ZILG Zilog (MM)

Inventories are stated at the lower of cost (which approximates actual cost on a first-in, first-out basis) or market. Provisions, when required, are made to reduce inventory values from cost to their estimated net realizable values. It is possible that estimates of net realizable value can change in the short-term. Inventory reductions for excess or obsolete inventory are released only upon sale, scrap or other disposition of the reduced inventory. Inventories, net of provisions, consist of the following (unaudited, in thousands):

Stock-based compensation. The Company has a stock-based compensation program that includes non-statutory stock option awards and restricted stock awards ("RSAs"). Stock options are generally time-based, vesting 25% on the first anniversary of the grant-date and monthly thereafter over the next three years and expire ten years from the grant-date. As of December 26, 2009, the Company had 2,361,700 shares available for grant under all plans.

Additionally, the Company has an Employee Stock Purchase Plan ("ESPP") that allows employees to purchase shares of common stock at 85% of the fair market value at the lower of either the date of enrollment or the date of purchase. In addition to the shares available for issuance under the stock option and restricted stock plans , the Company had approximately 918,817 shares of common stock reserved for future issuance under its ESPP plan as of December 26, 2009.

The Company records stock-based compensation in accordance with the provisions of FASB ASC 718 "Compensation — Stock Compensation" which establishes valuation and accounting resulting in the Company's recognition of expense related to the fair value of its stock-based compensation awards.

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During the three and nine month periods ended December 26, 2009, the Company recorded $0.3 million and $0.7 million, respectively, in stock compensation expense for continuing operations which includes the applicable compensation expenses for the Company's fiscal 2010 employee stock incentive plan. In comparison, during the three and nine month periods ended December 27, 2008, the Company recorded $0.5 million and $1.1 million, respectively, in stock compensation expense for continuing operations, which included the applicable compensation expenses for the Company's fiscal 2009 stock incentive plan.

The following table sets forth the total non-cash stock-based compensation expense resulting from equity plans and incentive programs included in the Company's unaudited condensed consolidated statements of operations (unaudited, in thousands)

The fair value of stock-based awards expense resulting from equity plans was estimated on the date of grant using the Black-Scholes valuation pricing model with the following weighted-average assumptions:

The computation of expected volatility for the three and nine months ended December 26, 2009 and December 27, 2008 is based on historical implied volatility. The computation of expected life is based on a combination of historical and expected exercise patterns. The interest rate for periods within the contractual life of the award is based on the U.S. Treasury yield curve in effect at the time of grant.

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Stock option activity for the nine months ended December 26, 2009, is as follows (unaudited):

The aggregate intrinsic value in the table above represents the total pretax intrinsic value, that is, the difference between the Company's closing stock price on the last trading day of the period and the exercise price times the number of shares that would have been received by the option holders had all option holders exercised their options on December 26, 2009. This amount will change based on fluctuations of the fair market value of the Company's stock. The total intrinsic value of options vested and expected to vest, including current forfeiture rates, is approximately $318,600 at December 26, 2009.

There were no stock option exercises during the nine months ended December 26, 2009. The weighted-average exercise price of options granted for the nine months ended December 26, 2009 and December 27, 2008 was $2.35 and $3.37 per share, respectively.

No income tax benefit was realized from stock option exercises during the three and nine months ended December 26, 2009 and December 27, 2008. In accordance with FASB ASC 718 "Compensation - Stock Compensation", the Company presents excess tax benefits from the exercise of stock options, if any, as financing cash flows rather than operating cash flows.

As of December 26, 2009, $620,000 of total unrecognized compensation costs related to stock options is expected to be recognized over a weighted-average remaining period of 1.69 years. The total unrecognized compensation cost related to restricted shares granted as of December 26, 2009 is $240,000, is expected to be recognized over a weighted-average remaining period of 1.35 years.

