All stockholders are cordially invited to attend the Annual Meeting in person; however, to assure your representation at the Annual Meeting, you are requested to complete, sign and date the enclosed proxy card and return it in the enclosed envelope or follow the instructions on the enclosed proxy card to vote by telephone or via the Internet. Any stockholder attending the Annual Meeting may vote in person even if he or she previously returned a proxy card or voted by telephone or via the Internet.

QUESTIONS AND ANSWERS REGARDING PROXY SOLICITATION AND VOTING

The Board of Directors of KLA-Tencor Corporation (“KLA-Tencor,” the “Company” or “we”) is providing these proxy materials to you in connection with KLA-Tencor’s Annual Meeting of Stockholders to be held on Thursday, March 29, 2007 at 1:00 P.M. local time. As a stockholder of record, you are invited to attend the Annual Meeting, which will be held in the Crystal B Room of the Crowne Plaza Hotel located at 777 Bellew, Milpitas, CA 95035. The purposes of the Annual Meeting are set forth in the accompanying Notice of Annual Meeting of Stockholders and this Proxy Statement.

These proxy solicitation materials, together with the Company’s Annual Report for fiscal year 2006, were first mailed on or about February 28, 2007 to all stockholders entitled to vote at the Annual Meeting. KLA-Tencor’s principal executive offices are located at 160 Rio Robles, San Jose, California 95134, and our telephone number is (408) 875-3000.

QUESTIONS AND ANSWERS ABOUT THE ANNUAL MEETING

You may vote if our records showed that you owned shares of KLA-Tencor Common Stock as of February 15, 2007 (the “Record Date”). At the close of business on that date, we had a total of 224,837,996 shares of Common Stock issued and outstanding, which were held of record by approximately 810 stockholders. As of the Record Date, we had no shares of Preferred Stock outstanding. You are entitled to one vote for each share that you own.

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.

In addition to such other business as may properly come before the Annual Meeting or any adjournment thereof, the following two proposals will be presented at the Annual Meeting:

1.      Election of three Class II Directors to each serve for a three-year term and of one Class I Director to serve for a two-year term, each until his successor is duly elected; and

2.      Ratification of the appointment of PricewaterhouseCoopers LLP as the Company’s independent registered public accounting firm for the fiscal year ending June 30, 2007.

If your shares are registered directly in your name with our transfer agent, you are considered, with respect to those shares, the stockholder of record, and these proxy materials are being sent directly to you. You may vote in accordance with the instructions described below. If you hold your shares in your own name as a holder of record, you may instruct the proxy holders how to vote your shares in the following ways:

1.      By Telephone: Use the toll-free telephone number provided on the proxy card prior to 11:59 P.M. EST on March 28, 2007 (specific instructions for using the telephone voting system are on the proxy card);

2.      By Internet: Use the Internet voting site listed on the proxy card prior to 11:59 P.M. EST on March 28, 2007 (specific instructions for using the Internet voting system are on the proxy card);

3.      By Mail: Complete, sign, date and mail the proxy card in the postage paid envelope that we have provided for delivery to the Company prior to 11:59 P.M. EST on March 28, 2007 (specific instructions for mailing are on the proxy card); or

4.      In Person: Attend the Annual Meeting and vote your shares in person.

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. 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.

You may change your vote at any time prior to the vote at the Annual Meeting. To change your proxy instructions if you are a stockholder of record, you must:

•     Advise our General Counsel in writing at our principal executive office, before the proxy holders vote your shares, that you wish to revoke your proxy instructions; or

•     Deliver proxy instructions dated after your earlier proxy instructions as follows:

a.      By Phone: Use the toll-free telephone number provided on the proxy card to vote again prior to 11:59 P.M. EST on March 28, 2007 (specific instructions for using the telephone voting system are on the proxy card);

b.      By Internet: Use the Internet voting site listed on the proxy card to vote again prior to 11:59 P.M. EST on March 28, 2007 (specific instructions for using the Internet voting system are on the proxy card);

c.      By Mail: Complete, sign and date another proxy card bearing a later date and deliver such proxy card prior to 11:59 P.M. EST on March 28, 2007 (specific instructions for mailing are on the proxy card); or

d.      In Person: Attend the Annual Meeting and vote your shares in person.

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.

The Board of Directors recommends that stockholders vote as follows:

1.      “FOR” the election of the three nominated Class II Directors to the Board of Directors: H. Raymond Bingham, Robert T. Bond and David C. Wang; and the election of one nominated Class I Director to the Board of Directors: Robert M. Calderoni; and

2.      “FOR” ratification of the appointment of PricewaterhouseCoopers LLP as the Company’s independent registered public accounting firm for the fiscal year ending June 30, 2007.

The stockholder’s notice must set forth, as to each proposed matter, the following:

1.      A brief description of the proposed matter and reasons for conducting such business at the meeting;

2.      Name and address of the stockholder, as they appear on KLA-Tencor’s books;

3.      The class and number of shares of KLA-Tencor that are beneficially owned by the stockholder;

4.      Any material interest of the stockholder in such business; and

5.      Any other information that is required to be provided by such stockholder pursuant to Regulation 14A under the Securities Exchange Act of 1934.

Stockholders may present proposals for action at a future meeting only if they comply with the requirements of the proxy rules established by the SEC and the provisions of our bylaws. We must receive stockholder proposals that are intended to be presented by such stockholders at our next Annual Meeting of Stockholders (related to our fiscal year ending June 30, 2007) no later than September 9, 2007 to be considered for inclusion in the Proxy Statement and form of Proxy relating to that meeting.

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 are subject to the advance notice provisions set forth above under “Can I present other business to be transacted at the Annual Meeting?” and other requirements set forth in the proxy rules established by the SEC and the provisions of our bylaws.

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 II 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.

There is currently one incumbent Class I Director, Lida Urbanek, as Kenneth Levy retired as a Director on October 16, 2006 and Jon D. Tompkins resigned as a Director on December 21, 2006. Robert M. Calderoni, who is not an incumbent Director, has been nominated for election at the Annual Meeting to serve as a Class I Director by the Board of Directors. The Class I Directors will serve until the annual meeting of stockholders to be held in 2008 or until their respective successors are duly elected and qualified.

