UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

SCHEDULE 14A

Proxy Statement Pursuant to Section 14(a) of the

Securities Exchange Act of 1934

(Amendment No.     )

Filed by the Registrant x                            Filed by a Party other than the Registrant ¨

Check the appropriate box:

KLA-Tencor Corporation

(Name of Registrant as Specified In Its Charter)

(Name of Person(s) Filing Proxy Statement, if other than the Registrant)

Payment of Filing Fee (Check the appropriate box):

NOTICE OF ANNUAL MEETING OF STOCKHOLDERS

November 13, 2008

To the Stockholders:

YOUR VOTE IS IMPORTANT

NOTICE IS HEREBY GIVEN that the Annual Meeting of Stockholders of KLA-Tencor Corporation (the “Company”), a Delaware corporation, will be held on Thursday, November 13, 2008 at 1:00 P.M., local time, in Multipurpose Rooms East and West in Building Three of the Company’s Milpitas facility, located at Three Technology Drive, Milpitas, California 95035, for the following purposes:

The foregoing items of business are more fully described in the Proxy Statement accompanying this Notice.

Only stockholders of record at the close of business on September 30, 2008 are entitled to notice of, and to vote at, the Annual Meeting and any adjournment or postponement thereof.

Sincerely,

Richard P. Wallace

Chief Executive Officer

Milpitas, California

October 9, 2008

ANNUAL MEETING OF STOCKHOLDERS

OF

KLA-TENCOR CORPORATION

To be held on November 13, 2008

PROXY STATEMENT

QUESTIONS AND ANSWERS REGARDING PROXY SOLICITATION AND VOTING

These proxy solicitation materials, together with the Company’s Annual Report for fiscal year 2008, were first mailed on or about October 9, 2008 to all stockholders entitled to vote at the Annual Meeting. KLA-Tencor’s principal executive offices are located at One Technology Drive, Milpitas, California 95035, and our telephone number is (408) 875-3000.

QUESTIONS AND ANSWERS ABOUT THE ANNUAL MEETING

The Annual Meeting will be held if a majority of the outstanding Common Stock entitled to vote is represented at the Annual Meeting. If you have returned valid proxy instructions or attend the Annual Meeting in person, your Common Stock will be counted for the purpose of determining whether there is a quorum, even if you wish to abstain from voting on some or all matters at the Annual Meeting.

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Whichever of these methods you select to transmit your instructions, the proxy holders will vote your shares in accordance with those instructions.

If you vote by mail, telephone or Internet without giving specific voting instructions, your shares will be voted FOR Proposal One (the election of the nominees listed herein for the Board of Directors) and FOR Proposal Two (the ratification of our independent registered public accounting firm). When proxies are properly dated, executed and returned (whether by returned proxy card, telephone or Internet), the shares represented by such proxies will be voted at the Annual Meeting in accordance with the instructions of the stockholder. However, if no specific instructions are given, the shares will be voted in accordance with the recommendations of our Board of Directors and as the proxy holders may determine in their discretion with respect to any other matters that properly come before the meeting.

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Since abstentions will be counted for purposes of determining both (i) the presence or absence of a quorum for the transaction of business and (ii) the total number of Votes Cast with respect to a proposal (other than the election of Directors), abstentions will have the same effect as a vote against the proposal (other than the election of Directors).

Shares that are subject to a broker non-vote are counted for purposes of determining whether a quorum exists but not for purposes of determining whether a proposal has passed.

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Stockholder proposals that are not intended to be included in our proxy materials for such meeting, but that are to be presented by the stockholder from the floor of the meeting are subject to the advance notice provisions set forth above under “Can I present other business to be transacted from the floor at the Annual Meeting?” and other requirements set forth in the proxy rules established by the SEC and the provisions of our bylaws.

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PROPOSAL ONE:

ELECTION OF DIRECTORS

The Company has a classified Board of Directors with three classes. At each annual meeting, a class of Directors is elected for a full term of three years to succeed those Directors whose terms expire at the annual meeting. At this Annual Meeting, the terms of the Class I Directors are expiring. If there is a nominee for a class other than the class which is up for election, such nominee, upon election, is added to the designated class and serves out the remainder of the term for that class.

The three incumbent Class I Directors that are up for re-election at the Annual Meeting are Robert M. Calderoni, John T. Dickson and Kevin J. Kennedy. Director Lida Urbanek also serves as a Class I Director as of the date of this Proxy Statement and will continue to serve in such capacity until the date of the Annual Meeting. However, on September 13, 2008, Ms. Urbanek notified the Company of her decision not to stand for re-election at the Annual Meeting.

The four incumbent Class II Directors are Robert P. Akins, Robert T. Bond, Kiran M. Patel and David C. Wang. The Class II Directors will serve until the annual meeting of stockholders to be held in 2009 or until their respective successors are duly elected and qualified.

The three incumbent Class III Directors are Edward W. Barnholt, Stephen P. Kaufman and Richard P. Wallace. The Class III Directors will serve until the annual meeting of stockholders to be held in 2010 or until their respective successors are duly elected and qualified.

The three nominees for election as Class I Directors by the stockholders are:

If elected, the nominees for Class I Directors will serve as Directors until the Company’s annual meeting of stockholders in 2011, each until his successor is duly elected and qualified. If any nominee declines to serve or becomes unavailable for any reason, or a vacancy occurs before the election, the proxies may be voted for such substitute nominees as the Board of Directors may designate. As of the date of this Proxy Statement, the Board of Directors is not aware of any nominee who is unable or who will decline to serve as a Director.

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THE MEMBERS OF THE BOARD OF DIRECTORS UNANIMOUSLY RECOMMEND A VOTE “FOR” EACH OF THE CLASS I DIRECTOR NOMINEES, WITH THE DIRECTORS WHO ARE NOMINEES ABSTAINING.

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INFORMATION ABOUT THE DIRECTORS AND THE NOMINEES

The following table sets forth certain information with respect to the Company’s Board of Directors as of the date of this Proxy Statement:

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PROPOSAL TWO:

RATIFICATION OF APPOINTMENT OF

PRICEWATERHOUSECOOPERS LLP AS THE COMPANY’S

INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM FOR

THE FISCAL YEAR ENDING JUNE 30, 2009

The Board of Directors, following the Audit Committee’s determination, unanimously recommends that the stockholders vote for ratification of such appointment.

Although ratification by stockholders is not required by law, the Board of Directors has determined that it is desirable to request approval of this selection by the stockholders. If the stockholders do not ratify the appointment of PricewaterhouseCoopers LLP, the Audit Committee may reconsider its selection.