The components of special charges and credits are as follows (unaudited, in thousands):

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During the three and nine months ended December 26, 2009 the Company incurred special charges of $0.6 million and $0.8 million, respectively. These charges primarily include $0.5 million in legal costs and expenses associated with a definitive merger agreement with IXYS Corporation signed on December 5, 2009. Additionally, special charges included costs and expenses associated with the Company's consolidation activities following the sale of the discontinued operations. These charges include facility lease costs, supplier commitment expenses as well as remaining severance and other costs related to the Company's workforce reductions in December 2008 and January 2009 which actions were associated with lower demand and sales affected by the global economic crisis.

During the three and nine months ended December 27, 2008, the Company incurred $1.7 million and $2.8 million, respectively, in special charges. Special charges include severance and other costs related to the Company's test outsourcing activities.

The following table summarizes activity in accrued special charges which is included in other accrued liabilities on the condensed consolidated balance sheets (unaudited, in thousands):

Segment Information . The Company's business is comprised of one operating segment. The Company engages primarily in the design, development, manufacture and marketing of semiconductor products. The Company sells its products to distributors and direct customer accounts including original equipment manufacturers ("OEMs") and original design manufacturers ("ODMs") in a broad range of market segments. The Company's operations outside the United States consist of a test development and global support facility in the Philippines as well as sales and support centers in certain foreign countries. U.S. domestic operations are responsible for the design, development and marketing of the Company's products. The Philippine activity and support is reimbursed in relation to its value added with respect to test development and global support functions performed, and certain foreign sales offices receive a commission on export sales within their territory. Accordingly, for financial statement purposes, it is not meaningful to segregate sales or operating profits for the global support and foreign sales office operations.

The following table summarizes the Company's net sales by region and by channel (unaudited, in thousands):

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Major customers: For the three months ended December 26, 2009, one distributor accounted for greater than 10 percent of the Company's total net sales from continuing operations. The distributor accounted for approximately 48 percent of total net sales from continuing operations during the three months ended December 26, 2009.

For the nine months ended December 26, 2009, two distributors and one customer each individually accounted for greater than 10 percent of the Company's total net sales from continuing operations. The two distributors and one customer accounted for approximately 43 percent, 11 percent, and 10 percent respectively, of total net sales from continuing operations.

For the three months ended December 27, 2008, three distributors each individually accounted for greater than 10 percent of the Company's total net sales. The distributors accounted for approximately 40 percent, 17 percent and 10 percent of total net sales from continuing operations, respectively.

For the nine months ended December 27, 2008, three distributors accounted for greater than 10 percent of the Company's total net sales from continuing operations. The distributors accounted for 42 percent, 12 percent and 10 percent of total net sales from continuing operations, respectively.

On August 11, 2005, Microchip Technology, Inc. ("Microchip") filed a patent infringement claim against the Company in the U.S. District Court of Arizona (case number CV05-2406-PHX-MHM). Microchip alleges that the Company has infringed, and currently infringes, its patents numbered 5,847,450, 6,696,316 and 6,483,183. Microchip claims that unspecified products of the company, including the Z8 Encore! XP 4K Series of products, infringe these patents and is seeking preliminary and permanent injunctive relief, unspecified damages and costs, including attorneys' fees. The Company filed a response to the claims on September 15, 2005 generally denying the claims and challenging the validity of the patents. On January 10, 2006, the Company filed a request for patent re-examination with the U.S. PTO, which was granted in February and March 2006 for all 3 patents. On April 11, 2008, the Company received a notice that all of Microchip's claims under these three patents have been rejected by the U.S. PTO. After this favorable ruling, Microchip filed appeal notices in the U.S. PTO in May 2008. The Company does not believe it is feasible to predict or determine the outcome or resolution of this litigation at this time. The Company believes it has meritorious defenses and will defend itself against these claims vigorously. The Company may incur substantial expenses in its defense against these claims. In the event of a determination adverse to the Company, it may incur substantial monetary liabilities and be required to change its business practices. Either of these could have a material adverse effect on its financial position, results of operations and/or cash flows.

