LTXX Ltx (MM)

Compensation Committee Report

The Compensation Discussion and Analysis set forth below has been reviewed and discussed with management. Based on the review and discussion with management, the Compensation Committee has recommended to the Board of Directors (and the Board has approved) that the Compensation Discussion and Analysis be included in this proxy statement and in LTX’s Annual Report on Form 10-K for the year ended July 31, 2007.

COMPENSATION COMMITTEE

Stephen M. Jennings (Chair)

Mark S. Ain

Robert E. Moore

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The information contained in the report above shall not be deemed to be “soliciting material” or to be “filed” with the SEC, nor shall such information be incorporated by reference into any future filing under the Securities Act or the Exchange Act, except to the extent that LTX specifically incorporates it by reference in any such filing.

Compensation Discussion and Analysis

The Compensation Committee of our Board of Directors oversees our executive compensation program. In this role, the Compensation Committee reviews and approves all compensation decisions relating to our named executive officers. For a discussion of the processes and procedures followed by the Compensation Committee, including a discussion of the role of management and of the Committee’s independent compensation consultant, Pearl Meyer & Partners, see “Board Committees—Compensation Committee” above.

Objectives of Our Executive Compensation Program

The primary objectives of our executive compensation program are to:

Benchmarking

The Compensation Committee evaluates our executive compensation program with the goal of setting compensation at levels the Committee believes are competitive with those of other companies in our industry and our region that compete with us for executive talent. In making compensation decisions, the Compensation Committee compares our executive compensation against that paid by a peer group of publicly traded companies in the semiconductor and semiconductor equipment industry developed by the Compensation Committee and its

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independent consultant. This peer group, which is periodically reviewed and updated, consists of companies the Committee believes are generally comparable to our company and against which the Committee believes we compete for executive talent. The companies included in this peer group during fiscal 2007 were:

When evaluating fiscal 2008 compensation, three semiconductor test equipment companies that recently completed initial public offerings were added to the peer group (Eagle Test Systems, Inc., Verigy Ltd. and Nextest Systems Corporation) and one other company was also added (Cascade Microtech, Inc.).

The Compensation Committee generally targets overall compensation for executives between the median and 65 ^th percentile paid to similarly situated executives of the companies in the peer group. Variations to this general target may occur as dictated by the experience level of the individual and market factors. For fiscal 2007 the Committee reviewed benchmarking data for equity awards and for fiscal 2008 the Committee reviewed benchmarking data for base salary, annual cash incentive bonus and equity awards.

Discussion and Analysis of Decisions and Policies

We do not have any formal or informal policy or target for allocating compensation between long-term and short-term compensation, between cash and non-cash compensation or among the different forms of non-cash compensation. Instead, the Compensation Committee, after considering the factors described below, including information provided by the Committee’s independent compensation consultant, determines subjectively what it believes to be the appropriate level and mix of the various compensation components.

Base Salary

When establishing base salaries for fiscal 2007, the Compensation Committee considered the seniority of the individual, the level of the individual’s responsibility, the ability to replace the individual, and the base salary of the individual in prior years. Based on these factors and the Committee’s subjective assessment of the appropriate base salary for the Chief Executive Officer of a company of the size and performance in the Company’s industry, the Committee increased the base salary of the Chief Executive Officer by 10%. The Committee’s decision to increase the base salaries of the other named executive officers for fiscal 2007 was based on these factors and a recommendation of the Chief Executive Officer, following a discussion with the Chief Executive Officer of his recommendations.

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Generally, we believe that executive base salaries should be targeted near the median of the range of salaries for executives in similar positions at comparable companies. The annual base salaries of the named executive officers paid in 2006 and 2007, and the base salaries of the named executive officers set for 2008, are set out in the table below:

The increase in the Chief Executive Officer’s base salary for fiscal 2008 was based on the factors described above as well as a report and recommendation on executive compensation produced by the Committee’s independent compensation consultant comparing compensation to the peer group listed above. The Committee increased the Chief Executive Officer’s base salary but did not adjust the base salaries of the other named executive officers after reviewing benchmarking data which showed that the Chief Executive Officer’s base salary was below the 50 ^th percentile and the other executives were within the targeted range. The increase to the Chief Executive Officer’s base salary brought it within the targeted range.