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On a quarterly basis, management provides written updates to the Audit Committee with regard to audit and non-audit services, the amount of audit and non-audit service fees incurred to date, and the estimated cost to complete such services.

THE BOARD OF DIRECTORS UNANIMOUSLY RECOMMENDS A VOTE “FOR” THE RATIFICATION OF THE APPOINTMENT OF PRICEWATERHOUSECOOPERS LLP AS THE COMPANY’S INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM FOR THE FISCAL YEAR ENDING JUNE 30, 2009.

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OUR CORPORATE GOVERNANCE PRACTICES

At KLA-Tencor, we believe that strong and effective corporate governance procedures and practices are an extremely important part of our corporate culture. In that spirit, we have summarized several of our corporate governance practices below.

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ABOUT THE BOARD OF DIRECTORS AND ITS COMMITTEES

All Directors other than Mr. Wallace meet the definition of independence within the meaning of The NASDAQ Stock Market director independence standards.

The Board of Directors has three standing committees: the Audit Committee; the Compensation Committee; and the Nominating and Governance Committee. The Board of Directors has determined that each of the members of each of the Committees has no material relationship with the Company (including any relationship that, in the opinion of the Board, would interfere with the exercise of independent judgment as a Director) and is independent within the meaning of The NASDAQ Stock Market director independence standards, including in the case of the Audit Committee, the heightened “independence” standard required for such Committee members.

Each Committee meets regularly and has a written charter approved by the Board of Directors, all of which are available via our website at

http://ir.kla-tencor.com. The Board of Directors and each Committee regularly reviews the Committee charters. In addition, at each regularly scheduled Board of Directors’ meeting, a member of each Committee reports on any significant matters addressed by the Committee.

During the fiscal year ended June 30, 2008, each of the incumbent Directors, other than Mr. Dickson (who joined the Board of Directors in late fiscal year 2007, when the fiscal year 2008 Board and Committee meetings had already been scheduled, and informed the Company prior to his appointment that he would be unable to attend several of such meetings due to pre-existing commitments) and Mr. Wang, attended at least 75% of the aggregate of (a) the total number of meetings of the Board of Directors held during the period for which such person served as a Director and (b) the total number of meetings held by all Committees of the Board on which such Director served (during the periods that each such Director served).

Although we do not have a formal policy mandating attendance by members of the Board of Directors at our annual meetings of stockholders, we do have a formal policy encouraging their attendance at annual meetings of KLA-Tencor stockholders. Six of our then-current ten members of the Board of Directors attended our annual stockholder meeting held on November 15, 2007.

For more information regarding the responsibilities of our Board Committees, please refer to the various charters which can be found on our corporate governance website located at http://ir.kla-tencor.com.

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The Audit Committee is responsible for appointing and overseeing the work of the Company’s independent auditors, approving the services performed by the Company’s independent auditors, and reviewing and evaluating the Company’s accounting principles and system of internal accounting controls. The Audit Committee held seven meetings during the fiscal year ended June 30, 2008 at which a quorum was present.

The Board of Directors has determined that each of the members of the Audit Committee: (1) meets the definition of independence within the meaning of NASDAQ’s director independence standards, (2) meets the definition of audit committee member independence within the meaning of Rule 10A-3 under the Securities Exchange Act of 1934 and (3) has no material relationship with the Company (including any relationship that, in the opinion of the Board, would interfere with the exercise of independent judgment as a Director).

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The Compensation Committee reviews and either approves or recommends to the full Board of Directors (depending upon the category of the compensation and the executive involved) the Company’s executive compensation policy and administers the Company’s employee equity award plans. The Compensation Committee also reviews (and, in certain cases, approves) the cash and equity compensation for our executive officers, as well as for members of the Board of Directors. See “Compensation Discussion and Analysis—Compensation Approval Procedures” for more information concerning the procedures and processes the Compensation Committee follows in setting such compensation and implementing the various cash and equity compensation programs in effect for such individuals, including the retention of an independent compensation consultant to provide relevant market data and advice. The Compensation Committee held seven meetings during the fiscal year ended June 30, 2008.

The Nominating and Governance Committee is primarily responsible for identifying and evaluating the qualifications of all candidates for election to the Board of Directors, as well as reviewing corporate governance policies and procedures. The Nominating and Governance Committee held five meetings during the fiscal year ended June 30, 2008.

It is the Nominating and Governance Committee’s policy to consider candidates for the Board of Directors recommended by, among other persons, the Company’s stockholders. Stockholders wishing to submit recommendations must notify the Company’s General Counsel in writing of their intent to do so and provide the Company with certain information set forth in Article II, Section 11 of our bylaws and all other information regarding nominees that is required to be provided pursuant to Regulation 14A of the Securities Exchange Act of 1934, or as otherwise requested by the Nominating and Governance Committee. In addition, stockholders may nominate candidates for the Board of Directors pursuant to the provisions of Article II, Section 11 of our bylaws and in conformance with the requirements of Regulation 14A of the Securities Exchange Act of 1934.

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In considering candidates for Director nomination, including evaluating any recommendations from stockholders as set forth above, the Nominating and Governance Committee considers only candidates who have demonstrated executive experience, have experience in an applicable industry, or have significant high level experience in accounting, legal or a technical field applicable to the Company. In addition, in evaluating Director candidates, the Nominating and Governance Committee considers all factors it considers appropriate, which may include strength of character, mature judgment, career specialization, relevant technical skills, diversity of experience and the extent to which the candidate would fill a present need on the Board of Directors.

During fiscal year 2007, the Board of Directors approved a recommendation by the Nominating and Governance Committee to adopt a new governance policy. Under this policy, anyone who is elected as a Director in any uncontested election by a plurality and not a majority of votes cast will promptly tender his or her resignation to the Board of Directors, subject to acceptance, after certification of the election results. The Nominating and Governance Committee will make a recommendation to the Board of Directors whether to accept or reject the resignation or take some other appropriate action, taking into account any stated reasons why stockholders withheld votes and any other factors which the Nominating and Governance Committee determines in its sole discretion are relevant to such decision. The Board of Directors will in its sole discretion act on the recommendation of the Nominating and Governance Committee within 90 days after the date of certification of the election results. The Director who tenders his or her resignation will not participate in the decisions of the Nominating and Governance Committee or the Board of Directors regarding his or her resignation.

The Nominating and Governance Committee regularly assesses the appropriate size and composition of the Board of Directors, and whether any vacancies on the Board are expected. In the event that vacancies are anticipated, or otherwise arise, the Nominating and Governance Committee considers potential candidates that may come to its attention through current members of the Board of Directors, professional search firms, stockholders or other persons. In evaluating properly submitted stockholder recommendations, the Nominating and Governance Committee uses the evaluation standards discussed above and seeks to achieve a balance of knowledge, experience and capability on the Board of Directors.