The three incumbent Class II Directors are H. Raymond Bingham, Robert T. Bond, and David C. Wang. They are up for re-election at the Annual Meeting.

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 the second half of 2007, or until their respective successors are duly elected and qualified.

The term of the three current Class II Directors will expire on the date of the Annual Meeting. The three Class II Directors and one Class I Director of the Board of Directors are nominated for election at the Annual Meeting. The Nominating and Governance Committee, consisting solely of independent Directors as determined under the rules of The Nasdaq Stock Market, recommended the Class II Director nominees, each of whom is an incumbent Director, and the Class I Director nominee, as set forth in this Proposal One. Based on that recommendation, the members of the Board of Directors unanimously resolved to nominate such individuals for election.

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

•     H. Raymond Bingham;

•     Robert T. Bond; and

•     David C. Wang.

In addition, the nominee for election as a Class I Director by the stockholders is Robert M. Calderoni.

If elected, the nominees for Class II Directors will serve as Directors until the Company’s annual meeting of stockholders in 2009 and the nominee for Class I Director will serve as Director until the Company’s annual meeting of stockholders in 2008, each until his successor is duly elected and qualified. If

INFORMATION ABOUT THE DIRECTORS AND THE NOMINEES

Principal Occupation of Board Members

During the Past Five Years

Principal Occupation of Board Members

During the Past Five Years

PROPOSAL TWO:
RATIFICATION OF APPOINTMENT OF PRICEWATERHOUSECOOPERS LLP AS THE COMPANY’S INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM FOR THE FISCAL YEAR ENDING JUNE 30, 2007.

The Audit Committee has the sole authority to retain or dismiss our independent auditors. The Audit Committee has selected PricewaterhouseCoopers LLP, an independent registered public accounting firm, to audit the consolidated financial statements of the Company for its fiscal year ending June 30, 2007. Before making its determination, the Audit Committee carefully considered that firm’s qualifications as independent auditors.

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.

Services Rendered/Fees

Audit Fees (1)

Audit-Related Fees (2)

Total Audit and Audit-Related Fees

Tax Compliance

Tax Planning and Consulting

Total Tax Fees (3)

All Other Fees (4)

(1)    For professional services rendered for the audits of annual financial statements set forth in KLA-Tencor’s Annual Report on Form 10-K for fiscal years 2006 and 2005, the review of quarterly financial statements included in KLA-Tencor’s Quarterly Reports on Form 10-Q for fiscal years 2006 and 2005 and fees for services related to statutory and regulatory filings or engagements.

(2)    For fiscal years ended 2006 and 2005, assurance and related services related to accounting consultations and for services rendered in connection with acquisition due diligence.

(3)    For fiscal years ended 2006 and 2005, tax services for U.S. and foreign tax compliance, planning and consulting.

(4)    For fiscal years ended 2006 and 2005, fees for services other that those described above.

The Audit Committee has adopted a policy regarding non-audit services provided by PricewaterhouseCoopers LLP, our independent registered public accounting firm. First, the policy ensures the independence of our auditors by expressly naming all services that the auditors may not perform and reinforcing the principle of independence regardless of the type of service. Second, certain non-audit services such as tax-related services and acquisition advisory services are permitted but limited in proportion to the audit fees paid. Third, the Chair of the Audit Committee pre-approves non-audit services not specifically permitted under this policy and the Audit Committee reviews the annual plan and any subsequent engagements. Thus, all of the services described above under audit-related fees, tax fees and all other fees were approved by the Audit Committee pursuant to its pre-approval policies and procedures.

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.

OUR CORPORATE GOVERNANCE PRACTICES

ABOUT THE BOARD OF DIRECTORS AND ITS COMMITTEES

The Board of Directors of the Company held a total of seven meetings during the fiscal year ended June 30, 2006.

All Directors other than Mr. Wallace meet the definition of independence within the meaning of The Nasdaq Stock Market director independence standards. None of the Company’s Directors falls outside of the SEC’s 10% ownership safe harbor.

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 standing 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 standing Committee meets regularly and has a written charter approved by the Board of Directors, all of which were attached as appendices to the Proxy Statement related to our 2003 Annual Meeting, which was filed with the SEC on September 23, 2003. All of the charters are available via our website at http://ir.kla-tencor.com. In addition, at each regularly scheduled Board of Directors’ meeting, a member of each standing Committee reports on any significant matters addressed by the Committee. In 2002, after reviewing the Sarbanes-Oxley Act of 2002 and the proposed rules of the SEC and the Nasdaq Stock Market, the Board of Directors revised all of its standing Committee charters to implement voluntarily the proposed standards and to expand the responsibilities of each Committee as well as establish independence and self-assessment requirements. The Board of Directors and each standing Committee regularly reviews the Committee charters.

During the fiscal year ended June 30, 2006, all incumbent Directors attended at least 80% of the total number of meetings of the Board of Directors and each Director attended at least 80% of the aggregate of the total number of meetings held by all Committees of the Board on which each 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.

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.

In addition to the three standing Committees, in May 2006 the Board appointed a Special Committee, consisting of Mr. Bingham and Mr. Kaufman, to conduct an independent investigation of the Company’s historical stock option practices, and in the fall of 2006, the Board of Directors appointed a

The Nominating and Governance Committee consists of Mr. Barnholt, Mr. Bingham and Mr. Kaufman. Mr. Barnholt served as the Chairman of the Nominating and Governance Committee during fiscal year 2006. 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 four meetings during the fiscal year ended June 30, 2006.

It is the Nominating and Governance Committee’s policy to consider candidates for the Board of Directors recommended by stockholders who have owned at least 1% of the Company’s outstanding shares for at least one year and who have evidenced intent to continue as substantial stockholders for the long term. 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

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.

On August 3, 2006, 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 who have owned at least 1% of the Company’s outstanding shares for at least one year and who have evidenced intent to continue as a substantial stockholder for the long term, 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.