Annual Cash Incentive Bonus

Our annual cash incentive bonus plan is intended to compensate for the achievement of company, operational and financial goals, as measured by Company profitability. The plan provides that an annual cash bonus be paid to officers calculated under a formula based upon net income. The formula provides that no bonus would be paid if the Company is not profitable. For fiscal 2007, the Committee assigned target incentive compensation equal to 50% of the executive officer’s base salary, subject to a maximum amount not to exceed 175% of the executive officer’s base salary. Specific participation percentages for each executive officer were established with reference to the officer’s area and scope of responsibility within the Company. For 2007, under the plan 0.113% of net income would have been payable to Mr. Tacelli, 0.084% of net income would have been payable to Mr. Gallenberger and 0.066% of net income would have been payable to Mr. Rood. No amounts were awarded under the annual cash incentive bonus plan in 2007 because the Company was not profitable. The Compensation Committee has the discretion to make equitable adjustments to any amounts payable under the annual bonus plan, but did not make any adjustments for fiscal 2007.

Prior to fiscal 2006, a portion of the annual cash incentive bonus plan was dependent upon achievement of individual goals. Beginning in fiscal 2006, the Committee eliminated any bonus based upon an executive’s achievement of individual goals. The Committee made this change so that no cash incentive compensation would be paid to executive officers unless the Company was profitable and to emphasize the focus on achievement of profitability.

Equity Compensation

Our equity award program is the primary vehicle for offering long-term incentives to our executives. We believe that equity grants provide our executives with a strong link to our long-term performance, create an ownership culture and help to align the interests of our executives and our stockholders. In addition, the vesting feature of our equity grants should further our goal of executive retention because this feature provides an incentive to our

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executives to remain in our employ during the vesting period. In determining the size of equity grants to our executives, our Compensation Committee considers comparative share ownership of executives in our compensation peer group, our company-level performance, the applicable executive’s performance, the amount of equity previously awarded to the executive, the vesting of such awards and the recommendations of management and the Committee’s independent compensation consultant. These factors are not assigned specific weights however, and ultimately the Committee reaches a subjective determination based on its business judgment.

We typically make an initial equity award of restricted stock units (“RSUs”) to new executives and annual equity grants as part of our overall compensation program under our 2004 Stock Plan. All grants of RSUs to our executives are approved by the Compensation Committee.

Prior to the adoption of the 2004 Stock Plan, the Company provided equity-based compensation to its executive officers exclusively in the form of stock options. Under the 2004 Stock Plan, the Company may grant equity awards in the form of stock options, restricted stock, RSUs or other equity-based awards. RSUs are obligations of the Company to issue common stock to the employee on future vesting dates. Beginning in fiscal 2006, the Company began to grant its equity compensation in the form of RSUs rather than stock options because RSUs possess a number of advantages as compared to stock options, including:

When determining the number and terms of stock options and RSUs to be granted to an executive, the Compensation Committee subjectively considers individual performance, overall contribution to the Company and retention and also considers the number of equity-based securities held, and recommendations and data from its independent compensation consultant, including grant data from peer group companies. The Company compares the total value (based on the fair market value of the award as of the determination date) of its RSU grants against market data collected regarding the equity grant practice for the peer group companies listed above under “Benchmarking”. In making equity awards to the named executive officers other than the Chief Executive Officer, the Compensation Committee receives a recommendation from the Chief Executive Officer.

Our equity awards have typically taken the form of stock options and restricted stock grants. The Compensation Committee reviews all components of the executive’s compensation when determining annual equity awards to ensure that an executive’s total compensation conforms to our overall philosophy and objectives. We intend that the annual aggregate value of these awards will be set between the median and 65 ^th percentile for companies in our compensation peer group, and the equity awards to the executive officers for fiscal 2007 were within this range.