On December 22, 2009, a plaintiff filed a putative class action entitled Louise Garcia v. Darin Billerbeck et al ., Case No. 1-09-CV-159955, in the Superior Court of the State of California, Santa Clara County. The defendants are ZiLOG, and the members of our board of directors (together with ZiLOG, the "ZiLOG Defendants"), IXYS, and Merger Sub (together with IXYS, the "IXYS Defendants"). This action alleges that the individual defendants breached their fiduciary duties to our stockholders in connection with the merger agreement and the transactions contemplated thereby. Specifically, the complaint alleges, among other things, that the proposed transaction arises out of a flawed process, that the individual defendants failed to maximize shareholder value and that the consideration offered in the merger is inadequate and does not fairly reflect our true value. The plaintiff also alleges that the individual defendants agreed to no-solicitation and termination provisions in the merger agreement in order to prevent any potential suitors from making competing proposals. The suit further alleges that we and the IXYS Defendants aided and abetted the individual defendants' breaches of fiduciary duties. The plaintiff seeks, among other things, an order enjoining the ZiLOG Defendants and the IXYS Defendants from consummating the merger, damages in the event the merger is consummated prior to the court's entry of a final judgment, and attorneys' fees.

On December 30, 2009, the plaintiff in this suit filed a first amended complaint, repeating the allegations in her original complaint and adding allegations that the individual defendants are engaged in self-dealing in connection with the merger because they will receive accelerated vesting of certain benefits and/or have change-of-control

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agreements that will be triggered upon consummation of the merger. The plaintiff also alleges that the preliminary proxy statement filed by us on Schedule 14A on December 29, 2009 contains misleading disclosures and/or omits material information.

On January 19, 2010, the defendants removed the action to the United States District Court for the Northern District of California. On January 27, 2010, the plaintiff filed a second amended complaint, repeating the allegations of her earlier two complaints and adding a claim that the individual defendants violated Section 14(a) of the Securities Exchange Act of 1934 and Rule 14a-9 promulgated thereunder by issuing an allegedly misleading preliminary proxy statement. On January 28, 2010, the plaintiff filed a purported "ex parte" application for expedited discovery and for an order shortening time to be heard on a motion for a preliminary injunction to stop the shareholder vote on the proposed merger. On February 1, the court advised plaintiff that her application did not comply with the court's rules and directed plaintiff to submit her request for relief in the proper form. Later that day, plaintiff filed a motion for expedited discovery and proceedings. Concurrently with the filing of her motion for expedited discovery and proceedings, plaintiff filed a motion for an order shortening time. The motion for an order shortening time asks the court to hear plaintiff's motion for expedited discovery and request for a preliminary injunction before the February 17, 2010 vote of shareholders on the proposed merger. Defendants' responses to plaintiff's motions for an order shortening time and for expedited discovery and proceedings are not yet due. Also on February 1, 2010, the ZiLOG Defendants filed a motion to strike plaintiff's second amended complaint and to dismiss her first amended complaint.

We believe that this action is wholly without merit and intend to defend vigorously against it. However, because this case is in the early stages, we cannot predict the outcome at this time, and we cannot be assured that the action will not delay the consummation of the merger or result in substantial costs; even a meritless lawsuit may potentially delay consummation of the merger.

On January 4, 2010, a putative class action entitled Mark C. Reppa v. ZiLOG, Inc. et al., Case No. 5186-VCL was filed in the Court of Chancery of the State of Delaware against the ZiLOG Defendants and the IXYS Defendants. This action alleges that the individual defendants breached their fiduciary duties to our stockholders in connection with the merger. Specifically, the complaint alleges, among other things, that the proposed transaction arises out of a flawed process, that the individual defendants failed to maximize shareholder value and that the consideration offered in the merger is inadequate and does not fairly reflect the true value of us. The plaintiff also alleges that the individual defendants agreed to no-solicitation and termination provisions in the merger agreement and entered into support agreements, pursuant to which they have agreed to vote in favor of the merger, in order to prevent any potential suitors from making competing proposals. The suit further alleges that we and the IXYS Defendants aided and abetted the individual defendants' breaches of fiduciary duties. The plaintiff seeks, among other things, an order enjoining the ZiLOG Defendants and the IXYS Defendants from consummating the merger, damages in the event the merger is consummated prior to the court's entry of a final judgment, and attorneys' fees.

