FSL

Freescale Semiconductor Inc.

With over 50 years of operating history, Freescale is a leader in the design and manufacture of embedded processors. We are based in Austin, Texas and have design, research and development, manufacturing and sales operations around the world. We generated $3.5 billion in revenue for the year ended December 31, 2009.

Our largest end-markets are the automotive and networking markets, but we also provide products to both industrial and consumer electronics markets. In each of our markets, we offer families of embedded processors. In their simplest forms, embedded processors provide the basic intelligence for electronic devices and can be programmed to address specific applications or functions. Examples of our embedded processors include microcontrollers, digital signal, applications and communications processors.

In addition to our embedded processors, we offer our customers a broad portfolio of complementary devices that provide connectivity between products, across networks and to real-world signals, such as sound, vibration and pressure. Our complementary products include sensors, radio frequency semiconductors, power management and other analog and mixed-signal integrated circuits. Through our embedded processors and complementary products, we also offer customers complex combinations of semiconductors with software, which we refer to as “platform-level products.” We believe that our ability to offer platform-level products will be increasingly important to our long-term success in many markets within the semiconductor industry as our customers continue to move toward providers of embedded processors and complementary products.

Freescale was incorporated in Delaware in 2003. In the second quarter of 2004, Motorola, Inc. (“Motorola”) transferred substantially all of its semiconductor businesses’ assets and liabilities to Freescale (the “Contribution”) in anticipation of an initial public offering (“IPO”) of Freescale Class A common stock. The IPO was completed on July 21, 2004. Prior to the IPO, Freescale was a wholly owned subsidiary of Motorola. All of the Freescale Class B shares of common stock were held by Motorola until Motorola distributed its remaining ownership interest in us by means of a special dividend to its common stockholders (the “Distribution”) on December 2, 2004 (the “Distribution Date”).

On December 1, 2006, Freescale was acquired by a consortium of private equity funds (the “Merger”). The consortium includes The Blackstone Group, The Carlyle Group, funds advised by Permira Advisers, LLC, TPG Capital and others (collectively, the “Sponsors”). The acquisition was accomplished pursuant to the terms of an Agreement and Plan of Merger entered into on September 15, 2006 (the “Merger Agreement”). Pursuant to the terms of the Merger Agreement, Freescale became an indirect subsidiary of Freescale Semiconductor Holdings I, Ltd. (“Holdings I”) which in turn is a direct subsidiary of Freescale Holdings, L.P., a Cayman Islands limited partnership (“Parent”), an entity controlled by the Sponsors. Holdings I is a Bermuda exempted limited liability company and was organized in 2006. Additional information regarding Freescale can be found on our website at www.freescale.com.

Our Industry

Cyclicality of Semiconductor Industry and Current Business Conditions

Our business is highly dependent on demand for electronic content in automobiles, networking and wireless infrastructure equipment and other electronic devices. Historically, the relationship between supply and demand in the semiconductor industry has caused cyclicality in the market, characterized by technological change, product obsolescence, price erosion, evolving standards and fluctuations in product supply and demand. The industry has experienced downturns, often in connection with, or in anticipation of, maturing product cycles of both semiconductor companies’ and their customers’ products and declines in general economic conditions. These downturns can lead to diminished product demand, production overcapacity, higher inventory levels and accelerated erosion of average selling prices. We have historically experienced adverse effects on our profitability and cash flows during such downturns.

In the second half of 2008 and continuing into 2009, the semiconductor industry experienced a downturn driven by overall weakness in global macroeconomic demand for semiconductor products. We experienced lower revenues and profitability, as well as lower factory utilization because of the downturn in general and our position as an electronic content provider to the automotive industry, which experienced significant declines in demand in 2009 compared to peak levels.
In response to these economic pressures, we executed a series of strategic investment and cost reduction actions in late 2008 and 2009 to sharpen our strategic focus on growth markets and key market leadership positions where we anticipate above market growth opportunities over the long term. Specifically, during 2009, we executed actions to align our cost structure with our prior decision to wind-down our cellular handset business. We also announced the initiation of a plan to exit our remaining 150mm manufacturing capability in Sendai, Japan and Toulouse, France as well as finalized the closure of our 150mm manufacturing capability in East Kilbride, Scotland because of a general migration away from 150mm technologies and products to more cost-effective advanced technologies and products.

