Statement

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Your stock options

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This presentation

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Available on KLA-Tencor’s Stock Option Website

Sample Statement

Your Name Here

Your Address Here

This will be important at the commencement of the tender

offer. Please keep it available.

This is a sample statement of an employee’s entire stock option portfolio

What if I still have questions?

•Follow-up meetings:

Watch your E-mail

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2/5 9:00 and 11:00 in Milpitas Multi-purpose

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the 11 will also be available via Web-Ex

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2/5 1:30 and 3:30 in San Jose, Cafeteria 1:30 will

be Web-Ex

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2/12 Milpitas Multi-Purpose 3:00

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2/22 1:30 San Jose and 3:30 Milpitas

We will add additional meetings if necessary

•Any questions should be directed to

401k.stock@kla-tencor.com

Tax Advice

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Taxation of stock option transactions can be

very complicated.

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KLA-Tencor policy prohibits any employees

from providing personal income tax advice to

any other employee.

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This presentation is general and you should

consult with your personal tax advisor for

advice relevant to your specific situation.

Circular 230 Disclaimer Notice

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Any tax advice included in this presentation was not

intended or written to be used, and it cannot be

used by the taxpayer, for the purpose of avoiding

any penalties that may be imposed by any

governmental taxing authority or agency;

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This tax advice was written to support the promotion

of the matter addressed by the presentation; and

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The taxpayer should seek advice based on the

taxpayer’s particular circumstances from an

independent tax advisor.