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DIRECTOR COMPENSATION

If a new Outside Director joins the Board after the date of an annual stockholders meeting, his or her first restricted stock unit award will be granted promptly after he or she joins the Board and will be prorated to take into account the period of time from the last annual stockholders meeting to the date the new Outside Director joined the Board.

The cash compensation component of the Outside Director compensation program will continue to remain in effect unchanged for fiscal year 2009.

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However, in fiscal year 2008, during the period from July 1, 2007 through November 15, 2007, the Company issued non-statutory stock options to the Outside Directors pursuant to the terms of the Company’s director compensation program that continued in effect until November 15, 2007. On each of July 31 and October 30, 2007, the Company granted a 1,250-share option grant to each Outside Director then in office as part of the Company’s former annual option grant program, under which the Company would make such quarterly grants approximately two business days following the Company’s earnings release for the prior fiscal quarter. The options granted to the Outside Directors during fiscal year 2008 have a maximum term of seven years, subject to earlier termination following the cessation of Board service, and have an exercise price per share equal to the fair market value of the Common Stock on the grant date. Each such option was fully vested and immediately exercisable upon grant. Stock option grants are no longer a component of the Company’s compensation program for Outside Directors.

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Director Compensation Table

The following table sets forth certain information regarding the compensation earned by or awarded to each Outside Director during fiscal year 2008 who served on our Board of Directors during fiscal year 2008.

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INFORMATION ABOUT EXECUTIVE OFFICERS

Set forth below are the names, ages and positions of the executive officers of KLA-Tencor as of the date of this Proxy Statement.

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SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND
MANAGEMENT

Principal Stockholders

As of September 2, 2008, based on our review of filings made with the SEC, we are aware of the following entities being beneficial owners of more than 5% of the Company’s Common Stock:

Management

The following table sets forth the beneficial ownership of the Company’s Common Stock as of September 2, 2008 by all current Directors, each of the named executive officers set forth in the Summary Compensation Table, and all current Directors and executive officers as a group. Except for shares held in brokerage accounts which may from time to time, together with other securities held in those accounts, serve as collateral for margin loans made from those accounts, none of the shares reported as beneficially owned are currently pledged as security for any outstanding loan or indebtedness. Shares that become issuable under outstanding restricted stock units upon satisfaction of the applicable vesting requirements are not included in the table but are indicated in footnotes 15 and 16 to such table:

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Section 16(a) Beneficial Ownership Reporting Compliance

Section 16(a) of the Securities Exchange Act of 1934 requires the Company’s executive officers, Board members, and persons who own more than ten percent of a registered class of the Company’s equity securities to file reports of ownership and changes in ownership with the SEC, and such persons are also required by SEC regulations to furnish the Company with copies of all Section 16(a) forms they file. Based solely on its review of the copies of such forms received by it, the Company believes that during fiscal 2008 all executive officers, Board members and greater than ten percent stockholders of the Company complied with all applicable filing requirements.

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COMPENSATION DISCUSSION AND ANALYSIS

The Compensation Committee utilizes a holistic approach to the determination of executive compensation packages that takes into account a number of data sources and factors, including the highly cyclical nature of the industries in which the Company operates and the compensation data described under “Market Data” below, and the Compensation Committee engages in extensive deliberation every year to set target performance levels appropriate for that particular year. The Compensation Committee applies this philosophy in determining appropriate executive compensation levels and other compensation factors, and reaches its decisions with a view towards the Company’s overall financial performance.

An important element of the Compensation Committee’s deliberations is the condition of the markets in which the Company participates, including the anticipated economic environment over the course of the fiscal year. As a result, the Company’s fiscal year 2009 compensation program has been structured to reflect the challenging economic conditions currently being experienced in the semiconductor capital equipment market and related industries and the importance of minimizing Company expenses during this challenging period. For example, salary increases for fiscal year 2009 for all employees, including the Executives, will not take effect until January 1, 2009. In addition, the bonus payout multiples payable under the fiscal year 2009 Performance Bonus Plan have been lowered at each level of Company performance relative to the applicable year’s target (for example, bonus payouts to the Executives at less than target even if the Company achieves its target operating results), which would generally result in total cash compensation for the Executives in fiscal year 2009 that is lower than fiscal year 2008 total cash compensation for similar performance relative to the applicable year’s target operating results.

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The transition process in the Company’s compensation structure continued in fiscal year 2009. For fiscal year 2009, the independent members of the Board of Directors and the Compensation Committee, after careful consideration of peer group data and the other information described under “Market Data” below, increased key employees’ base salaries while simultaneously lowering the bonus payout multiples payable under the fiscal year 2009 Performance Bonus Plan at each level of Company performance relative to the applicable year’s target. As a result of these changes, the Executives’ total cash compensation in fiscal year 2009 will, under many scenarios, decline from the prior year—an outcome that the Compensation Committee and independent members of the Board of Directors feel is reasonable in the current economic environment within the Company’s primary industries.

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In structuring the fiscal year 2008 compensation packages for all of the named executive officers (other than the Chief Executive Officer), the Compensation Committee received comprehensive industry compensation data and analysis from its independent compensation consultant (Semler Brossy Consulting Group, LLC) and initial recommendations regarding such packages from the Chief Executive Officer based upon internal performance reviews and the competitive compensation data described under the section entitled “Market Data” below. The Compensation Committee reviewed the data provided by its compensation consultant and the Chief Executive Officer’s recommendations and engaged in detailed discussions over the course of multiple meetings, in closed sessions as well as with the Chief Executive Officer, to determine the final compensation packages for the executives for fiscal year 2008. Following these discussions, the Chief Executive Officer presented final recommendations regarding the fiscal year 2008 compensation packages for the named executive officers that reflected these discussions, which recommendations were adopted by the Compensation Committee and the independent members of the Board of Directors in September 2007.

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In the case of the Chief Executive Officer’s compensation, the Compensation Committee developed a proposed compensation package for fiscal year 2008 and recommended it to the Board of Directors. The independent members of the Board then discussed and, in September 2007, approved the Compensation Committee’s recommendation with respect to the fiscal year 2008 compensation for the Chief Executive Officer, who was not present and did not participate in the discussion.

The compensation levels, including base salary, performance targets, target bonus amounts and equity awards, to be in effect for the named executive officers for fiscal year 2009 were determined in August 2008.