DIRECTOR COMPENSATION

INFORMATION ABOUT EXECUTIVE OFFICERS

Name and Position

Principal Occupation of the Executive Officers

During the Past Five Years

Richard P. Wallace

Chief Executive Officer

John H. Kispert

President & Chief Operating Officer

Jeffrey L. Hall

Senior Vice President & Chief Financial Officer

Lawrence A. Gross

Executive Vice President-

Legal & Interim General

Counsel

Name and Position

Principal Occupation of the Executive Officers

During the Past Five Years

Jorge L. Titinger

Senior Vice President &

Chief Administrative

Officer

Benjamin Tsai

Executive Vice President &

Chief Technology Officer

SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT

Name and Address

Percent of Shares
Beneficially

Owned (1)

Capital Group International, Inc. (2)

11100 Santa Monica Blvd.

Los Angeles, CA 90025

Capital Guardian Trust Company (2)

11100 Santa Monica Blvd.

Los Angeles, CA 90025

Capital Research & Management Co. (2)

333 South Hope Street

Los Angeles, CA 90071

The Growth Fund of America, Inc. (2)

333 South Hope Street

Los Angeles, CA 90071

Fidelity Management Research (2)

82 Devonshire Street

Boston, MA 02109

(1)    Based on 198,824,000 outstanding shares of Common Stock as of December 31, 2006.

(2)    Based on information provided pursuant to Schedules 13D and 13G filed with the Securities and Exchange Commission.

Name of Beneficial Owner

Number of
Shares

Beneficially
Owned

Percent of

Outstanding

Class (1)

Richard P. Wallace (2)

Edward W. Barnholt (3)

H. Raymond Bingham (4)

Robert T. Bond (5)

Stephen P. Kaufman (6)

Lida Urbanek (7)

David C. Wang

John H. Kispert (8)

Jeffrey L. Hall (9)

Kenneth Schroeder(10)(13)

Avi Cohen(11)(13)

Lance Glasser(12)(13)

All Directors and current executive officers as a group
(12 persons) (14)

  *      Less than 1%.

 (1)     Based on 199,086,000 outstanding shares of the Common Stock of the Company as of December 31, 2006.

 (2)     Includes 227,794 shares subject to options which are presently exercisable or will become exercisable within 60 days after December 31, 2006.

 (3)     Includes 70,832 shares subject to options which are presently exercisable or will become exercisable within 60 days after December 31, 2006.

 (4)     Includes 60,000 shares subject to options which are presently exercisable or will become exercisable within 60 days after December 31, 2006.

 (5)     Includes 55,000 shares subject to options which are presently exercisable or will become exercisable within 60 days after December 31, 2006.

 (6)     Includes 35,000 shares subject to options which are presently exercisable or will become exercisable within 60 days after December 31, 2006.

 (7)     Includes 81,666 shares subject to options which are presently exercisable or will become exercisable within 60 days after December 31, 2006, 1,271,414 shares of which are held in trust for the benefit of Ms. Urbanek’s family, and 29,555 shares of which are held by the Urbanek Family Foundation.

 (8)     Includes 160,700 shares subject to options which are presently exercisable or will become exercisable within 60 days after December 31, 2006 and 7,241 shares which are held in trust for the benefit of Mr. Kispert’s family.

 (9)     Includes 60,603 shares subject to options which are presently exercisable or will become exercisable within 60 days after December 31, 2006.

(10)    Includes 82,446 shares subject to options which are presently exercisable or will become exercisable within 60 days after December 31, 2006.

(11)    Includes 172,581 shares subject to options which are presently exercisable or will become exercisable within 60 days after December 31, 2006.

(12)    Includes 166,965 shares subject to options which are presently exercisable or will become exercisable within 60 days after December 31, 2006.

(13)    No longer an executive officer of the Company as of December 31, 2006.

(14)    Includes options to purchase an aggregate of 819,155 shares of Common Stock of the Company held by the current officers and Directors which are presently exercisable or will become exercisable within 60 days of December 31, 2006. Messrs. Schroeder, Cohen and Glasser are not included in this group as they were no longer executive officers of the Company as of December 31, 2006. Kenneth Levy is also not included in this group total; his position as Chairman Emeritus is honorary.

(15)    As of December 31, 2006, the executive officers listed below each held restricted stock units. Each restricted stock unit will entitle that officer to one share of the Company’s Common Stock upon satisfaction of the applicable service or performance vesting requirement in effect for that unit.

Name

Number of Shares

Subject to Restricted

Stock Units

Richard P. Wallace

John H. Kispert

Jeffrey L. Hall

Jorge Titinger

Section 16(a) Beneficial Ownership Reporting Compliance

EXECUTIVE COMPENSATION AND OTHER MATTERS

The following table sets forth the compensation earned for services rendered in all capacities to the Company and its subsidiaries for the fiscal year ended June 30, 2006 and each of the preceding two fiscal years by each person who served as Chief Executive Officer during the fiscal year ended June 30, 2006 and each of the four other most highly compensated executive officers whose salary plus bonus for that fiscal year exceeded $100,000. The listed individuals will be referred to as the named executive officers. No executive officer terminated employment with the Company during fiscal year 2006.

Name and Principal
Position

Richard P. Wallace

Chief Executive Officer

John H. Kispert

President & Chief Operating Officer

Jeffrey L. Hall

Senior Vice President &

    Chief Financial Officer

Avi Cohen Former

Group Vice President

Lance Glasser

Former Chief Technical Officer

Kenneth L.

Schroeder Former Chief Executive Officer (13)

(1)      Includes amounts deferred by the named Executive Officer.

