FREESCALE SEMICONDUCTOR, LTD. - 10-K/A - : Management's Discussion and Analysis of Financial Condition and Results of Operations

(Edgar Glimpses Via Acquire Media NewsEdge) MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The following is a discussion and analysis of our financial position and results of operations for each of the three years ended December 31, 2012, 2011, and 2010. The following discussion of our results of operations and financial condition should be read in conjunction with our accompanying audited Consolidated Financial Statements and the notes in "Item 8: Financial Statements and Supplementary Data" of this Annual Report on Form 10-K. This discussion contains forward looking statements and involves numerous risks and uncertainties, including, but not limited to, those described in the "Risk Factors" in Part I, Item 1A of this Annual Report on Form 10-K. Actual results may differ materially from those contained in any forward looking statements.

Freescale Semiconductor Ltd. and its wholly-owned subsidiaries, including Freescale Semiconductor, Inc. ("Freescale Inc."), are collectively referred to as the "Company," "Freescale," "we," "us" or "our," as the context requires. We refer to our principal shareholder, Freescale Holdings L.P., as "Freescale LP," its general partner, Freescale Holdings G.P., Ltd., as "Freescale GP," our direct subsidiary, Freescale Semiconductor Holdings II, Ltd., as "Holdings II" and our indirect subsidiaries, Freescale Semiconductor Holdings III, Ltd., Freescale Semiconductor Holdings IV, Ltd. and Freescale Semiconductor Holdings V, Inc., as "Holdings III," "Holdings IV," and "Holdings V," respectively.

Overview Our Business. We are a global leader in embedded processing solutions. An embedded processing solution is the combination of embedded processors, complementary semiconductor devices and software. Our embedded processor products include microcontrollers (MCUs), single-and multi-core microprocessors, digital signal controllers, applications processors and digital signal processors (DSPs). They provide the core functionality of electronic systems, adding essential control and intelligence, enhancing performance and optimizing power usage while lowering system costs. We also offer complementary semiconductor products, including radio frequency (RF), power management, analog, mixed-signal devices and sensors. A key element of our strategy is to combine our embedded processors, complementary semiconductor devices and software to offer highly integrated solutions that are increasingly sought by our customers to simplify their development efforts and shorten their time to market. We have a heritage of innovation and product leadership spanning over 50 years and have an extensive intellectual property portfolio. Our close customer relationships have been built upon years of collaborative product development.

We sell our products directly to original equipment manufacturers, distributors, original design manufacturers and contract manufacturers through our global direct sales force. Our ten largest end customers accounted for approximately 39%, 43% and 44% of our net sales in 2012, 2011 and 2010, respectively. Other than Continental Automotive, no other end customer represented more than 10% of our total net sales for any of the last three years. For each of the last three years, greater than 80% of our products were sold in countries other than the United States. Our net product sales in the Asia-Pacific; Europe, Middle East and Africa (EMEA); Americas; and Japan regions represented approximately 45%, 24%, 25% and 6%, respectively, of our net sales in 2012.

During 2012 and in connection with the detailed review of our strategic direction under Gregg Lowe, our president and chief executive officer (CEO), we aligned our product revenues into five focused product groups as described below: • Microcontrollers include our MCUs and application processors focusing on industrial, multi-market, connectivity, smart energy, healthcare and multimedia applications. This group will also be the primary driver for our overall microcontroller technology development, creating technology platforms that will eventually be deployed to our Automotive MCU product group.

45 -------------------------------------------------------------------------------- Table of Contents • Digital Networking includes a scalable portfolio of multi-core communication and DSP system-on-chip solutions serving the networking and communications markets. We are increasing our investment in software to effectively enable our highly integrated solutions in systems aimed at these markets.

• Automotive MCUs includes our MCUs developed for the automotive market. Our focus is to capture new growth opportunities in Asia and Japan and to gain overall market share in automotive MCUs. We plan to accomplish this by building on our latest developments for powertrain, advanced safety and vehicle networking applications while leveraging existing and new applications.