For fiscal year 2008, the Compensation Committee used, in addition to the data described below in this “Market Data” section, a two-tiered list of peer group companies to track industry trends and practices related to compensation. The Company’s primary peer group was comprised of three global companies competing in the semiconductor manufacturing industry—Applied Materials, Inc., Lam Research Corporation and Novellus Systems, Inc. The Company’s secondary peer group consisted of Credence Systems Corporation, FEI Company, Teradyne, Inc., and Veeco Instruments Inc. The companies in the primary and secondary peer groups were selected primarily based upon their industry focus and the frequency with which they compete with the Company for the same employee candidates. The Compensation Committee placed greater emphasis on the data obtained from companies in the Company’s primary peer group than on the data obtained from those in the secondary peer group.

In meetings held in July and August 2008, the Compensation Committee conducted its annual review of the list of peer group companies that it would utilize in establishing its fiscal year 2009 compensation programs and practices. For fiscal year 2009, the Compensation Committee consolidated the primary and secondary peer groups into a single list of peer group companies. In addition, the Compensation Committee removed from the peer group three companies that had 2007 revenue of less than $500 million (Credence Systems Corporation, FEI Company and Veeco Instruments Inc.) and replaced them

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with two larger companies more comparable in size to the Company (ASML Holdings and Varian Semiconductor Equipment, Inc.). Accordingly, for fiscal year 2009, the Company’s peer group is comprised of Applied Materials, Inc., Lam Research Corporation, Novellus Systems, Inc., Teradyne, Inc., ASML Holdings and Varian Semiconductor Equipment, Inc. Before adopting these changes to the composition of the Company’s peer group, the Compensation Committee analyzed prior years’ data using both sets of peer group companies to ensure that the change would not introduce any inappropriate bias in the market analysis utilized by the Compensation Committee in determining annual compensation levels.

The Compensation Committee reviews the compensation programs and practices of its peer group companies to obtain additional information to identify compensation trends and practices. Data regarding these peer group companies is primarily obtained through searches of publicly available information, such as the proxy filings of the relevant companies. The market data consists primarily of base salary and total cash compensation rates, as well as incentive bonus and stock programs of other companies considered by the Compensation Committee to be peers in the Company’s industry. In addition, the Company subscribes to the Radford Executive Survey (with a focus on high technology companies with revenue between $1 billion to $3 billion, as well as certain other selected companies within the Company’s relevant industries) and the Computer and High Performance Systems (CHiPS) Executive Survey to obtain additional data concerning target cash compensation levels.

Among the various types of market data considered by the Compensation Committee in its deliberations, the Compensation Committee reviews percentile data to understand the spectrum of compensation packages offered by other similarly situated companies. In doing so, the Compensation Committee references the data points that represent the median to 75th percentile, with an emphasis on the lower end of that range when reviewing base salary data, but structuring the Executives’ packages so that total compensation can be at or above the higher end of that range in years of strong Company performance.

The Independent Consultant generally attends all meetings of the Compensation Committee in which evaluations of the effectiveness of overall executive compensation programs are conducted or in which compensation for executive officers is analyzed or approved. During fiscal year 2008, the Independent Consultant’s duties included providing the Compensation Committee with relevant market and industry data and analysis, reviewing all materials and participating in the meetings in which the Compensation Committee made decisions regarding changes to executive compensation for fiscal year 2008. In fulfilling these duties, the Independent Consultant met, as needed and with the knowledge of the Chairman of the Compensation Committee, with the Company’s Chief Executive Officer, Senior Vice President of Human Resources, General Counsel and Chief Financial Officer.

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As noted above under the heading “Structural Changes in Compensation in Fiscal Years 2008 and 2009” and as described in more detail below, as part of a two-year transition process in establishing a simplified and more competitive compensation structure, a higher percentage of the named executive officers’ target cash compensation for fiscal year 2009 has been allocated in the form of fixed compensation (salary) and, at each level of corporate performance relative to the applicable performance target, a lower percentage to variable performance-based compensation. For example, if the Company were to achieve 100% of its targeted operating income in both fiscal years 2008 and 2009 (assuming, in each case, no incremental bonus payments attributable to relative revenue growth), the Company’s Chief Executive Officer’s base salary would have represented 40% of his total cash compensation for fiscal year 2008, as compared to 51.4% of his total cash compensation in fiscal year 2009. In implementing this change, the Compensation Committee intends for the executives’ compensation packages to continue to reward individual and corporate performance with meaningful variable compensation, yet also provide the executives’ with a higher minimum level of cash compensation to ensure that the Company’s compensation packages will remain competitive with those of other employers even in times of challenging business conditions.

Base Salary:

The Compensation Committee engages in annual reviews of the base salaries of the Executives. To develop his recommendations regarding the fiscal year 2008 base salaries for the named executive officers (other than his own base salary), Mr. Wallace, the Company’s Chief Executive Officer, reviewed a wide range of relevant market compensation information provided by the Company’s Senior Vice President of Human Resources and the Independent Consultant, as described under the heading “Market Data,” as well as each Executive’s job responsibilities, level of experience and short-term and long-term performance and contribution to the Company’s business. Following that review, Mr. Wallace made recommendations to the Compensation Committee regarding the base salary for each named executive officer (other than his own) for fiscal year 2008, in each case as part of an overall proposed compensation package for the applicable officer. The Compensation Committee reviewed the data provided by the Independent Consultant and the Chief Executive Officer’s recommendations and engaged in detailed discussions over the course of multiple meetings, in closed sessions as well as with the Chief Executive Officer, to determine the components of the final compensation packages for the executives for fiscal year 2008. The process for establishing the fiscal year 2008 base salary for the Chief Executive Officer was similar, except that Mr. Wallace was not involved in the process, so the Compensation Committee received all of its compensation data directly from the Independent Consultant and the Company’s Senior Vice President of Human Resources and then made recommendations regarding Mr. Wallace’s fiscal year 2008 base salary to the independent members of the Board of Directors for approval. The Compensation Committee and the independent members of the Board of Directors exercised their discretion and judgment based upon the data provided, and no specific formula was applied to determine the weight of each data point.