Going forward, we intend to focus our resources on our core automotive and networking products, as well as targeted opportunities in various industrial and consumer electronics markets. Our future revenue and profitability will be affected by, among other factors, a combination of (i) the extent to which a recovery occurs in the general global economic environment, both in size and duration, and (ii) our ability to secure design wins and adequately meet product development launch cycles in our targeted markets.

Semiconductor Overview

Semiconductors perform a broad variety of functions within electronic products and systems, such as processing data, storing information and converting or controlling signals. Advances in semiconductor technology have increased the functionality and performance of semiconductors, improving the features, functionality and power consumption characteristics of the devices enabled while reducing their size and cost of manufacturing. These advances have resulted in a proliferation of electronic content across a diverse array of products.

Semiconductors vary significantly depending upon the specific function or application of the end product in which the semiconductor is embedded. Within these classifications, semiconductors vary significantly depending upon a number of technical characteristics. Examples of these characteristics include:

Degree of Integration. “Integration” refers to the extent to which different elements are combined onto a single chip. Customers today are increasingly demanding higher degrees of integration from their semiconductor suppliers, resulting in more products that combine analog, digital, and memory circuitry onto a single chip. These types of semiconductors are often referred to as systems-on-a-chip.

Customization. “Customization” refers to the extent to which a semiconductor has been customized for a specific customer or application. Standard products are semiconductors that are not customized and can be used by a large number of customers for numerous applications. In addition, some standard products, such as microcontrollers, can be customized by using software rather than by changing the device hardware. Changing the device hardware can be a time-intensive and costly process. Customized semiconductors, also referred to as application specific integrated circuits, are made to perform specific functions in specific applications, sometimes for a specific customer.

Process Technology. Semiconductors are manufactured by using different process technologies, which can be likened to “recipes.” The process technology utilized during manufacturing impacts a semiconductor’s performance for a given application. As semiconductor materials science has evolved, the minimum feature sizes in each new process technology continue to decrease. This reduces the size and, generally, unit cost of semiconductors made with the new process technology. Today’s leading edge process technology typically refers to a minimum feature size of 45 nanometers, which is currently in volume production. Initial production launches at 32 nanometers have recently occurred and development of 22 nm feature size is underway. Each new reduction in feature size generally takes 18 to 24 months to develop. We will continue to utilize internal resources as well as existing foundry relationships for our process technology and manufacturing needs.

Customers, Sales and Marketing

We sell our products directly to original equipment manufacturers, original design manufacturers and contract manufacturers through our global direct sales force. Our direct sales force is organized by customer end markets in order to bring dedicated expertise and knowledge and response to our customers. We have 59 sales offices located in 22 countries that align us with the development efforts of our customers and enable us to respond directly to customer requirements. We also maintain a network of distributors that we believe has the global infrastructure and logistics capabilities to serve a wide and diversified customer base for our products. Expansion of our distribution sales network represents an opportunity for us to leverage our products and services to a wider array of customers.

Our net product sales in the Americas, Europe, Middle East and Africa (“EMEA”), Asia-Pacific and Japan regions represented approximately 38%, 34%, 18% and 8%, respectively, of our net sales in 2009. For additional information on our net sales by country, see Note 12 to the accompanying audited consolidated financial statements. We believe our Asia-Pacific region represents a market growth opportunity and, accordingly, we intend to enhance our sales and marketing capabilities and infrastructure in the Asia-Pacific region by strengthening our direct sales force and expanding the scope of our distribution network.

We generally target customers who are leaders in industries in which our products are used as well as companies that we believe will be future leaders in these industries. In the past, we have relied on a limited number of customers for a substantial portion of our total sales. Our ten largest end customers accounted for approximately 46% of our net sales in 2009. Continental Automotive and Motorola represented 11% and 10% of our total net sales, respectively, in 2009. Historically, Motorola was our largest end customer, comprising approximately 23% and 24% of our net sales in 2008 and 2007, respectively. In connection with the decision to wind-down our cellular handset business in 2008 and our agreement to cancel our purchase and supply agreement with Motorola, our cellular products sales to Motorola declined significantly beginning in the fourth quarter of 2008. Motorola continues, however, to be serviced by our cellular, networking and communications product portfolio. Beyond Motorola, no other end customer represented more than 10% of our total net sales for the last three years other than Continental Automotive, which represented approximately 11% of our total net sales in 2009. In 2009, excluding Continental Automotive and Motorola, the next eight largest end customers comprised approximately 25% of our total net sales. In 2008 and 2007, excluding Motorola, the next nine largest end customers comprised approximately 31% and 33% of our total net sales, respectively.