On January 11, 2010, the ZiLOG Defendants filed a motion for judgment on the pleadings and a brief in support, seeking to dismiss this action in its entirety. On January 21, 2010, the court directed the parties to confer on a schedule for completion of briefing and hearing on the ZiLOG Defendants' motion. On January 27, 2010, the IXYS Defendants filed a notice of motion to dismiss the action. Thereafter, plaintiff agreed to voluntarily dismiss the action, and the parties submitted a stipulation and proposed order dismissing the action with prejudice to the named plaintiff and without prejudice to the putative class. On February 2, the court entered the order dismissing the case.

The Company is participating in other litigation and responding to other claims arising in the ordinary course of business. The Company intends to defend itself vigorously in these matters. The Company's management believes that it is unlikely that the outcome of these matters will have a material adverse effect on the Company's financial statements, although there can be no assurance in this regard.

From time to time the Company has agreed to indemnify and hold harmless certain customers for potential allegations of infringement of intellectual property rights and patents arising from the use of its products. During the ordinary course of business, in certain limited circumstances, the Company has agreed to reimburse the indemnified party for losses suffered or incurred by the indemnified party, generally parties with which the Company has commercial relations, in connection with certain intellectual property infringement claims by any third party with

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respect to its products and services. The Company has an indemnification arrangement that limits its net contingent obligation to pay for defense costs, if any, up to a maximum of $2 million. In addition, the Company has agreed to indemnify the purchaser of the Company's remote control and secured transaction processor business for certain liabilities and have remaining $1.55 million in escrow to cover such indemnification obligations. This escrow amount is scheduled to be released in February 2010. To date, there have not been any costs incurred in connection with such indemnification arrangements; therefore, there is no accrual of such amounts at December 26, 2009. The Company discloses indemnification liabilities according to FASB ASC 460 "Guarantees". Under FASB ASC 450 "Contingencies", a claim would be accrued when a loss is probable and the amount can be reasonably estimated. At December 26, 2009, no such amounts are accrued.

In connection with the lease in July 2007 for its corporate headquarters located in San Jose, California, the Company established an Irrevocable Letter of Credit in the amount of $0.3 million with its bank.

The Company adopted the provisions of FASB ASC 740 "Income Taxes" as they relate to the accounting for the uncertainty in income taxes effective April 1, 2007. In connection with the adoption, the Company has analyzed filing positions in all of the federal and state jurisdictions where it is required to file income tax returns, as well as all open tax years in these jurisdictions.

As of December 26, 2009, the total amount of unrecognized tax benefits was approximately $5.6 million of which $4.6 million is recorded as a deferred tax asset that is fully offset by a valuation allowance and $1.0 million which if recognized would affect the Company's effective tax rate. The calculation of unrecognized tax benefits involves dealing with uncertainties in the application of complex global tax regulations. Management assesses the Company's tax positions in light of legislative, bilateral tax treaty, regulatory and judicial developments in the countries in which the Company operates.

A valuation allowance is required to be recorded if in management's judgment, based on available evidence, it is more likely than not that some portion or all of the deferred tax assets will not be realized.  Based on available evidence, management has concluded that a valuation allowance is necessary to reduce the net deferred tax asset.  Accordingly, deferred tax assets have been recognized only to the extent of deferred tax liabilities.

The Company's operations are subject to income and transaction taxes in the United States and in multiple foreign jurisdictions.  Significant estimates and judgments are required in determining its worldwide provision for income taxes.  Some of these estimates are based on interpretations of existing tax laws or regulations and as a result the proper amount of tax liability may be uncertain. 

The Company is subject to taxation in the United States and various states and foreign jurisdictions. There are no ongoing examinations by taxing authorities at this time. The Company's various tax years beginning in fiscal 2001 through fiscal 2010 remain open in various taxing jurisdictions.