(2)      In addition to the amounts earned under the Company’s regular Executive Incentive Plan (“EIP”), this column includes amounts earned under the Company’s Outstanding Corporate Performance Executive Bonus Plan (“OCPB”). Thirty-four percent (34%) of the OCPB earned in 2006 was paid shortly after the close of the fiscal year ended June 30, 2006. The remaining 66% is automatically deferred into the Company’s Executive Deferred Savings Plan (“EDSP”) as a Company contribution and vests 50% after year one, and the remaining 50% after year two. Executives who terminate employment before the end of the vesting period will receive a pro-rata distribution of the deferred bonus amount. The total bonus amount earned by each named executive officer for fiscal year 2006 is comprised as follows:

Mr. Wallace: 37% EIP Bonus and 63% OCPB

Mr. Kispert: 37% EIP Bonus and 63% OCPB

Mr. Hall: 37% EIP Bonus and 63% OCPB

Mr. Cohen: 37% EIP Bonus and 63% OCPB

Mr. Glasser: 39% EIP Bonus and 61% OCPB

Mr. Schroeder: 50% EIP Bonus and 50% OCPB

(3)      These awards consist of restricted stock units (RSUs). Each unit represents the right to receive one share of the Company’s Common Stock upon the vesting of that unit. These RSUs vest 50% at four years from award date and the remaining 50% at five years from award date, with each installment contingent upon the executive’s continued employment with the Company through the applicable vesting date. The award does not include any dividend or dividend-equivalent rights with respect to the underlying shares of the Company’s Common Stock.

(4)      These are the amounts contributed by the Company as a matching contribution to the 401(k) plan.

(5)      On June 30, 2006, Mr. Wallace held RSUs for 141,111 unvested shares of the Company’s Common Stock with an aggregate fair market value of $5,865,984 based on the $41.57 per share fair market value of the Common Stock on that date. RSU awards granted to Mr. Wallace for the respective fiscal years are as follows:

2006:   25,000 RSUs that had a fair market value per share of $47.95 when awarded on September 26, 2005; 75,000 RSUs that had a fair market value per share of $52.53 when awarded on February 17, 2006.

2005:   41,111 RSUs that had a fair market value per share of $40.68 when awarded on October 18, 2004.

(6)      On June 30, 2006, Mr. Kispert held RSUs for 98,333 shares of the Company’s Common Stock with an aggregate fair market value of $4,087,703 based on the $41.57 per share fair market value of the Common Stock on that date. RSU awards granted to Mr. Kispert for the respective fiscal years are as follows:

2006:   50,000 RSUs that had a fair market value per share of $52.53 when awarded on February 17, 2006.

2005:   48,333 RSUs that had a fair market value per share of $40.68 when awarded on October 18, 2004.

(7)      Includes $654 of profit sharing paid.

(8)      On June 30, 2006, Mr. Hall held RSUs for 25,000 shares of the Company’s Common Stock with an aggregate fair market value of $1,039,250 based on the $41.57 per share fair market value of the Common Stock on that date. RSU awards granted to Mr. Hall for the respective fiscal years are as follows:

2006:   15,000 RSUs that had a fair market value per share of $52.53 when awarded on February 17, 2006.

2005:   10,000 RSUs that had a fair market value per share of $41.95 when awarded on May 16, 2005.

(9)      In FY 2004, Mr. Cohen received a $62,257 housing allowance, a management retention award in the amount of $17,587, and $3,561 as reimbursement for relocation expenses. In FY 2005, Mr. Cohen received a management retention award in the amount of $33,539 as well as patent awards.

(10)    On June 30, 2006, Mr. Cohen held RSUs for 33,333 shares of the Company’s Common Stock with an aggregate fair market value of $1,385,653 based on the $41.57 per share fair market value of the Common Stock on that date. These RSUs were awarded to Mr. Cohen on October 18, 2004 when the fair market value per share of the underlying Common Stock was $40.68.

(11)    Represents amounts received by Mr. Glasser for patent awards.

(12)    On June 30, 2006, Mr. Glasser held RSUs for 33,333 shares of the Company’s Common Stock with an aggregate fair market value of $1,385,653 based on the $41.57 per share fair market value of the Common Stock on that date. These RSUs were awarded to Mr. Glasser on October 18, 2004 when the fair market value per share of the underlying Common Stock was $40.68.

(13)    Mr. Schroeder was the Chief Executive Officer until January 1, 2006. On June 30, 2006, Mr. Schroeder held RSUs for 100,000 shares of the Company’s Common Stock with an aggregate fair market value of $4,157,000 based on the $41.57 per share fair market value of the Common Stock on that date. These RSUs were awarded to Mr. Schroeder on October 18, 2004 when the fair market value per share of the underlying Common Stock was $40.68. As a result of the termination of Mr. Schroeder’s employment on October 16, 2006, vesting of his RSUs ceased and all of his outstanding RSUs (which were all unvested) were canceled.

OPTION/SAR GRANTS IN LAST FISCAL YEAR

The following tables set forth the number of securities underlying stock options granted to the named executive officers under the Company’s stock option plans and the options exercised by such named executive officers during the fiscal year ended June 30, 2006. No stock appreciation rights were granted to any of the named executive officers during the fiscal year ended June 30, 2006.

Exercise
or Base
Price

($/share)

Richard P. Wallace

Chief Executive Officer

Total

John H. Kispert

President & Chief Operating Officer

Total

Jeffrey L. Hall

Senior Vice President & Chief Financial Officer

Total

Avi Cohen

Former Group Vice President

Total

Lance Glasser

Former Chief Technical Officer

Total

Kenneth L. Schroeder

Former Chief Executive Officer(4)

Total

(1)    20% of each option will vest and become exercisable upon the optionee’s completion of one year of employment with the Company measured from the applicable grant date, and the balance of each option will vest and become exercisable in 48 successive equal monthly installments upon the optionee’s completion of each additional month of employment thereafter. The grant dates for the options were September 26, 2005 and February 17, 2006.

(2)    Based on a total of 4,856,055 options granted to employees in fiscal year 2006.

(3)    The 5% and 10% assumed rates of appreciation are prescribed by the rules and regulations of the Securities and Exchange Commission and do not represent the Company’s estimate or projection of the future trading prices of the Company’s Common Stock. The calculations assume annual compounding and continued retention of the options or the underlying Common Stock for the full year option term. Unless the market price of the Common Stock actually appreciates over the option term, no value will be realized by the optionee from these option grants. Actual gains, if any, on option exercises are dependent on numerous factors, including, without limitation, the future performance of the Company, overall business and market conditions, and the optionee’s continued employment throughout the vesting period and the option term. None of those factors is reflected in the calculations.