Research and Development

Our research and development activities comprise both product and technology development. Our product design engineering activities, which constitute the majority of our research and development expenditures, are primarily aligned with our product design groups, and the areas of focus for these investments are described within the relevant product and application sections. Our technology development programs primarily support our product design engineering efforts, and also cover process technology, packaging technology and system-on-a-chip design technology. Specialty technologies are also developed to provide differentiation and competitive advantage, such as embedded memories (particularly non-volatile), Silicon-On-Insulator (SOI), SMARTMOS, radio frequency and mixed-signal technologies. We believe that this approach allows us to apply our investments in process, packaging and design technologies across a broad portfolio of products.

We participate in alliances and other arrangements with external partners in the area of process technology, design technology, manufacturing technology and materials development to reduce the cost of development and accelerate access to new technologies. We have several research projects with IMEC (Leuven, Belgium) and collaborative research programs with CEA-LETI (Grenoble, France) and CNRS-LAAS (Toulouse, France). We continually review our memberships in these technology research alliances and arrangements, and we may make changes from time to time. Our research and development locations include facilities in the United States, Brazil, Canada, Mexico, Czech Republic, France, Germany, Israel, Romania, Russia, United Kingdom, China, India and Malaysia.

During 2009, we funded our research and development initiatives directed at our automotive, networking, consumer and industrial end-markets consistent with our strategy to focus on growth markets and key market leadership positions where we anticipate market growth opportunities over the long-term. Following our decision in 2008 to wind-down the cellular handset business, we reduced our research and development expenditures related to this area. Research and development expense was $833 million, $1,140 million and $1,139 million for the years ended December 31, 2009, 2008 and 2007, respectively.

Manufacturing

We manufacture our products either at our own facilities or obtain manufacturing services from contract manufacturers. We currently manufacture a substantial portion of our products at our own facilities. However, as part of our asset-light strategy, we utilize a balance of internal capabilities and contract manufacturing services for standard CMOS processes and high-volume products. This is intended to allow us to efficiently manage both our supply competitiveness and factory utilization in order to minimize the risk associated with market fluctuations and maximize cash flow. We have relationships with several wafer foundries and assembly and test subcontractors to meet our contract manufacturing needs, including 300-millimeter wafer size and scaling down to 45-nanometer technologies.

Semiconductor manufacturing is comprised of two broad stages: wafer manufacturing, or “front-end,” and assembly and test, or “back-end.” Based on total units produced in 2009, approximately 23% of our front-end manufacturing was outsourced to wafer foundries. We outsourced approximately 43% of our back-end manufacturing to assembly and test subcontractors, based on total units produced in 2009. Both of these percentages may change as our business and our product mix changes. We continually evaluate the in-sourcing or out-sourcing of selected wafer assembly and test products and technologies in order to improve our supply competitiveness, gross margin and cash flows.

We own and operate seven manufacturing facilities, five of which are wafer fabrication facilities and the remaining two are assembly and test facilities. These facilities are certified to the ISO/TS 16949:2002 international quality standards. This technical specification aligns existing U.S., German, French and Italian automotive quality system standards within the global automotive industry. These operations also are certified to ISO 9001:2000. Our ISO 14001 management systems are designed to meet and exceed regulatory requirements, with certified manufacturing operations in the United States, Scotland, France, Japan, China and Malaysia.Our manufacturing processes require many raw materials, such as silicon wafers, mold compound, packaging substrates and various chemicals and gases, and the necessary equipment for manufacturing. We obtain these materials and equipment from a large number of suppliers located throughout the world. These suppliers deliver products to us on a just-in-time basis, and we believe that they have sufficient supply to meet our current needs, although it is possible that we could experience inadequate supply due to a sudden worldwide surge in demand or supply chain disruption.

Like many global companies, we maintain plans to respond to external developments that may affect our employees, facilities or business operations. Business continuity is very important to us as we strive to ensure reliability of supply to our customers. TS16949 quality standards and our internal quality standards all require a business continuity plan to effectively return critical business functions to normal in the case of an unplanned event, and our operations are certified to all of these standards. We require our major foundries, assembly and test providers and other suppliers to have a business continuity plan as well. However, in the event that our manufacturing capacity, either internal or through contract manufacturers, is disrupted, we could experience difficulty fulfilling customer orders.