During the three and nine months ended December 26, 2009, the Company's income tax provision was $0.04 million and $0.1 million, respectively, which primarily reflects provisions for taxes in certain profitable foreign jurisdictions. During the three and nine months ended December 27, 2008, the Company's income tax provision was $0.1 million and $0.2 million, respectively, which primarily reflects amortization of deferred charges and provisions for taxes in certain profitable foreign jurisdictions.

The Company provides for income tax expense in foreign jurisdictions where its foreign subsidiaries operations generate profits that are taxable. The Company's income tax expense reflects the estimated annual effective tax rate at that time based on projections of operations. Tax authorities may challenge the allocation of profits between the Company's subsidiaries and may challenge certain tax benefits claimed on its tax returns, and the Company may not prevail in any such challenge.  If the Company were not to prevail, it could be subject to higher tax rates or lose certain tax benefit that could result in a higher tax rate.

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NOTE 14. RETIREMENT AND BENEFIT PLANS

U.S. 401(k) retirement plan: The Company has an employee savings plan that qualifies as a deferred salary arrangement under Section 401(k) of the Internal Revenue Code (the "401(k) Plan"). Under the 401(k) Plan, participating U.S. employees may defer a portion of their pretax earnings, up to the Internal Revenue Service annual contribution limit. The Company may make matching contributions on behalf of each participating employee in an amount equal to 100% of the participant's deferral contribution, up to 1.5% of the participant's compensation on a quarterly basis. The Company may also make additional discretionary contributions to the 401(k) Plan. Matching contributions to the 401(k) Plan were less than $0.1 million for the nine months ended December 26, 2009 and the nine months ended December 27, 2008, respectively. There were no discretionary contributions made in the nine months ended December 26, 2009 and the nine months ended December 27, 2008, respectively.

Philippine defined benefit plan: The Company's Philippines subsidiary maintains a defined benefit pension plan for local employees, which is consistent with local statutes and practices. The Company has adopted the provisions of FASB ASC 715 "Compensation - Retirement Benefits". As of December 26, 2009 based on the Plan's actuarial report, the pension plan was over-funded by approximately $350,000 which is classified as other assets on the consolidated balance sheet. During the nine months ended December 26, 2009, the net periodic benefit costs were not material.

The following table presents the calculation of basic and diluted net loss per share of common stock for the periods indicated (in thousands, except per share data):

At December 26, 2009, and December 27, 2008, options to purchase 1.5 million and 2.0 million shares of common stock, respectively, are excluded from the determination of diluted net income (loss) per share, as the effect of such shares is anti-dilutive.

For the three and nine months ended December 26, 2009, 9,851 and 1,060 shares, respectively, were calculated as dilutive using the treasury stock method of computation. For the three and nine months ended December 27, 2008, no shares were calculated as dilutive.

The Company has evaluated all events or transactions that occurred after December 26, 2009 through the filing date of this document and did not have any material subsequent events.

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Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations

Our actual results may differ materially from those anticipated in these forward-looking statements as a result of various factors including those set forth in the section entitled "Risk Factors" in our Form 10-K for the year ended March 31, 2009 and in other sections of this quarterly report.

The following is management's discussion and analysis of financial condition and results of our operations and those of our subsidiaries for the fiscal three-month and nine-month periods ended December 26, 2009 (fiscal 2010) and December 27, 2008 (fiscal 2009). This discussion and analysis should be read in conjunction with the unaudited condensed consolidated financial statements and notes thereto included elsewhere herein and in our fiscal 2009 annual report on Form 10-K. Management's discussion and analysis provides information concerning our business environment, consolidated results of operations and liquidity and capital resources.

Our fiscal year ends on March 31 with interim results based on fiscal quarters of approximately thirteen weeks in duration ending on the closest Saturday to each calendar quarter end, with the exception of the fourth quarter, which ends on March 31.  The operating results for any interim period are not necessarily indicative of results for any subsequent period or the full fiscal year.

On July 24, 2008, we announced that we were evaluating a broad range of strategic alternatives to enhance stockholder value and that we had retained Oppenheimer as our financial advisor to assist our board of directors with this process.