(4)    As a result of the termination of Mr. Schroeder’s employment on October 16, 2006, vesting of his stock options ceased and all of his outstanding unvested stock options were canceled. All of the options in the table were unvested as of October 16, 2006, with the exception of 15,000 vested options shares which subsequently expired under the terms of Mr. Schroeder’s agreement with the Company and/or the applicable equity plan.

AGGREGATED OPTION/SAR EXERCISES IN LAST FISCAL YEAR AND FISCAL YEAR-END OPTION VALUES

Number of
Shares

Acquired on

Exercise

Value

Realized

(1)

Number of Securities
Underlying Unexercised

Options on 6/30/2006

Value of Unexercised
In-the-Money Options

on 6/30/2006 (2)

Richard P. Wallace

Chief Executive Officer

John H. Kispert (4)

President & Chief Operating Officer

Jeffrey L. Hall

Senior Vice President & Chief Financial Officer

Avi Cohen

Former Group Vice President

Lance Glasser

Former Chief Technical Officer

Kenneth Schroeder (5)

Former Chief Executive Officer

(1)    Based on the market price of the purchased shares on the exercise date less the option exercise price paid for those shares.

(2)    Determined on the basis of the closing selling price per share of the Company’s Common Stock on June 30, 2006 ($41.57) less the option exercise price.

(3)    Mr. Wallace did not exercise any stock options during the fiscal year ended June 30, 2006.

(4)    The values of the options held by Mr. Kispert do not reflect the re-pricing of certain of his options in the quarter ended December 31, 2006.

(5)    In the quarter ended December 31, 2006, 596,740 and 890,914 of Mr. Schroeder’s exercisable and unexercisable options, respectively, were canceled in connection with the termination of his employment on October 16, 2006. After giving effect to the cancellations, the values of Mr. Schroeder’s unexercised in-the-money exercisable and unexercisable options on June 30, 2006 were $5,154,622 and $1,526,523, respectively.

EQUITY COMPENSATION PLAN

Number of Securities to
be Issued Upon Exercise
of Outstanding Options,
Warrants and
Rights (2)

A

Weighted-

Average
Exercise Price of
Outstanding
Options,
Warrants and
Rights (3)

B

Number of Securities
remaining available
for Future Issuance
Under Equity
Compensation Plans
(excluding securities
reflected in

Column A) (4)

C

Equity Compensation Plans Approved by Stockholders (1)(5)(6)

Equity Compensation Plans Not Approved by Stockholders (7)

Total

(1)    Consists of the Company’s (a) 2004 Equity Incentive Plan, (b) 1982 Stock Option Plan, (c) 1997 Employee Stock Purchase Plan (the “Purchase Plan”) and (d) 1998 Outside Director Option Plan (the “Outside Director Plan”).

(2)    Includes 1,106,060 shares of Common Stock subject to restricted stock units that will entitle each holder to the issuance of one share of Common Stock for each unit that vests over the holder’s period of continued employment with the Company. Excludes purchase rights accruing under the Purchase Plan. Under the Purchase Plan, each eligible employee may purchase shares of Common Stock at each semi-annual purchase date (the last business day of June and December each year), up to a maximum of $25,000 worth of stock (determined on the basis of the fair market value per share on the date the purchase right is granted) for each calendar year the purchase right remains outstanding. The purchase price payable per share will be equal to eighty-five percent (85%) of the lower of (i) the closing selling price per share of Common Stock on the employee’s entry date into the two-year offering period in which that semi-annual purchase date occurs and (ii) the closing selling price per share of Common Stock on the semi-annual purchase date.

(3)    Calculated without taking into account 1,106,060 shares of Common Stock subject to outstanding restricted stock units that will become issuable as those units vest, without any cash consideration or other payment required for such shares.

(4)    Includes shares of Common Stock available for future issuance under the 2004 Equity Incentive Plan, the Purchase Plan and the Outside Director Plan. No further shares are available for issuance under the 1982 Stock Option Plan.

(5)    As of June 30, 2006, 6.3 million shares of Common Stock were available for issuance under the 2004 Equity Incentive Plan. Shares reserved for issuance under this plan may be issued upon the exercise of stock options or stock appreciation rights or pursuant to full value awards such as restricted stock awards or restricted stock units that vest upon the completion of designated service periods or performance units or performance shares that vestupon the

         attainment of prescribed performance milestones. Shares issued pursuant to full value awards made under the 2004 Equity Incentive Plan will reduce the share reserve available under such plan by 1.8 shares for every one full value share issued.

(6)    As of June 30, 2006, 1,803,740 shares were reserved for issuance under the Purchase Plan. This plan contains an annual automatic share renewal provision pursuant to which the number of shares of Common Stock reserved for issuance under this plan will automatically increase on the first day of each fiscal year by an amount equal to the lesser of 2,000,000 shares or the number of shares which the Company estimates will be required to issue under the plan during the forthcoming fiscal year.

(7)    Consists solely of the 2000 Non-Statutory Plan pursuant to which options have been granted to employees and consultants of the Company. The 2000 Non-Statutory Plan was terminated during the fiscal year ended June 30, 2005, and no further options may be granted under that plan.

CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

Executive Severance Plan

On February 17, 2006, the Board of Directors of KLA-Tencor adopted the KLA-Tencor Corporation Executive Severance Plan (“Plan”). The Plan specifies the compensation and benefits that Plan participants will receive in the event their employment with the Company terminates under certain defined circumstances. In exchange for receiving severance benefits under the Plan, participants will be required to agree to non-compete and non-solicitation restrictions for the period of time during which they are receiving Plan benefits. The severance period for individual participants, and their eligibility (if any) for pre-change of control severance benefits will be determined by the Compensation Committee.

Plan participants are the Company’s Chief Executive Officer (“CEO”), Chief Operating Officer (“COO”), and Chief Financial Officer (“CFO”).