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Base salaries for the named executive officers for fiscal year 2008 were determined in August of 2007. For fiscal year 2008, the base salaries of the Company’s named executive officers (except as noted below) were increased over the applicable salary for the prior fiscal year as follows:

In August 2008, applying the fiscal year 2009 review process and criteria described above under the heading “Compensation Approval Procedures,” the Compensation Committee recommended, and the Board of Directors approved, an increase to Mr. Wallace’s annual base salary for fiscal year 2009 to $800,000 (an increase of 14.3% over Mr. Wallace’s annual base salary rate as of June 30, 2008). The Compensation Committee also approved salary increases for fiscal year 2009 for Messrs. Martin, Kirloskar and Tsai equal to an average increase of 7.6%. These increases are higher than the Company’s typical historical annual increases in base salaries, but they are consistent with the Compensation Committee’s shift to make the named executive officers’ overall compensation more competitive with the market by increasing fixed compensation as a percentage of the executives’ total cash compensation at each level of Company performance relative to the applicable year’s target, as described in the section above entitled “Structural Changes in Compensation in Fiscal Years 2008 and 2009.” As a result of these changes, although base salaries are being increased in fiscal year 2009, total targeted cash compensation at each level of corporate performance relative to the applicable year’s target is generally expected to decrease year over year from fiscal year 2008 to 2009, as disclosed in greater detail under “Cash Incentive Bonuses—

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The Company’s Performance Bonus Plan for Fiscal Year 2009.” Factors such as role, scope of responsibilities and complexity of the position, as well as market data for similar positions at comparator companies, were used to determine the amount of the increase to each executive officer’s base salary.

The increases in base salary for fiscal year 2009 will not take effect until January 1, 2009, as part of the Company’s continuing efforts to reduce operating expenses during the current challenging business environment.

Cash Incentive Bonuses:

Fiscal Year 2008 Performance Bonus Plan:

Prior to fiscal year 2008, the Company maintained a bonus structure that consisted of two separate bonus plans—an Executive Incentive Plan and an Outstanding Corporate Performance Executive Bonus Plan. However, in August 2007, in an effort to simplify the operation of the Company’s annual bonus structure, the Board of Directors eliminated the two separate bonus plan structure and established the Company’s performance and payout targets in effect for fiscal year 2008 so that the Executives’ annual cash bonuses would be paid under a single bonus plan—the Company’s Performance Bonus Plan (the “Bonus Plan”), an incentive bonus plan administered in conformity with Section 162(m) of the Internal Revenue Code.

Under the fiscal year 2008 Bonus Plan, Executives were eligible to earn a cash bonus based on the Company’s achievement of key financial and strategic Company goals as well as individual performance. For fiscal year 2008, the Compensation Committee reviewed the Bonus Plan as to Executives and then made a recommendation to the Board of Directors and submitted the Bonus Plan to the Board for approval.

All of the named executive officers participated in the Bonus Plan for fiscal year 2008. The initial determination under the Bonus Plan is the establishment of a target award for each participating Executive, which the Compensation Committee set as a percentage of the Executive’s base salary. For fiscal year 2008, to establish these target awards, the Compensation Committee and the independent members of the Board of Directors considered a wide range of market data (described under “Market Data” above), as well as the allocation of total compensation (both between base salary and variable bonus compensation, and between cash and non-cash compensation), competitive factors and the payout structure under the Company’s fiscal year 2008 Bonus Plan. After reviewing that information, the Compensation Committee and

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independent members of the Board of Directors approved target awards under the fiscal year 2008 Bonus Plan for the named executive officers as follows:

The actual bonuses paid under the Bonus Plan for fiscal year 2008 were dependent upon the financial performance of the Company and the contributions by the participating Executive (the individual performance multiplier is described in more detail below). Funding of the Bonus Plan was contingent upon the Company’s attainment of a pre-determined threshold amount of operating margin (including stock-based compensation charges and excluding expenses related to acquisitions, one-time charges and deal-related amortization).¹ Actual bonus payments were based on a calculation matrix that measured both operating margin and relative revenue growth (relative to an index of the revenue growth of 27 semiconductor capital equipment manufacturers², measured over the same period) for fiscal year 2008. The financial targets selected for use under the Bonus Plan for fiscal year 2008 were designed to reward strong financial performance by the Company,

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measured in absolute terms, while also reflecting the Company’s continuing emphasis on outperforming its competitors and other similarly situated companies. The Company believes that the use of these measures of financial and strategic success serve to closely align the interests of our executive officers with those of our stockholders.

In the establishment of the Bonus Plan for fiscal year 2008, the proposed financial metrics and payout percentages for the Bonus Plan were developed by the Company’s Chief Executive Officer, Chief Financial Officer and Senior Vice President of Human Resources, with the assistance of the Independent Consultant, and were subsequently submitted as recommendations to the Compensation Committee and then to the independent members of the Board of Directors for approval. The Compensation Committee, reviewing the recommendations provided by the Company as well as data provided directly to the Compensation Committee by the Independent Consultant, initially determined the threshold amount of operating margin for the upcoming fiscal year upon which the Bonus Plan would be funded and then identified a range of potential results for the Company’s relative revenue growth and operating margin for the upcoming fiscal year. The Compensation Committee then attached bonus payout percentages for various combinations of financial results within those ranges.

At the beginning of fiscal year 2008, many semiconductor capital equipment market analysts predicted that fiscal year 2008 might be a period of declining customer demand in the industry. The Compensation Committee considered these anticipated market trends in establishing the various threshold and target performance results for fiscal year 2008. As a result, whereas the Compensation Committee had set targets for fiscal year 2007 that, for example, would only have been achieved by generating operating income that exceeded the Company’s next highest year’s total by over 25% (a target that was ambitious but possible under the then-existing market conditions), the threshold and target levels that the Compensation Committee established for fiscal year 2008, while equally ambitious in light of the changed market conditions, were set at performance thresholds that were lower than those set for the prior year.

After the conclusion of the fiscal year, once the Compensation Committee determined that the Company had satisfied its threshold level of operating margin, the Compensation Committee reviewed the Company’s relative revenue growth and, after pairing that data with the Company’s operating margin, calculated the applicable payout percentage. The Compensation Committee or the independent Board members (as applicable) then had the discretion to adjust the actual bonus amount that would otherwise be due upon the attainment of the performance targets, downward to as low as 80% of such amount or upward to as high as 120% of such amount (but in no event to more than the maximum bonus amount payable under the plan (i.e., the amount deemed to be earned upon satisfaction of the Section 162(m) threshold)), based on their assessment of the officer’s performance for the year.

For the fiscal year 2008 Bonus Plan, the potential bonus payouts ranged from 0% (if the Company were to generate operating margin of less than $463 million) up to 325% (if the Company were to meet or exceed its operating

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margin from the prior fiscal year while also growing revenue significantly faster than the Company’s comparator group) of the participating Executives’ target bonus amount. For fiscal year 2008, in calculating the Company’s operating margin for purposes of the Bonus Plan, the Compensation Committee included stock-based compensation expense but excluded expenses related to acquisitions, one-time charges and deal-related amortization.