• Analog and Sensors includes our automotive analog, mixed-signal analog and sensor products. Our focus in analog is to capture new markets and target investments in automotive and mixed signal analog. We are developing analog products that complement our MCUs and various products sold into the consumer market. Our sensors portfolio is focused on high growth markets, including industrial and consumer, while continuing to develop applications for the automotive market.

• RF includes our RF power amplifiers. Our focus is to utilize increased research and development spending to drive into new markets and accelerate revenue growth.

Beginning in the fourth quarter of this year, we began reallocating our research and development investment to reflect the change in strategic focus as indicated above. We anticipate overall research and development spending levels at a target rate of 17% of sales over the long-term. We also began shifting sales resources to align with industry growth in China and select opportunities in Korea, Taiwan and Japan. As a result, we expect to increase the number of accounts covered and expand our presence in distribution. Along with these changes, we have combined all of our manufacturing operations under a single leader to drive a sharper focus on execution, efficiency and reduced manufacturing costs. Our manufacturing operations include our fabrication facilities, assembly and test operations, planning, procurement, quality and technology organizations.

The trend of increasing connectivity and the need for enhanced intelligence in existing and new markets are the primary drivers of the growth of embedded processing solutions in electronic devices. The majority of our net sales is derived from our five product groups. Our Microcontrollers product line represented 18%, 17% and 18% of our total net sales in 2012, 2011 and 2010, respectively. Our Digital Networking product line represented 22%, 20% and 23% of our total net sales in 2012, 2011 and 2010, respectively. Our Automotive MCU product line represented approximately 25%, 23% and 23% of our total net sales in 2012, 2011 and 2010, respectively. Our Analog and Sensors product line represented 18%, 17% and 16% of our total net sales in 2012, 2011 and 2010, respectively. Our RF product line represented 8%, 9% and 8% of our net sales in 2012, 2011 and 2010, respectively.

Reorganization of Business Program Activities. Following the appointment of Gregg Lowe as president and CEO of Freescale, we completed a detailed review of our strategic direction with the overall objective of identifying opportunities that would accelerate revenue growth and improve profitability. In connection with the 2012 realignment, we recorded cash charges of $41 million and non-cash accelerated amortization of $11 million during the fourth quarter of 2012. The cash charges relate primarily to severance and we expect the timing of the cash payments to occur through the fourth quarter of 2013. We estimate annualized savings of $35 million to $40 million associated with these actions, beginning in the first quarter of 2013.

We have completed a series of restructuring actions announced in 2008 and 2009 which included the exit of our remaining 150 millimeter manufacturing facilities in Toulouse, France and Sendai, Japan, as the industry experienced a migration from 150 millimeter technologies and products to more advanced technologies and products.

The Toulouse, France manufacturing facility ceased operations in the third quarter of 2012 following the scheduled end of production at the site. We estimate the remaining severance and other costs of this facility closure to be approximately $90 million, including $80 million in cash severance costs and $10 million in cash costs for other site decommissioning and exit expenses. We anticipate substantially all remaining payments will be made by the end of 2014; however, the timing of these payments depends on many factors, including the 46 -------------------------------------------------------------------------------- Table of Contents decommissioning of the manufacturing facility and local employment laws, and actual amounts paid may vary based on currency fluctuation. Additionally, we expect to receive future benefits related to selling the site and equipment, partially offset by selling costs.

The Sendai, Japan facility ceased operations in the first quarter of 2011 due to extensive damage following the March 11, 2011 earthquake off the coast of Japan.

During 2012, we recorded a benefit of $99 million attributable to finalizing our earthquake-related business interruption insurance recoveries and the proceeds from the sale of our Sendai Design Center which were partially offset by $9 million of expenses related to on-going closure costs and dissolution of the Sendai, Japan entity. We may incur additional charges associated with preparing the facility site for sale, which we expect to be offset by proceeds from the sale.