In fiscal 2006, 2007 and 2008, we made grants of RSUs to executives in lieu of options for the reasons stated above. We grant RSU awards at no cost to the executive. The grants of RSUs in fiscal 2006 and 2007 provide for performance-based vesting of the awards. The Committee, working with its independent compensation consultant, decided in fiscal 2006 that in connection with the change from using stock options to RSUs to also change the vesting of a significant portion of executive RSUs to be based on performance criteria. The Committee believes that performance-based RSUs advance the overall goals of the compensation program and long-term incentive objectives by ensuring that no value is provided unless the performance goal is achieved.

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The RSUs granted to executives in fiscal 2006 and 2007 were 100% performance-based. The performance criteria can be modified by the agreement of the Committee and the executive. For fiscal 2008, the Committee decided to use time-vested RSUs based on its assessment and market data that a blend of performance-vested and time-vested RSUs would be most likely to advance all objectives. Approximately two-thirds of total RSU awards made to executives in fiscal 2006, 2007 and 2008 were performance-based.

The RSUs granted in fiscal 2006, would only vest if the Company achieved a breakeven level of $41 million of quarterly revenue or less (the “First Breakeven Target”). The First Breakeven Target was achieved in the quarter ended April 30, 2006 and on the date of announcement of that quarter’s financial results (the “First Breakeven Date”), 25% of each executive officer’s RSUs vested immediately and the remaining 75% became scheduled to vest in three equal increments on the first, second and third anniversary of the First Breakeven Date. If prior to the first anniversary of the First Breakeven Date (i.e., April 2007), the Company had achieved a quarterly financial breakeven level of $37 million or less, then as of that date (the “Second Breakeven Date”) the second 25% of the Units would have vested and the remaining 50% of the Units would have vested in two equal increments on the first and second anniversary of the Second Breakeven Date. The Second Breakeven Target was not achieved and so the RSUs will vest in three equal increments on the first, second and third anniversary of the First Breakeven Date. If the First Breakeven Target had not been achieved, all of these RSUs would have been forfeited by the executive officers.

The RSUs granted in fiscal 2007 will only vest if the Company achieves positive operating income for two consecutive fiscal quarters above 3% of net sales for both quarters and if operating income averages at least 5% of net sales for the two quarters (the “Profitability Metric”). The award vests as to 20% of the RSUs upon announcement that the Profitability Metric has been achieved and as to an additional 20% for each subsequent two quarter period in which the Profitability Metric is achieved. Thus far, no portion of these RSUs has vested.

Typically, the stock options and time-vested RSUs we grant to our executives, including the RSUs we granted in fiscal 2008, vest at a rate of 25% per year over the first four years of the ten-year option term. Vesting and exercise rights cease shortly after termination of employment except in the case of death or disability. Prior to the exercise of an option, the holder has no rights as a stockholder with respect to the shares subject to such option, including voting rights and the right to receive dividends or dividend equivalents. We do not have any equity ownership guidelines for our executives.

Stock awards to our executives are typically granted annually in conjunction with the review of their individual performance. This review takes place at the regularly scheduled meeting of the Compensation Committee held in September of each year, following the public announcement of our financial results for the prior year. We set the exercise price of all stock options to equal the closing price of our common stock on NASDAQ Global Market on the date of grant.

Benefits and Other Compensation

We maintain broad-based benefits that are provided to all employees, including health and dental insurance, life and disability insurance, a 401(k) plan and an Employee Stock Purchase Plan. Executives are eligible to participate in all of our employee benefit plans, in each case on the same basis as other employees. Under the 401(k) plan, the Company contributes an amount equal to half of each participating employee’s contribution, up to a maximum of six percent of such employee’s base salary.

Severance and Change-of-Control Benefits

Pursuant to change-of-control employment agreements we have entered into with our executives and our stock option plans, including our 2004 Stock Plan, our executives are entitled to specified benefits in the event of the termination of their employment under specified circumstances, including termination following a change-of-control of our company. We believe providing these benefits helps us compete for executive talent.