If the CEO or COO are terminated other than for cause, or voluntarily resign for good reason, prior to a change in control, they will receive (i) salary continuation payments for two years, (ii) a pro-rated annual incentive payment, (iii) pro-rated vesting on any equity awards through the end of the month of their termination of employment, and (iv) any stock options or stock appreciation rights granted after February 16, 2006 will have a post-termination exercise period of one year, but in no event beyond the original term of the award. If the CEO is terminated other than for cause, or voluntarily resigns for good reason, within two years following a change in control, he will receive (i) salary continuation payments for a three-year period, (ii) an amount equal to three times his annual target bonus amount payable in equal installments over the salary continuation period, (iii) a pro-rated annual incentive payment, (iv) an additional payment of $2,000 per month over the salary continuation period, (v) 100% vesting acceleration on any equity awards and (vi) any stock options or stock appreciation rights granted after February 16, 2006 will have a post-termination exercise period of one year, but not beyond the original term of the award.

If the COO or the CFO are terminated other than for cause, or voluntarily resign for good reason, within two years following a change in control, they will receive (i) salary continuation payments for a two-year period, (ii) an amount equal to two times their annual target bonus payable in equal installments over the salary continuation period, (iii) a pro-rated annual incentive payment, (iv) an additional payment of $2,000 per month over the salary continuation period, (v) 100% vesting acceleration on any equity awards, and (vi) any stock options or stock appreciation rights granted after February 16, 2006 will have a post-termination exercise period of one year, but not beyond the original term of the award.

In addition, the CEO, COO and CFO will each be entitled under certain circumstances to a full tax gross-up payment to cover any excise tax liability they may incur under Internal Revenue Code Section 4999 and the resulting income and employment tax liability attributable to that payment, should the benefits to which they become entitled in connection with a change in control constitute parachute payments in excess of $50,000 of the maximum amount otherwise allowable under the federal tax laws without the imposition of Section 4999 excise tax.

REPORT OF THE COMPENSATION COMMITTEE ON EXECUTIVE COMPENSATION

The Compensation Committee is responsible for setting and administering the policies governing the compensation of executive officers and other key employees (“Executives”), based on their performance and the performance of the Company. The Committee operates under a written charter adopted by the Board of Directors, which is available at http://ir.kla-tencor.com.

The Committee is comprised of three independent, non-employee members of the Board of Directors, none of whom has interlocking relationships as defined by the Securities and Exchange Commission and all of whom meet current standards of independence requirements of The Nasdaq Stock Market.

The Committee periodically reviews its approach to executive compensation and makes changes as appropriate. The Committee meets regularly without employees present to discuss executive compensation matters. The Committee currently retains, and has retained in the past, consultants when necessary, as determined by the members of the Committee.

The philosophy of the Compensation Committee on executive compensation is that it should be designed to:

•     Attract, retain, and reward Executives who contribute to the overall success of the Company;

•     Support accomplishment of the Company’s business strategies, objectives and initiatives;

•     Have a substantial portion of annual compensation be contingent upon the Company’s financial performance and an individual’s contribution to the Company’s success; and

•     Align the interests of Executives with the long-term interests of stockholders.

Within this philosophy, the Committee’s objectives are to provide a comprehensive compensation package that is:

•     Competitive with pay levels in the semiconductor capital equipment industry and other selected companies with which KLA-Tencor competes, for executives of similar education and experience;

•     Driven by financial and strategic performance, through annual incentive programs that make up a substantial component of annual pay opportunity; and

•     Aligned with shareholder interests, through grants of equity-based, long-term incentives.

The Committee endeavors to structure each Executive’s overall compensation package to be consistent with this approach and to enable the Company to attract, retain and reward personnel who contribute to the success of the Company. The Committee applies this philosophy and these objectives in determining appropriate executive compensation levels and other compensation factors, and reaches its decisions with a view towards the Company’s overall financial performance.

Base Salary:

Salaries for Executives are set with reference to the median of salaries for comparable positions among other companies in the Company’s industry or in industries that employ individuals of similar education and experience to the Executive. Factors considered in making base salary recommendations include: each person’s job responsibilities, level of experience, individual performance and contribution to the Company’s business, data from the Company’s Human Resources department, and guidance provided by the Compensation Committee’s compensation consultants. The Committee exercised its discretion and judgment based upon these factors, and no specific formula was applied to determine the weight of each factor.

Executive Incentive Plan (EIP):

Each fiscal year since 1979, the Company has adopted an executive incentive plan (the “EIP”) which provides for payments to Executives based 50% on the financial performance of the Company or the relevant business unit, and 50% on the achievement of key strategic business objectives. The EIP as to Executives is approved by the Compensation Committee and submitted to the Board of Directors for ratification. In fiscal year 2006, target awards for such Executives ranged from 40% to 100% of salary. For the financial component of the program, the maximum payout is 150% of the target. For the strategic component, the maximum payout is 100% of the target. For purposes of the fiscal year 2006 EIP, the Committee set financial performance goals for pre-tax profit, and strategic objectives relating to managing the ratio of assets to sales and corporate goals. The target goals for fiscal year 2006 were exceeded on financial objectives but underachieved on strategic objectives. As a result, approximately 85% of the eligible EIP amounts for named executive officers were paid.

Outstanding Corporate Performance Executive Bonus Plan (OCPB):

The Outstanding Corporate Performance Executive Bonus Plan (“OCPB”) program provides a bonus to participants in years when the Company achieves certain levels of profitability and growth above both the Company’s budgeted goals and the relative performance of peer companies. The performance measures are the Company’s pre-tax margin and growth of the Company’s aggregate revenues over a twelve month period against a target group of public U.S. companies in the semiconductor capital equipment market measured over the same period. A participant’s target payout for the

OCPB is equal to the target percentage used in the EIP. This program is designed to pay below target in most years and only above target in years of exceptional financial performance. For fiscal year 2006, the combined strength in pre-tax margins and relative revenue growth resulted in a payout pursuant to the OCPB equal to 143% of target.

Any payouts under the OCPB are made in three annual installments: 34% of each amount is payable at the end of the fiscal year; an additional 33% of each amount is payable at the end of the next fiscal year, and the final 33% of each amount is payable at the end of the second following fiscal year. Installments not yet paid are held by and subject to the terms of the KLA-Tencor Executive Deferred Savings Program.