During fiscal 2009, we experienced a significant reduction in sales reflecting lower demand for product and the global worldwide recession. Associated with the strategic alternatives review process, and in anticipation of continued contraction in the market place, on February 18, 2009, we sold our universal remote control and secured transaction processor businesses to Maxim and UEI. The total consideration received was approximately $31 million in cash of which $3.1 million was held in escrow and classified as deferred revenue. The escrow amount was to satisfy any losses incurred by Maxim or UEI that may result from inaccuracies in our representations and warranties in the acquisition agreement or our failure to fulfill certain obligations in the acquisition agreement. The escrow was scheduled to be released 50 percent on August 16, 2009 or $1.55 million, which has been received and recorded as gain on sale of discontinued operations for the nine months ended December 26, 2009 and the remaining 50 percent is scheduled to be received on February 18, 2010. A gain on the sale of the businesses of $21.6 million was recorded in the twelve months ended March 31, 2009. In accordance with FASB ASC 205 "Presentation of Financial Statements" and FASB ASC 360-10-05 "Impairment or Disposal of Long Lived Assets", the assets and liabilities, results of operations and cash flows related to the sale businesses, have been classified as discontinued operations in the condensed consolidated financial statements for all periods presented. Cash flows associated with the discontinued operations have been segregated in the condensed consolidated statements of cash flows as separate line items within operating, investing and financing activities. As a result, our historical financial statements have been restated to exclude assets, liabilities and results of operations and cash flows related to the sale business which are reflected as discontinued operations. Restatement of these balances may make reconciliation or reference to previously filed financial statements difficult.

In May 2009 the Company was again contacted by representatives of IXYS Corporation (IXYS) to discuss a merger of the Company with IXYS. On December 5, 2009, the Company signed a definitive merger agreement (Merger Agreement) with IXYS whereby IXYS agreed to acquire all of the outstanding shares of the Company for $3.5858 per share in cash. A preliminary proxy statement regarding the merger was filed with the SEC on December 29, 2009. The definitive proxy statement regarding the merger was filed with the SEC on January 15, 2010. A special meeting of the Company's shareholders has been scheduled for February 17, 2010, to ratify and approve the merger. The meeting will be held at Zilog's headquarters at 6800 Santa Teresa Blvd., San Jose, CA 95120 at 9:00 a.m. local time.

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Critical Accounting Estimates

Our critical accounting policies are disclosed on pages 32-34 of the Annual Report on Form 10-K for the fiscal year ended March 31, 2009 and have not changed materially as of December 26, 2009.

On an on-going basis, we evaluate our estimates and assumptions, including those related to sales returns, allowance for doubtful accounts, inventory write-downs, asset impairments, stock-based compensation expense and deferred taxes. We base our estimates on historical trends and various other assumptions that we believe to be reasonable at the time the estimates are made. Actual results could differ from those estimates. The Company's critical accounting estimates are described in detail in our Form 10-K for the 2009 fiscal year ended March 31, 2009, filed on June 29, 2009.

We conduct our business in one reportable segment to reflect the manner in which our chief operating decision-maker allocates resources and assesses the performance of our business.

Our net sales by region and by channel are summarized for each period indicated, as follows (unaudited, in thousands):

Other key indices relevant in understanding our business and financial performance include the following metrics (unaudited):

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We calculate each of these key metrics based on annualized quarterly results of operations data and balance sheet data as of the end of the period indicated. Each of these key metrics is described below:

Days sales outstanding, DSO, is a common metric used to analyze how quickly our customers pay us. This metric is influenced largely by the timing of our customer billings, collections, and individual payment terms. At December 26, 2009, our DSO was 33 days as compared to 28 days at December 27, 2008. The increase in DSO is largely due to the growth of our shipments for the December 2009 quarter as a result of higher new order levels from higher demand resulting in higher receivables on a percentage basis versus the comparable quarter a year ago.