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We have provided more detailed information about these benefits, along with estimates of their value under various circumstances, under the caption “—Potential Payments Upon Termination or Change-of-Control” below.

Our practice in the case of change-of-control benefits has been to structure these as “double trigger” benefits. In other words, the change-of-control does not itself trigger benefits; rather, benefits are paid only if the Company terminates the executive’s employment (other than for cause, death or disability) or if the executive terminates for good reason during the three year period after the change-of-control or for any reason during the 30 day period following the first anniversary of the change-of-control (or upon certain terminations prior to a change-of-control or in connection with or in anticipation of a change-of-control). We believe a “double trigger” benefit maximizes shareholder value because it provides executives appropriate incentives to cooperate in negotiating any change-of-control in which they believe they may lose their jobs. The Committee believes that these change-of-control Agreements are a part of a competitive compensation package and will assist in the retention of critical talent if a possible or actual change-of-control should arise. It is important in a change-of-control to retain executive talent both to assist in the completion of the transaction and to be able to deliver all or a specified member of the management to an acquirer if that is a condition of closing.

As shown in the table below under the heading “Estimated Payments on Change-of-Control,” the Company will make an additional payment to the named executive officers to insulate them from the impact of excise taxes due under Section 280G and 4999 of the Internal Revenue Code (IRC). The effects of Sections 280G and 4999 generally are unpredictable and can have widely divergent and unexpected effects based on an executive’s personal compensation history. Therefore, to provide a predictable and equal level of benefit across individuals without regard to the effect of the excise tax, the Company determined that it was appropriate to pay the cost of this excise tax plus an amount needed to pay income taxes due on such additional payment. This practice is consistent with competitive pay packages and ensures the executive will receive the two years base salary and annual cash incentive bonus less only ordinary taxes on that amount.

Tax and Accounting Considerations

Deductibility of Executive Compensation

Section 162(m) of the Internal Revenue Code (the “Code”) imposes limitations on the deductibility for federal income tax purposes of compensation over $1 million paid to certain executive officers in a taxable year. Compensation above $1 million may only be deducted if it is “performance-based compensation” within the meaning of the Code. Income from options granted under the Company’s stock option plan would generally qualify for a deduction under these restrictions. Income from RSUs with time-based vesting will not qualify for a deduction under these restrictions but income from performance-based RSUs is intended to qualify. The Compensation Committee believes that at the present time it is unlikely that the salary and bonus compensation paid to any executive officer in a taxable year that is subject to the deduction limit will exceed $1 million. However, it is possible that the vesting of RSUs in the future could cause a payment that is subject to the deduction limit. In addition, based on the terms of the 2004 Stock Plan, no employee may receive in any fiscal year awards to purchase in excess of 500,000 shares. The Compensation Committee intends to continue to evaluate the effects of the Code and any Treasury regulations and the advisability of qualifying its executive compensation for deductibility of such compensation. The Compensation Committee’s policy is to qualify its executive compensation for deductibility under applicable tax laws to the extent practicable.

Accounting for Stock-Based Compensation

The Company has expensed stock option grants under FASB Statement No. 123(R), Share-Based Payment , (“FAS No. 123(R)”) beginning in 2006. FAS No. 123(R) requires companies to include the fair value of equity compensation as a compensation expense in their income statements. In 2004, the Company adopted the 2004 Stock Plan, in part to give it the flexibility to grant such other forms of equity-based compensation to enable it to control compensation expense, as deemed appropriate.

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SUMMARY COMPENSATION TABLE

The following table sets forth certain information with respect to compensation of the Company’s Chief Executive Officer, Chief Financial Officer and the Company’s other most highly compensated executive officer who was serving as an executive officer at the end of fiscal 2007 (such persons are sometimes collectively referred to herein as the “named executive officers”). During fiscal 2007, we did not have any other persons serving as executive officers whose total compensation exceeded $100,000.