For fiscal year 2007, the OCPB measures are based on achievement of increased revenue and operating margin gains. In addition, the payout component is changed such that any payouts from the plan will be paid in full instead of in installments over three years.

Long-term Incentives:

Long-term incentives are currently provided under the 2004 Equity Incentive Plan through grants of stock options and restricted stock units. Such awards provide value to Executives through the growth in value of the Company’s Common Stock. The Compensation Committee believes that employee equity ownership is highly motivating, provides a major incentive for employees to build stockholder value and serves to align the interests of employees with those of stockholders.

Grants of stock options to Executives are based upon each Executive’s relative position, responsibilities, historical and expected contributions to the Company, and the Executive’s existing stock ownership and previous option grants. Stock options are granted at market price on the date of grant and will provide value to the Executive only when the price of the Company’s Common Stock increases over the exercise price.

In addition to stock options, grants of restricted stock units were made to the CEO, COO, and CFO to reflect their promotions. These grants have significant vesting restrictions—50% of the award vests four years from the date of grant, and 50% five years from the date of the grant.

On January 1, 2006, the Board of Directors announced the promotion of Richard P. Wallace to the position of Chief Executive Officer, succeeding Kenneth L. Schroeder. The components of Mr. Wallace’s compensation are outlined below:

Base Salary:

In recognition of Mr. Wallace’s promotion to CEO, the Committee raised his base salary from $480,000 to $650,000. The new base salary was determined after a review of competitive and comparable data of other executives provided by the Company’s human resources staff and compensation consultants. The Committee determined the increase was warranted based upon the data provided and in consideration of Mr. Wallace’s new responsibilities, job performance, experience and talent.

Annual Incentives:

For fiscal year 2006, Mr. Wallace participated in the EIP and the OCPB. In recognition of Mr. Wallace’s promotion to CEO his bonus targets for both these plans were increased from 90% to 100% of base salary, effective January 1, 2006. In determining actual incentive compensation payable to Mr. Wallace for performance in fiscal year 2006, the Committee relied on the results of the EIP and the OCPB. For the financial component of the EIP, the Committee awarded Mr. Wallace 95% of target, based primarily on achievement of pre-tax profitability goals. For the strategic component of the EIP, the Committee awarded Mr. Wallace 71% of target, based on goals primarily related to Product Development, Customer Satisfaction and Quality.

Mr. Wallace’s total incentive payout for fiscal year 2006 resulting from these two programs was $1,182,960. The EIP generated a payout of 83% of target, or $ 436,220. The OCPB generated a payout of 143% of target, or $ 746,740, which vests over three years.

For fiscal year 2007, Mr. Wallace’s target bonus under both the EIP and the OCPB will remain at 100% of base salary. The EIP is based on revenue and profit objectives established by the Committee after consideration of the Company’s revenue and profit in the prior fiscal year and data supplied by the Compensation Committee’s compensation consultants, in addition to Mr. Wallace’s expected performance and continuing contributions to the Company. The payout component of the OCPB will be changed for fiscal year 2007 such that any payouts from the plan will be paid in full as compared to previous years whereby payouts were made in three annual installments.

Long-Term Incentives:

In fiscal year 2006, the Board of Directors granted Mr. Wallace stock options exercisable for an aggregate of 175,000 shares of Common Stock (“FY2006 Options”). The following outlines the vesting schedule for each grant that makes up the FY2006 Options: 125,000 of the FY2006 Options were granted in recognition of Mr. Wallace’s promotion to President and Chief Operating Officer in July 2005. In addition, 50,000 of the FY2006 Options were granted in February 2006 in recognition of Mr. Wallace’s promotion to Chief Executive Officer of the Company. These options become exercisable as follows: 20% of each option will vest and become exercisable upon the optionee’s completion of one year of employment with the Company measured from the applicable grant date, and the balance of each option will vest and become exercisable in 48 successive equal monthly installments upon the optionee’s completion of each additional month of employment thereafter.

In addition to stock options, Mr. Wallace received an aggregate award of 100,000 Restricted Stock Units (“FY2006 RSUs”). The following outlines the vesting schedule for each grant that makes up the FY2006 RSUs: 25,000 of the FY2006 RSUs were granted in recognition of Mr. Wallace’s promotion to President and Chief Operating Officer in July 2005; 75,000 of the FY2006 RSUs were granted in February 2006 in recognition of Mr. Wallace’s promotion to Chief Executive Officer of the Company. Each of these FY2006 RSU grants have significant vesting restrictions—50% of the award vests four years from the date of grant, and 50% five years from the date of grant.

While Mr. Schroeder served as Chief Executive Officer of the Company for a portion of fiscal year 2006, the terms of his employment were governed by the employment agreement between Mr. Schroeder and the Company, dated February 23, 2005. This agreement reserved to the Committee the right to maintain or increase Mr. Schroeder’s base salary and to permit his continued participation in the Company’s annual and long-term incentive programs. The components of Mr. Schroeder’s compensation while he served as Chief Executive Officer in fiscal year 2006 are outlined below:

Base Salary:

For fiscal year 2006, the Committee maintained Mr. Schroeder’s base salary at $750,090, based on a review of competitive and comparable data of other executives provided by the Company’s human resources staff and compensation consultants and of the Company’s performance during fiscal year 2005. The full base salary was payable to Mr. Schroeder in accordance with the terms of the Amended and Restated Schroeder Agreement.

Annual Incentives:

For fiscal year 2006, Mr. Schroeder’s target bonus under both the EIP and the OCPB were set at 100% of salary, based on the Committee’s consideration of the Company’s revenue and profit in the prior fiscal year, the Company’s market capitalization, and data from comparable companies supplied by the Compensation Committee’s compensation consultants, in addition to Mr. Schroeder’s expected performance and continuing contributions to the Company.

The annual incentive compensation payable to Mr. Schroeder was equal to the target bonus under both the EIP and the OCPB in accordance with the terms of the Amended and Restated Schroeder Agreement. Mr. Schroeder’s total annual incentive payout for fiscal year 2006 resulting from these two programs was $1,500,180, with $750,090 from the EIP and $750,090 from the OCPB.