The Company has previously estimated that it expected to receive approximately $120 million in annualized savings once the closure process has been completed and production moved to our remaining 200 millimeter facilities. As of the end of 2012, we have realized approximately $50 million of annualized cost savings related to the closure of the Sendai, Japan facility. We will begin realizing a portion of the $70 million in estimated annualized cost savings associated with the closure of the Toulouse, France facility beginning in the first quarter of 2013. Actual cost savings realized, and the timing thereof, will depend on many factors, some of which are beyond our control and could differ materially from our estimates.

Debt Restructuring Activities. During 2012, Freescale Inc. amended the Credit Facility to allow for the issuance of a new senior secured term loan, the proceeds of which were used to redeem Senior Subordinated Notes with nearer term maturities bearing a higher rate of interest. The effect of this transaction extended the maturity of $500 million of debt from 2016 to 2019 and is expected to result in annualized interest savings of $20 million, which we began to realize during the second quarter of 2012, through the lower interest rate on the 2012 Term Loan compared to that on the Senior Subordinated Notes.

Additionally, we redeemed $200 million of senior notes during the second half of 2012, which will have the effect of reducing our annual interest expense by approximately $20 million. Refer to "Liquidity and Capital Resources - Financing Activities" below for the definition and additional discussion of capitalized terms and transactions referenced in this section.

On February 8, 2013, Freescale Inc. was advised by the lead arranger under its proposed new senior secured term loan facility that sufficient orders have been received by the arrangers to allocate and close the proposed new term loan facility. The proposed new term loan facility provides for two term loan tranches in an aggregate principal amount of approximately $2.74 billion, consisting of a $350 million term loan that will mature in December 2016 and a $2.39 billion term loan that will mature in March 2020. The maturity of the 2020 term loan may be accelerated to December 2017 under specified circumstances.

The proceeds anticipated from the proposed new term loan facilities are intended to be used to refinance Freescale's outstanding term loans under the Credit Facility and to pay a portion of the related fees and expenses. Freescale expects to use cash on hand to pay any remaining fees and expenses. The refinancing is expected to, among other things, (i) reduce principal amount of indebtedness currently due in 2016, (ii) extend to 2020 the maturities of our indebtedness currently due in 2019 and a portion of our indebtedness currently due in 2016 and (iii) increase our cash interest expense by approximately $6 million annually based on current interest rates. The proposed new term loan facilities will be effected as an amendment to, or an amendment and restatement of, the Credit Facility subject to customary conditions.

These transactions are currently scheduled to close on March 1, 2013, subject to customary closing conditions, at which time we expect the 2016 loan will be issued at par and the 2020 loan will be issued with an original issue discount of $24 million, subject to accretion to par value over the term of the facility. There can be no assurance that Freescale Inc. will be successful in obtaining the proposed new term loan facility on the terms discussed above, on reasonably acceptable terms or at all.

Conditions Impacting Our Business. Our business is significantly impacted by demand for electronic content in automobiles, networking and wireless infrastructure equipment, industrial automation and consumer 47-------------------------------------------------------------------------------- Table of Contents electronic devices. We operate in an industry that is cyclical and subject to constant and rapid technological change, product obsolescence, price erosion, evolving standards, short product life-cycles, customer inventory levels and fluctuations in product supply and demand. In 2012, weak global economic conditions negatively impacted our overall sales on a year over year basis. Our revenues declined 14% in 2012 as compared to 2011.

Our revenues decreased 5% and our gross margin decreased 280 basis points in the fourth quarter of 2012 as compared to the third quarter of 2012. The decline in revenue was driven by our exposure in the European automotive market along with declines in our cellular and intellectual property revenues. Distribution sales in the fourth quarter of 2012 were flat compared to the third quarter of 2012.