In establishing the relevant thresholds and payout criteria for the fiscal year 2008 Bonus Plan, the Board of Directors and the Compensation Committee set the relevant thresholds and criteria so that the plan would:

For fiscal year 2008, despite extremely challenging market conditions and a period of declining customer demand in the semiconductor capital equipment industry, the Company posted very strong results, generating operating margin in the amount of $666 million, and grew revenue at a rate that was 5% greater than the average growth rate of the companies in the Company’s comparator group. As a result, the Company’s financial performance for fiscal year 2008 resulted in a payout pursuant to the Bonus Plan equal to 141% of target, subject to upward or downward adjustment (if any) based on individual performance.

Individual Bonus Payout Amounts for Fiscal Year 2008:

As a result of the Company’s strong financial performance during fiscal year 2008, the Bonus Plan provided for payment of bonuses at 141% of target (though considerably less than the maximum bonus amount potentially payable under the plan). All named executive officers who were eligible to receive payments under the fiscal year 2008 Bonus Plan, other than the Company’s Chief Executive Officer, were awarded an individual performance multiplier of 100%, meaning that such officers had generally met their individual objectives and expectations and, therefore, the Compensation Committee did not elect to adjust any of such

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executives’ bonus payout for fiscal year 2008, upward or downward, based on individual performance criteria. However, with respect to Mr. Wallace, the independent members of the Board of Directors determined that, as a result of Mr. Wallace’s contributions to the Company’s success during the year, his individual performance multiplier would be 110%, yielding a total bonus payout to Mr. Wallace of 155.1% (i.e., 110% multiplied by 141%) of his target bonus amount. Please see Note 11 to the Summary Compensation Table for the payout amounts to each named executive officer under the Bonus Plan with respect to their performance during fiscal year 2008.

The Company’s Performance Bonus Plan for Fiscal Year 2009:

In August 2008, the Compensation Committee and, with respect to the Company’s Chief Executive Officer, the independent members of the Board of Directors established the Company performance targets and bonus potentials (at threshold, target and maximum payout levels) in effect for fiscal year 2009 under the Bonus Plan. The performance targets for fiscal year 2009 are tied to the Company’s operating margin and relative revenue growth (again, relative to an index of the revenue growth of 27 semiconductor capital equipment manufacturers, measured over the same period), with targets set at levels that the independent members of the Board of Directors, the Compensation Committee and the Company believe will be very challenging to achieve. Following the close of fiscal year 2009, the Compensation Committee (or, in the case of the Company’s Chief Executive Officer, the independent members of the Board of Directors) will determine the actual bonus amount for each named executive officer participating in the fiscal year 2009 Bonus Plan based on the actual levels at which the performance targets for that year are attained. To calculate an Executive’s actual bonus payment, the Executive’s target bonus amount will be multiplied by the payout percentage set forth in the fiscal year 2009 Bonus Plan, which will be determined based upon the Company’s actual performance level for the year. The Compensation Committee or the independent Board members (as applicable) will have the discretion to adjust the actual bonus amount that would otherwise be due upon the attainment of the performance targets, based on their assessment of the executive’s performance for fiscal year 2009. The actual bonus amounts (if any) will be paid within ninety days after the close of the fiscal year.

For fiscal year 2009, as previously noted, the payout percentages under the Bonus Plan have been significantly reduced from fiscal year 2008 payout percentages at each level of comparable Company performance in relation to the applicable year’s target operating results, in an effort to reduce the Company’s compensation expenses in light of the challenging business conditions currently facing the semiconductor capital equipment industry. So, for example, the Company’s achievement of target operating income in fiscal year 2009 (if revenue grows at the same rate as the average growth rate for the Company’s comparator group) will result in a payout under the fiscal year 2009 Bonus Plan of only 70% of the Executives’ target bonus amounts. As a result, while many of the Executives’ target bonus percentages (as a percentage of base salary) have increased in fiscal year 2009 as compared to their target percentages in fiscal year 2008, such increases are offset by the lower payout percentages provided for under the fiscal year 2009 Bonus Plan (as compared to the fiscal year 2008 Bonus Plan for comparable levels of Company performance relative to target), such that the Executives’ total cash compensation in fiscal year 2009 will generally decline from the prior year for similar performance relative to the year’s target—an outcome that the Compensation Committee and independent members of the Board of Directors

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feel is reasonable in the current economic environment within the Company’s primary industries.

The following named executive officers will participate in the Company’s Performance Bonus Plan for fiscal year 2009, with bonus potentials at the following minimum, threshold, target and maximum payout levels:

The actual bonus award (if any) will depend upon the actual level at which the performance targets for fiscal year 2009 are attained, but no executive officer will receive a bonus award under the fiscal year 2009 Performance Bonus Plan in excess of the maximum dollar award indicated for him above, and no executive officer will receive any bonus award under such plan if the Section 162(m) threshold level of Company performance (tied to operating margin) is not attained.

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Equity Awards:

The Company’s 2004 Equity Incentive Plan permits various types of equity awards, including grants of stock options, performance shares and restricted stock units. Stock options were historically the primary form of equity award issued by the Company. However, since the beginning of fiscal year 2007, the equity awards to the Company’s executive officers have been comprised entirely of performance shares.

Several factors have contributed to this transition. The adoption by the Company of FAS 123R in 2006 gave rise to a change in the accounting treatment for stock options, which made them less attractive from an accounting point of view. Also, the Compensation Committee believes that restricted stock units and performance shares provide greater retention value than do stock options, due to the more certain value provided by such awards. Furthermore, the Compensation Committee believes that compensation plans tied to Company performance, as opposed to stock price performance, are a more appropriate way to provide incentives to Executives and reward success. Executives and other employees are more able, through their positive contributions to the Company, to directly impact the Company’s performance than the Company’s stock price. Therefore, the Compensation Committee believes that equity awards, primarily in the form of performance shares, are highly motivating, provide a major incentive for employees to build stockholder value and serve to align the interests of employees with those of stockholders.

Company Performance-Based Share Grants for Fiscal Year 2008:

The Compensation Committee used performance share awards as the primary form of equity compensation for the named executive officers for fiscal year 2008. Other than new hire or promotion grants, the Compensation Committee grants performance shares to the executive officers one time per year, typically in August. The initial determination under the performance share program is the establishment, at the beginning of each fiscal year, of target award ranges for each participating Executive and target performance metrics (operating margin, in the case of fiscal 2008) for the Company. For fiscal year 2008, such target award ranges and performance metrics were developed by the Company’s Chief Executive Officer, Chief Financial Officer and Senior Vice President of Human Resources, with the assistance of the Independent Consultant, and were subsequently submitted as recommendations to the Compensation Committee and then to the independent members of the Board of Directors for approval. These target award ranges are established with reference to the Executive’s role and responsibilities within the Company, as well as compensation data from the Radford Executive Survey and the Independent Consultant for similar positions at peer companies.