Net sales to inventory ratio is a metric we use to analyze how quickly our investment in inventories is recovered by our sales and is calculated by dividing ending inventory into sales for the quarter annualized. This metric may not be comparable to other companies who use inventory ratios to analyze inventory and is not the same as a typical inventory turns ratio. Our net sales to inventory ratio increased to10.6 from 8.0 in the fiscal quarter ended December 26, 2009 compared to the fiscal quarter ended December 27, 2008 reflecting lower inventory levels versus the sales level.

Current ratio represents current assets divided by current liabilities and is commonly used to assess a company's liquidity. We use this ratio to make spending determinations on discretionary items. Our current ratio as of December 26, 2009 was 3.0, an increase from 1.5 as of December 27, 2008. This increase is primarily due to an increase in cash and cash equivalents including the proceeds from the sale of our remote control and secured transaction businesses as well as the increase in our ending accounts receivable, redemptions of our ARPS which are reclassified from long-term investments to cash and cash equivalents, reduction in short term liabilities related to short term loans and the decline in deferred income on shipments to our distributors as their inventory levels decreased, offset by decreases in current assets related to discontinued operations.

Net Sales . Net sales from continuing operations were $8.7 million for the fiscal quarter ended December 26, 2009, as compared to net sales from continuing operations of $9.0 million for the fiscal quarter ended December 27, 2008.

Our net sales declined 4 percent for the fiscal quarter ended December 26, 2009, as compared to the fiscal quarter ended December 27, 2008, reflecting the impact of the recessionary trends in the worldwide economy that affected the demand for our products both regionally and within market applications including consumer and industrial type products. The decline reflects a reduction in sales of our embedded flash products partially offset by an increase in our classic microcontroller products. The embedded flash decline in the quarter reflects lower demand generally for consumer products versus year ago levels. The increase in classic was broad based and reflective of a general increase in consumer and industrial applications On a year on year basis for the quarter royalties received on licensed products increased driven by an increase in the overall sales volume of licensed products. These royalties were $0.8 million or approximated 5 cents per share for the three months ended December 26, 2009 as compared to $0.6 million or approximately 4 cents per share in the comparable quarter a year ago.

Gross Margin . Cost of sales primarily represents manufacturing costs relating to wafer fabrication, package assembly, product testing operations and logistics costs. Cost of sales fluctuates, depending on materials and services prices from our vendors, manufacturing productivity, product mix, equipment utilization and depreciation. Gross margin as a percent of net sales was 49.7 percent of sales for the fiscal quarter ended December 26, 2009 as compared to gross margin percent of 32.6 percent for the fiscal quarter ended December 27, 2008. The increase in gross margin percent of sales reflects higher sales mix of higher margin classic products and improvements in margins of our embedded flash products. Additionally, margins improved as a result of lower supplier costs savings from consolidation and rationalization activities and higher licensing royalties.

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Selling, General and Administrative Expenses. Selling, general and administrative expenses related to continuing operations decreased to $2.3 million for the fiscal quarter ended December 26, 2009 from $4.7 million for the fiscal quarter ended December 27, 2008. Spending on sales and marketing as well as general and administrative costs decreased reflecting savings from the significant workforce reduction and consolidation implemented in December 2008 and January 2009. We have also streamlined our global distribution and sales representation support activities, reduced and refocused our marketing activities including trade shows and advertising, and streamlined third party consulting activities in line with global demand.

Special Charges and Credits . Special charges and credits for the periods indicated were as follows (unaudited, in thousands):

During the fiscal quarter ended December 26, 2009, special charges totaled $0.6 million, including $0.5 million in legal costs associated with the definitive merger agreement with IXYS. Additionally, special charges included costs and expenses associated with our consolidation activities following the sale of the discontinued operations.

For the fiscal quarter ended December 27, 2008, special charges totaled $1.7 million that included costs associated with our workforce reduction implemented in December, 2008 and January, 2009 of $1.2 million. Additionally, special charges included ongoing costs related to our strategic alternatives review of $0.3 million and manufacturing test operations outsource activities of $0.2 million.