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NONQUALIFIED DEFERRED COMPENSATION FOR FISCAL 2007

Since 2001 the Company had maintained a nonqualified deferred compensation plan pursuant to which select highly compensated employees could elect to defer salary for retirement saving and tax planning. The Company has not made contributions to the plan since the plan was established. Effective December 31, 2006, the Company terminated its nonqualified deferred compensation plan due to low participation rates and to save administrative costs. Pursuant to the termination, the accumulated balances are being distributed in two installments, in January 2007 and January 2008. The following table sets forth information concerning the nonqualified deferred compensation plan for fiscal 2007 for each of the named executive officers.

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POTENTIAL PAYMENTS UPON TERMINATION OR CHANGE-OF-CONTROL

The Company has entered into change-of-control employment agreements with each of the named executive officers. The change-of-control employment agreements have three year terms, which terms extend for one year upon each anniversary unless a notice not to extend is given by the Company.

Under these agreements, if a change-of-control of the Company occurs during the term of an agreement, then the agreement becomes operative for a fixed three year period. The agreements provide generally that the executive’s terms and conditions of employment (including position, location, compensation and benefits) will not be adversely changed during the three year period after a change-of-control of the Company. If the Company terminates the executive’s employment (other than for cause, death or disability) or if the executive terminates for good reason during such three year period or for any reason during the 30 day period following the first anniversary of the change-of-control (or upon certain terminations prior to a change-in-control or in connection with or in anticipation of a change-of-control), the executive is entitled to receive severance compensation.

The terms “change-of-control,” “cause,” and “good reason” are each defined in the agreements. Change-of-control means, in summary: the acquisition by a person or group of 20% or more of the outstanding stock of LTX; a change, without Board of Directors approval, of a majority of the Board of Directors; consummation of a reorganization merger, consolidation or asset sale, except where stockholders of the Company receive 50% or more of the stock of the resulting company, at least a majority of the Board of the resulting company were on the Board of LTX prior to the transaction and after which no stockholder owns 20% or more of the stock of the resulting company which did not own such stock immediately prior to the transaction; or the approval of a liquidation or dissolution of LTX. Cause means, in summary: the executive’s willful and continue failure to substantially perform his reasonable assigned duties, which failure continues after written notice; or the executive’s willful engagement in illegal conduct or gross misconduct injurious to LTX. Good reason means, in summary: a diminution on the executives’ position, authority or responsibilities; a reduction in his salary or benefits; a relocation of the executive; a breach of an employment contract with the executive; or a resignation by the executive, for any reason, during the 30-day period immediately following the one-year anniversary of the change-of-control.

If severance compensation is payable under an agreement, the named executive would receive a lump sum cash payment paid within 30 days of termination equal to the sum of (a) the Company’s accrued obligations for base pay and prorated bonus through the date of termination based upon the higher of the bonus paid in the last fiscal year or the average of the highest bonus paid in two of the last three fiscal years (the “Highest Annual Bonus”) and (b) an amount equal to two times the executive’s then base salary and Highest Annual Bonus. Additionally, the executive would also receive continued health benefits for two years and outplacement services.

In the event such severance is payable, the stock plans and award agreements provide that all unvested RSUs will become vested in full. In the event of a change-of-control, regardless of whether or not the executives employment is terminated, unvested options shown above in the table under “Outstanding Equity Awards at Fiscal 2007 Year-end” held by the executive will become vested in full until termination or expiration in accordance with their terms.

Under the change-of-control agreements, the Company also agrees to reimburse the executive for any excise tax due on severance compensation including any additional federal, state and local income tax consequences, as a result thereof.

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The following table describes the potential payments, benefits and value of acceleration of vesting applicable to stock options and RSUs pursuant to the change-of-control employment arrangements with each of the named executive officers, assuming that a qualifying termination of employment occurred on July 31, 2007. Actual amounts payable to each executive listed below upon his termination can only be determined definitively at the time of each executive’s actual departure.

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