Intellectual property agreements entered into during the second quarter of 2012 may limit our ability to sell or license some of our intellectual property to other parties through the second quarter of 2013 and may reduce our intellectual property revenues that are not associated with these agreements. Refer to Note 2, "Other Financial Data-Intellectual Property Revenue" for additional information regarding our intellectual property revenue. For more information on trends and other factors affecting our business, see the "Risk Factors" section in Part I, Item IA included herein.

Effect of Acquisition Accounting. On December 1, 2006, Freescale Inc. was acquired by a consortium of private equity funds we describe as our "Sponsors" in a transaction we refer to as the "Merger." In connection with the Merger, Freescale Inc. incurred significant indebtedness. In addition, the purchase price paid in connection with the Merger was allocated to state the acquired assets and assumed liabilities at fair value. Accordingly, subsequent to the Merger, interest expense and non-cash depreciation and amortization charges significantly increased. During 2008, however, we incurred substantial non-cash impairment charges against the intangible assets established at the time of the Merger. This reduced the post-Merger increase in our non-cash amortization charges, although they were still above pre-Merger levels. The term purchase price accounting ("PPA") refers to the effect of acquisition accounting. Certain PPA impacts are recorded in our cost of sales and affect our gross margin and earnings from operations, and other PPA impacts are recorded in our operating expenses and only affect our earnings from operations. The majority of the PPA impacts were finalized in 2011 driven by tools and equipment which had PPA depreciable lives that ended during 2011 and a significant portion of our developed technology that became fully amortized during 2011.

Selected Statement of Operations Items Orders Orders are placed by customers for delivery for up to as much as 12 months in the future. However, only orders expected to be fulfilled during the 13 weeks following the last day of a quarter are included in orders for that quarter.

Orders presented as of the end of a year are the sum of orders for each of the quarters in that fiscal year. Typically, agreements calling for the sale of specific quantities at specific prices are contractually subject to price or quantity revisions and are, as a matter of industry practice, rarely formally enforced. Therefore, most of our orders are cancelable. We track orders because we believe that it provides visibility into our potential future net sales.

Net Sales Our net sales originate from the sale of our embedded processors and other semiconductor products and the licensing of our intellectual property. The majority of our net sales are derived from our five major product groups: Microcontrollers, Digital Networking, Automotive MCU, Analog & Sensors, and RF.

We also derive net sales from "Other" which consists of product sales associated with end markets outside of target markets, including the cellular market, intellectual property licensing and sales, foundry wafer sales to other semiconductor companies and net sales from sources other than semiconductors. We sell our products primarily through our direct sales force. We also use distributors for a portion of our sales and recognize net sales upon the delivery of our products to the distributors. Distributor net sales are reduced for estimated returns and distributor sales incentives.

48-------------------------------------------------------------------------------- Table of Contents Cost of Sales Cost of sales are costs incurred in providing products and services to our customers. These costs consist primarily of the cost of semiconductor wafers and other materials, the cost of assembly and test operations, shipping and handling costs associated with product sales and provisions for estimated costs related to product warranties (which are made at the time the related sale is recorded based on historic trends).

We currently manufacture a substantial portion of our products internally at our three wafer fabrication facilities and two assembly and test facilities. We track our inventory and cost of sales by using standard costs that are reviewed at least once a year and are valued at the lower of cost or estimated net realizable value.

Gross Margin Our gross margin is significantly influenced by the utilization rates in our owned wafer fabrication facilities. Utilization refers only to our wafer fabrication facilities and is based on the capacity of the installed equipment.

As utilization rates increase, operating leverage increases because fixed manufacturing costs are spread over higher output. We experienced a decrease in our utilization rate to 71% in the fourth quarter of 2012 compared to 80% in the fourth quarter of 2011.

Selling, General and Administrative Selling, general and administrative expenses are costs incurred in the selling and marketing of our products and services to customers, corporate overhead and other operating costs. Selling expenses consist primarily of compensation and associated costs for sales and marketing personnel, costs of advertising, trade shows and corporate marketing. General and administrative expense consists primarily of compensation and associated costs for executive management, finance, human resources, information technology and other administrative personnel, outside professional fees and other corporate expenses.