The actual payout amount of each named executive officer’s equity award (that is, the actual number of shares to be issued pursuant to the officer’s performance share award based on Company performance) was determined following the conclusion of fiscal year 2008. The Company’s actual operating margin, as compared to pre-determined levels of operating margin established at the beginning of the fiscal year, determined the percentage of the executive’s target award that would actually be issued. Achieving $385.5 million of operating margin (including stock-based compensation charges and excluding expenses related to acquisitions, one-time charges and deal-related amortization) would

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trigger the issuance of 50% of the target number of shares, and achieving $771 million or more of operating margin would trigger the issuance of 125% of the target number of shares. Any operating margin result between $385.5 million and $771 million would be mapped linearly between the 50% and 125% award amounts. If less than $385.5 million of operating margin were achieved, then no shares would be issued under the performance share awards for that fiscal year. The Compensation Committee reviewed the Company’s performance for fiscal year 2008 to calculate the appropriate number of shares to be issued to each participant for fiscal year 2008 and made recommendations to the independent members of the Board of Directors. The independent members of the Board of Directors then reviewed and approved the recommendations made by the Compensation Committee with respect to the number of shares to be issued to each named executive officer.

The level of operating margin for fiscal year 2008 at which the participants would receive the maximum number of shares under their performance share awards was set at $771 million—a level that would have approached the Company’s record performance from fiscal year 2007³ and would have been the Company’s second-highest total in its history. This operating margin amount was considered especially aggressive, taking into consideration the industry-wide slowdown that began to impact the semiconductor capital equipment and related industries during the first quarter of fiscal year 2008 and eventually continued throughout the remainder of the fiscal year. Despite these challenging business conditions, the Company achieved operating margin of $666 million for the fiscal year. As a result, in August 2008, 104.58% of the target number of shares subject to the performance share award made to each named executive officer for fiscal year 2008 were issued, as set forth in the following table:

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The shares issued in accordance with the foregoing table also have a significant service vesting component. Fifty percent (50%) of the issued shares will vest two years from the date of the award, and the remaining fifty percent (50%) will vest four years from the date of the award, in each case subject to the executive’s continued employment with the Company through the applicable vesting date.

Individual Performance-Based Supplemental Share Grants for Fiscal Year 2008:

In addition to the performance share awards granted to the named executive officers for fiscal year 2008 with share payouts tied to the Company’s financial results, the Compensation Committee and the independent members of the Board of Directors also awarded supplemental grants of restricted stock units to Messrs. Wallace and Kispert. The supplemental awards had not been a component of the prior year’s compensation program and were aligned with specific strategic Company targets for fiscal year 2008, emphasizing the Company’s focus on strategic objectives.

For fiscal year 2008, each of Messrs. Wallace and Kispert was granted a supplemental grant of restricted stock units under which up to 25,000 shares of the Company’s common stock could become issuable. The actual number of shares issuable under the supplemental awards was determined following the conclusion of fiscal year 2008 with reference to Messrs. Wallace and Kispert’s success in achieving certain specific strategic objectives (which differed for the two executives and are further described below), with the number of shares potentially issuable to each of Messrs. Wallace and Kispert under those supplemental grants capped at the target share number of 25,000.

For fiscal year 2008, the number of shares issuable under the supplemental awards, as well as the criteria for issuance of such shares, were developed by the Compensation Committee, with the assistance of the Independent Consultant and the Company’s Senior Vice President of Human Resources and, in the case of Mr. Kispert’s award amount and criteria, with the assistance of Mr. Wallace, and were subsequently submitted as recommendations to the independent members of the Board of Directors for approval. The Board of Directors and the Compensation Committee structured the supplemental grants so that Messrs. Wallace and Mr. Kispert would not receive any shares under their supplemental grants, notwithstanding satisfaction of any of the strategic objectives established for each individual, unless the Company’s operating margin (as calculated for purposes of the fiscal year 2008 Bonus Plan) for fiscal year 2008 equaled or exceeded $578.2 million. In addition to that initial threshold, the Compensation Committee and

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the independent members of the Board of Directors established strategic objectives for each of Messrs. Wallace and Kispert, and the extent to which these objectives were satisfied would determine the actual number of shares that would become issuable to each executive under his respective supplemental award. For Mr. Wallace, his strategic objectives for fiscal year 2008 consisted of (a) making significant progress toward the Company’s achievement of its near-term product roadmap, (b) aggressively pursuing acquisition opportunities, to the extent they become available and are in the best interests of the Company and its stockholders; and (c) making significant progress on executive succession planning. For Mr. Kispert, his strategic objectives for fiscal year 2008 were comprised of (1) substantially increasing the number of tools shipped from the Company’s Singapore operations; and (2) achieving the financial, strategic and operational objectives that had been established for the first full fiscal year of post-closing operations by the Therma-Wave and ADE businesses, which were acquired by the Company during fiscal year 2007.

Following the conclusion of fiscal year 2008, the Compensation Committee reviewed the performance by the Company and by each of Messrs. Wallace and Kispert for the year to determine the appropriate number of shares to be issued to each individual and, with respect to the number of shares issuable under Mr. Wallace’s supplemental award, made recommendations to the Board of Directors. The independent members of the Board of Directors then reviewed and approved the recommendations made by the Compensation Committee with respect to the number of shares to be issued to Mr. Wallace.

As described above, despite the challenging business conditions facing the Company during fiscal year 2008, the Company achieved operating margin of $666 million for the fiscal year, thereby satisfying the initial threshold under the supplemental awards. The Compensation Committee, with respect to Mr. Kispert, and the independent members of the Board of Directors, with respect to Mr. Wallace, then reviewed each executive’s strategic objectives that had been established at the beginning of the fiscal year and determined that, taking into consideration the Company’s performance and the market conditions during fiscal year 2008, each of the objectives had been achieved. As a result, in August 2008, the maximum number of shares subject to the supplemental performance share award made to each of Messrs. Wallace and Kispert were issued, as set forth in the following table:

The shares issued in accordance with the foregoing table also have a significant service vesting component. Fifty percent (50%) of the issued shares will vest two years from the date of the award, and the remaining fifty percent (50%) will vest four years from the date of the award, in each case subject to the executive’s continued employment with the Company on the applicable vesting date.