Long-Term Incentives:

In fiscal year 2006, the Board of Directors granted Mr. Schroeder stock options exercisable for an aggregate of 325,800 shares of Common Stock. As noted above, all of the unvested stock options and equity awards held by Mr. Schroeder on October 16, 2006 immediately ceased vesting and were canceled. No restricted stock units

Title

Section 162(m) of the Internal Revenue Code disallows an income tax deduction to publicly-traded companies such as KLA-Tencor for compensation paid to the CEO and the four other highest paid executive officers, to the extent that compensation exceeds $1 million per officer in any taxable year and does not otherwise qualify as performance-based compensation. The Company’s existing equity compensation plans, including the 2004 Equity Incentive Plan, are structured so that the compensation deemed paid to an executive officer in connection with the exercise of stock options granted under those plans should qualify as performance-based compensation not subject to the $1 million limitation. However, the Company has determined that certain of its past stock options were retroactively priced and, therefore, have exercise prices below the fair market values of the underlying shares on the grant dates of the options. Because retroactively priced options do not qualify as performance-based compensation, the compensation deemed paid when those options are exercised is subject to the Section 162(m) limitation. As a result, a substantial portion of the compensation realized by Mr. Kispert in connection with his option exercises during fiscal year 2006 is subject to the Section 162(m) limitation. In addition, other awards made under those plans may or may not qualify as performance-based compensation. The restricted stock unit awards made to the executive officers in fiscal years 2005 and 2006 will not qualify as performance-based compensation because the vesting of those awards is tied to continued service over a four-to-five year period.

Until fiscal year 2006, the Company’s annual cash incentive programs were not designed to provide bonus payments that would qualify as performance-based compensation under Section 162(m). However, at the 2005 annual meeting, the stockholders approved a new Performance Bonus Plan 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 not subject to the $1 million limit on deductibility under Section 162(m). As a result, a substantial portion of the incentive compensation

earned by the executive officers under that plan for fiscal year 2006 should qualify as performance-based compensation not subject to the Section 162(m) limitation. However, a portion of the incentive compensation earned by certain executive officers for fiscal year 2006 is not expected to constitute performance-based compensation under Section 162(m), and that portion, when added to other non-performance based compensation earned for fiscal year 2006, is expected to exceed the $1 million limit under Section 162(m) for Mr. Wallace, Mr. Kispert and possibly other executive officers.

The Committee believes that, as a result of the new Performance Bonus Plan, the risk of lost deductions with respect to the annual incentive compensation awards paid under that plan in subsequent fiscal years will be minimized. The Committee also continues to consider other 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 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. For that reason, the Committee may deem it appropriate to continue to provide one or more executive officers with the opportunity to earn incentive compensation, including cash bonuses tied to both Company and individual performance and restricted stock unit awards, that may be in excess of the amount deductible by reason of Section 162(m) or other provisions of the Internal Revenue Code. The 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.

MEMBERS OF THE COMPENSATION COMMITTEE

Robert T. Bond, Chairman

Edward W. Barnholt

Lida Urbanek

REPORT OF THE AUDIT COMMITTEE

The Company’s Audit Committee is comprised of three non-employee Directors, each of whom meets current standards of independence and financial experience requirements of The Nasdaq Stock Market. The Board has determined that H. Raymond Bingham is an “audit committee financial expert” within the meaning of the rules promulgated by the Securities and Exchange Commission. For fiscal year 2006, H. Raymond Bingham, Robert T. Bond, and Stephen P. Kaufman served as members of the Audit Committee. Mr. Elkus served on the Committee until his mandatory retirement in November 2006. Mr. Bingham served as the Chairman of the Audit Committee for fiscal year 2006. The Board of Directors has adopted a written charter for the Audit Committee that details the responsibilities of the Audit Committee and was attached as Exhibit A to the Proxy Statement related to the 2003 Annual Meeting. This report relates to the activities undertaken by the Audit Committee in fulfilling such responsibilities. The charter is reviewed at least annually for changes, as appropriate, and is posted on the Company’s website at http://ir.kla-tencor.com, in the Investor Presentations and Corporate Governance section.

KLA-Tencor’s management is responsible for establishing and maintaining a system for internal controls and the financial reporting process. The Audit Committee is responsible for overseeing KLA-Tencor’s auditing, accounting and financial reporting processes, system of internal controls, and legal and ethical compliance. This report relates to the activities undertaken by the Audit Committee in fulfilling such responsibilities. During fiscal year 2006, the Audit Committee reviewed, discussed and provided input on the Company’s audited consolidated financial statements contained in KLA-Tencor’s Annual Report on Form 10-K for the fiscal year ended June 30, 2006. The Audit Committee also met routinely with the independent auditors, with and without members of the KLA-Tencor management team present, to evaluate and approve the Company’s internal controls and the overall quality of the Company’s financial reporting. The Audit Committee also met with the Company’s Chief Executive Officer and Chief Financial Officer to discuss and act, as necessary, on accounting issues and risks facing the Company.

The Audit Committee also discussed with the Company’s independent auditors the matters required to be discussed by Statement on Auditing Standards No. 61, (Communication With Audit Committees).

The Audit Committee received the written disclosures and the letter from the auditors required by Independence Standards Board Standard No. 1, Independence Discussions with Audit Committees. In addition, on a quarterly basis they reaffirmed their independence. After reviewing such information, the Audit Committee determined that the independent auditors are independent from management and KLA-Tencor. The Audit Committee also concluded that the provision of services covered by fees paid to its independent auditors was compatible with maintaining their independence.

MEMBERS OF THE AUDIT COMMITTEE

H. Raymond Bingham, Chairman

Robert T. Bond

Stephen P. Kaufman

PERFORMANCE GRAPH

Comparison of Five-Year Cumulative Total Return Among KLA-Tencor Corporation, the NASDAQ Composite Index and the Philadelphia Semiconductor Index (1)

KLA-Tencor Corporation

NASDAQ Composite Index

Philadelphia Semiconductor Index

(1)    Assumes $100 invested on June 30, 2001. The Company’s fiscal year end is June 30.