Research and Development Research and development expenses are expensed as incurred and include the cost of activities attributable to development and pre-production efforts associated with designing, developing and testing new or significantly enhanced products or process and packaging technology. These costs consist primarily of compensation and associated costs for our engineers engaged in the design and development of our products and technologies; amortization of purchased technology; engineering design development software and hardware tools; depreciation of equipment used in research and development; software to support new products and design environments; project material costs; and third-party fees paid to consultants.

Amortization Expense for Acquired Intangible Assets Amortization expense for acquired intangible assets consists primarily of the amortization of assets acquired as a part of the Merger. They are being amortized on a straight line basis over their respective estimated useful lives ranging from two to ten years. The useful lives of the intangible assets were established in connection with the allocation of fair values at December 2, 2006. A significant portion of our developed technology initially established in connection with the Merger became fully amortized during 2011. (Refer to Note 14, "Supplemental Guarantor Condensed Consolidating Financial Statements", for the definition and discussion of the term Merger.) 49-------------------------------------------------------------------------------- Table of Contents Results of Operations Year Ended Year Ended Year Ended December 31, December 31, December 31, (in millions, except per share amounts) 2012 2011 2010 Orders (unaudited) $ 4,004 $ 4,369 $ 4,631 Net sales $ 3,945 $ 4,572 $ 4,458 Cost of sales 2,304 2,677 2,768 Gross margin 1,641 1,895 1,690 Selling, general and administrative 438 510 502 Research and development 742 797 782 Amortization expense for acquired intangible assets 13 232 467 Reorganization of businesses and other (15 ) 82 - Operating earnings (loss) 463 274 (61 ) Loss on extinguishment or modification of long-term debt, net (32 ) (97 ) (417 ) Other expense, net (531 ) (559 ) (600 ) Loss before income taxes (100 ) (382 ) (1,078 ) Income tax expense (benefit) 2 28 (25 ) Net loss $ (102 ) $ (410 ) $ (1,053 ) Net loss per share (1): Basic $ (0.41 ) $ (1.82 ) $ (5.35 ) Diluted $ (0.41 ) $ (1.82 ) $ (5.35 ) Weighted average common share outstanding (1): Basic 248 226 197 Diluted 251 227 197 Percentage of Net Sales Year Ended Year Ended Year Ended December 31, December 31, December 31, 2012 2011 2010 Orders (unaudited) 101.5 % 95.6 % 103.9 % Net sales 100.0 % 100.0 % 100.0 % Cost of sales 58.4 % 58.6 % 62.1 % Gross margin 41.6 % 41.4 % 37.9 % Selling, general and administrative 11.1 % 11.2 % 11.3 % Research and development 18.8 % 17.4 % 17.5 % Amortization expense for acquired intangible assets 0.3 % 5.1 % 10.5 % Reorganization of businesses and other * 1.7 % - Operating earnings 11.7 % 6.0 % * Loss on extinguishment or modification of long-term debt, net * * * Other expense, net * * * Loss before income taxes * * * Income tax expense 0.1 % 0.6 % * Net loss * * * * Not meaningful.

(1) Year ended December 31, 2010 adjusted for the impact of the 1-for-5.16 reverse stock split as discussed in Note 2 of the accompanying audited Consolidated Financial Statements.

50 -------------------------------------------------------------------------------- Table of Contents Net Sales Our net sales in 2012 decreased by $627 million, or 14%, compared to the prior year period, and orders decreased 8% over the same period, reflecting weaker demand in our core automotive, networking and consumer markets and declines in industrial products purchased through our distribution channel, as compared to the prior year. This decline included a decrease of $204 million in other net sales largely the result of lower demand for our cellular products offset by an increase in intellectual property revenue. Distribution sales were approximately 23% of our total net sales and represented a decrease of 10% compared to the prior year. Distribution inventory, in dollars, was 9.7 weeks at December 31, 2012, compared to 11.1 weeks at December 31, 2011. The decrease in weeks of distribution inventory resulted from our distribution partners working through higher than normal inventory levels at the end of 2011 due to concerns surrounding supply over the course of 2011 after the Sendai, Japan earthquake in March 2011.