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Performance-Based and Service-Based Share Grants for Fiscal Year 2009:

In August 2008, the Compensation Committee and, with respect to grants to the Company’s Chief Executive Officer, the independent members of the Board of Directors approved minimum, target and maximum levels of performance share awards for the Company’s executive officers for target performance for fiscal year 2009. In addition to the base grants for each officer, the Compensation Committee also approved supplemental awards to certain of the named executive officers (Messrs. Wallace, Martin, Kirloskar and Tsai), as set forth in the table below. As with the grants for fiscal year 2008 performance, the number of shares to be issued pursuant to the base performance share awards for fiscal year 2009 will be determined in relation to the Company’s operating margin as measured against a pre-determined range of results, with potential payout of up to 100% of target.

The supplemental award to Mr. Wallace is aligned with specific strategic Company targets for fiscal year 2009, emphasizing the Company’s focus on strategic objectives. The number of shares issuable under the supplemental award to Mr. Wallace will be determined following the conclusion of fiscal year 2009 with reference to Mr. Wallace’s success in achieving certain specific strategic objectives (which differ from the objectives applicable to the base grants or the Company’s bonus plan for fiscal year 2009), with the number of shares potentially issuable under those supplemental grants capped at the target share number.

The supplemental grants to Messrs. Martin, Kirloskar and Tsai, which are expected to be one-time supplemental grants, will vest based solely on the executive’s continued service with the Company, with 50% of the shares vesting two years from the date of the award, and the remaining 50% vesting four years from the date of the award, in each case subject to the executive’s continued employment with the Company on the applicable vesting date. These service-based grants provide the participating executives with a portion of their equity-based compensation that is not tied to the Company’s operational results, which are subject to the highly cyclical nature of the industries in which the Company participates, and, in the opinion of the Compensation Committee and the Board of Directors, provide greater certainty and therefore significant retention value.

The size and vesting terms of the equity awards to the Executives are determined by the Compensation Committee after reviewing external market data to ensure that the Company’s compensation packages are competitive, while also taking into account retention issues and the portion of each Executive’s equity position that remains unvested. The minimum, target and maximum numbers of shares potentially issuable to each of the named executive officers under the performance share awards and supplemental

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awards made for fiscal year 2009, as approved by the Compensation Committee and the Board in August 2008, are as follows:

Any shares that may eventually be issued under the performance share awards for fiscal year 2009 listed above will also have a significant service vesting component. Fifty percent (50%) of any issued shares will vest two years from the date of the award, and the remaining fifty percent (50%) will vest four years from the date of the award, in each case subject to the executive’s continued employment with the Company through the applicable vesting date.

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The Company makes only nominal use of perquisites in compensating its executive officers. All executive officers of the Company, including some former executives, are entitled to be reimbursed for the cost of professional financial services. These services include tax planning, preparation and filing, as well as financial and estate planning services, up to a maximum of $20,000 per calendar year.

Unexercised options and unearned performance shares or units do not count for purposes of measuring compliance with the ownership guidelines. The

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value of unvested restricted stock or stock units is included in measuring compliance. The recommended time period for reaching the guidelines is the later of (a) October 1, 2012 or (b) the fourth anniversary from when the individual becomes subject to these guidelines. With respect to the Company’s Chief Executive Officer, President and Chief Operating Officer positions, the Compensation Committee will conduct an annual review to assess compliance with the guidelines, once they become effective. Vice Presidents’ compliance will be evaluated by the Chief Executive Officer and Chief Operating Officer. The Company believes that each of its executives subject to these ownership guidelines is on schedule to be in compliance with the guidelines by the applicable deadline.

The Company’s annual Performance Bonus Plan is structured in a manner that will allow the Company to qualify all or part of the compensation earned under that plan as performance-based compensation. As a result, it is anticipated that a substantial portion of the incentive compensation earned by the executive officers under that plan for fiscal year 2008 should qualify as performance-based compensation and not subject to the $1 million limitation.

The Compensation Committee continues to consider steps that might be in the Company’s best interests to comply with Section 162(m). However, in establishing the cash and equity incentive compensation programs for the executive officers, the Compensation Committee believes that the potential deductibility of the compensation payable under those programs should be only one of a number of relevant factors taken into consideration, and not the sole or primary factor. The Compensation Committee believes that cash and equity incentive compensation must be maintained at the requisite level to attract and retain the executive officers essential to the Company’s financial success, even if all or part of that compensation may not be deductible by reason of the Section 162(m) limitation.

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COMPENSATION COMMITTEE REPORT

The information contained in this report shall not be deemed to be “soliciting material” or “filed” with the SEC or subject to the liabilities of Section 18 of the Securities Exchange Act of 1934, as amended, except to the extent that KLA-Tencor specifically incorporates it by reference into a document filed under the Securities Act of 1933, as amended, or the Securities Exchange Act of 1934, as amended.

The Compensation Committee has reviewed and discussed with management the Compensation Discussion and Analysis. Based on that review and its discussions, the Compensation Committee recommended to the Board that the Compensation Discussion and Analysis be included in this Proxy Statement.

Kevin J. Kennedy, Chairman¹

Robert P. Akins²

Edward W. Barnholt

Robert T. Bond

John T. Dickson

Lida Urbanek

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EXECUTIVE COMPENSATION AND OTHER MATTERS

Summary Compensation Table

The following table sets forth certain summary information concerning the compensation earned for services rendered in all capacities to the Company and its subsidiaries for the fiscal years ended June 30, 2008 and 2007 by the Company’s Chief Executive Officer, all persons who served as Chief Financial Officer during fiscal year 2008 and each of the other executive officers whose total compensation for that fiscal year exceeded $100,000 and who were serving as executive officers as of June 30, 2008. In addition, Dr. Tsai is listed because he served as an executive officer of the Company for part of the fiscal year ended June 30, 2008 and had he continued to be designated as an executive officer as of June 30, 2008 (note that Dr. Tsai continues to serve as an employee of the Company as of the date of this Proxy Statement, but was not designated as an executive officer as of June 30, 2008), he would have been one of the three most highly compensated executive officers of the Company other than the Chief Executive Officer and the Chief Financial Officer. No other executive officers who would have otherwise been includable in such table on the basis of their compensation for the fiscal year ended June 30, 2008 have been excluded by reason of their termination of employment or change in executive status during that year. Mr. Kirloskar did not serve as an executive officer of the Company during any part of the fiscal year ended June 30, 2007; therefore, his compensation information for fiscal year 2007 is not included in the following table. The listed individuals will be referred to as the “named executive officers.”

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