Our net sales in 2011 increased modestly compared to the prior year, while orders decreased by 6% over the same period. We experienced higher overall net sales, primarily as a result of increased production in the global automotive industry and strength in our RF product sales due to continued increases in wireless telecommunications network investments in certain regions. This growth was offset, in part, by weakness in our core networking business and declines in industrial products purchased through our distribution channel. Distribution sales were approximately 23% of our total net sales in 2011 and were flat compared to 2010. Distribution inventory, in dollars, was 11.1 weeks at December 31, 2011, compared to 9.4 weeks at December 31, 2010. The growth in weeks of distribution inventory was due to increased product inventory throughout the market supply chain. Net sales by product group for the years ended December 31, 2012, 2011 and 2010 were as follows: Year Ended Year Ended Year Ended December 31, December 31, December 31, (in millions) 2012 2011 2010 Microcontrollers $ 707 $ 790 $ 801 Digital Networking 852 928 1,013 Automotive MCUs 986 1,072 1,013 Analog and Sensors 722 785 700 Radio Frequency 303 418 356 Other 375 579 575 Total Net Sales $ 3,945 $ 4,572 $ 4,458 Microcontrollers Microcontrollers' net sales decreased by $83 million, or 11%, in 2012 compared to 2011 driven by decreased demand for our products included in various consumer devices (primarily eReaders) and a decline in the products purchased through our distribution channel, largely within the Americas and EMEA in connection with economic uncertainty in those regions impacting demand primarily in the industrial markets we target.

Microcontrollers' net sales decreased by $11 million, or 1%, in 2011 compared to 2010 associated with greater than expected decline in net sales associated with products purchased through our distribution channel, primarily by the industrial market, in the second half of 2011 compared to the second half of 2010, partially offset by growth in our multimedia product revenues in connection with higher eReader net sales.

Digital Networking Digital Networking's net sales decreased by $76 million, or 8%, in 2012 compared 2011. We experienced weaker enterprise and wireless spending in the Americas and EMEA, particularly during the fourth quarter of 2012. This was compounded by some customers going through inventory corrections over the course of 2012. In addition, capital expenditures in wireless infrastructure declined in 2012, except for limited investments in infrastructure in China over the second half of 2012.

51 -------------------------------------------------------------------------------- Table of Contents Digital Networking's net sales decreased by $85 million, or 8%, in 2011 compared to 2010. This contraction was driven primarily by an overall decline in our core networking business due to high inventory levels through the market supply chain and lower capital investment in wireless infrastructure markets on a global basis.

Automotive MCUs Automotive MCUs' net sales decreased by $86 million, or 8%, in 2012 compared to 2011 primarily as a result of lower demand in the European automotive market along with changes in the mix of products sold.

Automotive MCUs' net sales increased by $59 million, or 6%, in 2011 compared to 2010, primarily as a result of a gradual increase in overall global automotive production.

Analog and Sensors Analog and Sensors' net sales decreased by $63 million, or 8%, in 2012 compared to 2011 primarily as a result of lower demand in the European automotive market and decreased demand for our products included in various consumer devices. This decrease was partially offset by increases in certain of our sensors products sold in the automotive market.

Analog and Sensors' net sales increased by $85 million, or 12%, in 2011 compared to 2010 due to greater demand for analog products and as a result of a gradual increase in overall global automotive production. Additionally, revenues increased related to sales of certain of our products serving the consumer market.

RF RF's net sales decreased by $115 million, or 28%, in 2012 compared to 2011 as a result of decreased investment in wireless infrastructure in various emerging and established markets and the overall weak global macroeconomic environment.

RF's net sales increased by $62 million, or 17%, in 2011 compared to 2010 largely related to an increase in wireless telecommunication network investments in China and India.

Other Other net sales decreased by $204 million, or 35%, in 2012 compared to 2011 due primarily to a decrease in cellular product sales, partially offset by an increase in intellectual property revenue. As a percentage of net sales, intellectual property revenue was 5% and 3% for 2012 and 2011, respectively.

Other net sales remained relatively flat in 2011 compared to 2010 due primarily to an increase in intellectual property revenue, offset by a decrease in contract manufacturing sales and cellular products sales. As a percentage of net sales, intellectual property revenue was 3% and 2% for 2011 and 2010, respectively.

Gross Margin In 2012, our gross margin decreased $254 million, or 13%, compared to 2011. This decline was the result of (i) net sales decreasing by 14%, (ii) decreases in average selling prices as a result of our annual negotiations with our customers put into effect during the first quarter of 2012 and (iii) changes in product sales mix. Utilization of our front-end manufacturing assets remained flat at 77% in both 2012 and 2011. As a percentage of net sales, gross margin in 2012 was 41.6%, reflecting a slight increase of 0.2 percentage points compared to 2011. This improvement in gross margin as a percentage of net sales was the result of (i) a $209 million decrease in depreciation expense, largely due to $167 million of PPA depreciation incurred in 2011, (ii) the realization of cost savings from the closure of our Sendai, Japan manufacturing facility, (iii) higher intellectual property revenue, (iv) procurement and productivity cost savings and (v) lower incentive compensation.

52-------------------------------------------------------------------------------- Table of Contents In 2011, our gross margin increased $205 million, or 12%, compared to 2010. As a percentage of net sales, gross margin in 2011 was 41.4%, reflecting an increase of 3.5 percentage points compared to 2010. Gross margin was positively impacted by (i) higher intellectual property and net product sales, (ii) procurement cost savings, (iii) an increase in utilization of our manufacturing assets, (iv) improved yields and (v) lower incentive compensation. Gross margin benefited from lower depreciation expense of $61 million resulting from a change in the useful lives of certain of our probe, assembly and test equipment in the first quarter of 2011. The improvement in wafer manufacturing facility utilization (from 72% in 2010 to 77% in 2011) and the decrease in depreciation expense contributed to continued improvement in operating leverage of our fixed manufacturing costs. Partially offsetting these improvements in gross margins were decreases in average selling price resulting from our annual negotiations with our customers put into effect in the first quarter of 2011 and changes in product sales mix. Our gross margin included PPA impact and depreciation acceleration related to the closure of our 150 millimeter manufacturing facilities of $167 million and $156 million in 2011 and 2010, respectively.

The term "PPA" refers to the effect of acquisition accounting. Certain PPA impacts were recorded in our cost of sales and affect our gross margin and earnings from operations and other PPA impacts are recorded in our operating expenses and only affect our earnings from operations. The majority of the prior year quarter PPA depreciation impact was driven by tools and equipment which had PPA depreciable lives that ended during 2011.

Selling, General and Administrative Our selling, general and administrative expenses decreased $72 million, or 14%, in 2012 compared to 2011. This decrease was primarily the result of (i) lower incentive compensation, (ii) the elimination of management fees in connection with the 2011 IPO, (iii) decreased spending on certain sales and marketing programs and (iv) discretionary cost reductions. As a percentage of our net sales, our selling, general and administrative expenses remained relatively flat as compared to the prior year.

Our selling, general and administrative expenses increased $8 million, or 2%, in 2011 compared to 2010. This increase was primarily the result of (i) a focus on select sales and marketing programs, (ii) higher litigation costs and (iii) annual merit increases in compensation. These increases were partially offset by lower incentive compensation and the elimination of management fees at the IPO. As a percentage of our net sales, our selling, general and administrative expenses remained relatively flat as compared to the prior year.

Research and Development Our research and development expense for 2012 decreased $55 million, or 7%, compared to 2011. This decrease was primarily the result of lower incentive compensation and decreased spending on certain research and development programs that are no longer essential as a result of the implementation of the 2012 Strategic Realignment. These cost reductions were partially offset by increased expenses related to focused investment in our core businesses. As a percentage of our net sales, our research and development expenses were 18.8% in 2012, reflecting an increase of 1.4 percentage points over the prior year, primarily due to lower net sales.

Our research and development expense for 2011 increased $15 million, or 2%, compared to 2010. This increase was the result of annual merit increases in compensation and continued focused investment in our core businesses, including the reallocation of resources to continue our focus on new product introduction initiatives. These increases were partially offset primarily by lower incentive compensation in 2011. As a percentage of our net sales, our research and development expenses remained relatively unchanged as compared to the prior year.

Amortization Expense for Acquired Intangible Assets Amortization expense for acquired intangible assets related to developed technology and tradenames/trademarks decreased by $219 million, or 94%, in 2012 compared to 2011 and by $235 million, or 50%, in 2011 compared to 2010. These decreases were primarily associated with portions of our developed technology and tradenames/trademarks becoming fully amortized during both 2011 and 2010.

53 -------------------------------------------------------------------------------- Table of Contents Reorganization of Business and Other In 2012, we recorded a benefit of $90 million for earthquake-related business interruption insurance recoveries related to our Sendai, Japan fabrication facility which suffered extensive damage from the March 2011 earthquake. We also recorded a benefit of $9 million related to proceeds received in connection of the sale of the Sendai, Japan design center. These benefits were partially offset by $9 million of expenses related to on-going closure costs and costs associated with the dissolution of the Sendai, Japan entity. Additionally, we recorded benefits totaling $16 million primarily related to the expiration of contractual obligations in regards to the wind down of our cellular handset business and the expiration of indemnification obligations under a contract previously executed outside the ordinary course of business. These benefits were partially offset by charges of $52 million including a non-cash accelerated amortization charge and cash costs for employee termination benefits and other exit costs recorded in connection with the 2012 Strategic Realignment.

Additionally we recorded charges of $39 million for (i) exit costs related to the termination of various supply agreements, on-going closure and decommissioning costs incurred in connection with the closure of our Toulouse, France manufacturing facility, (ii) the change in the executive leadership of the Company and (iii) costs recorded in connection with the termination of our corporate aircraft lease agreement.

In 2011, in connection with the closing of the Sendai, Japan fabrication facility due to extensive damage from the March 11, 2011 earthquake off the coast of Japan, we incurred $118 million in charges associated with non-cash asset impairment and inventory charges, cash costs for employee termination benefits, contract termination and other on-going closure costs. These charges were partially offset by (i) a $95 million benefit attributable to earthquake-related insurance recoveries, (ii) a $10 million benefit related to the sale of certain tools and equipment previously impaired and (iii) a $2 million settlement of the majority of our Sendai, Japan subsidiary's pension plan liability. We also recorded $71 million of cash costs attributable primarily to the termination of various management agreements with affiliates and advisors of the Sponsors in connection with the completion of our IPO.

(Refer to Note 11, "Certain Relationships and Related Party Transactions" for more information regarding the Sponsors.) In 2010, in connection with our Reorganization of Business Program, we reversed $21 million of severance accruals as a result of employees previously identified for separation who either resigned and did not receive severance or were redeployed due to circumstances not foreseen when the original plans were approved. This reversal also includes amounts associated with outplacement services and other severance-related costs that were ultimately not incurred. We also recorded a $4 million benefit related to the sale of our facility in Dunfermline, Scotland. These benefits were partially offset by charges of (i) $8 million attributable to employee severance costs associated with the separation of certain employees in management positions in the fourth quarter of 2010, thus concluding our workforce transformation efforts under the Reorganization of Business Program; (ii) $11 million related primarily to underutilized office space which was vacated in the prior year, also in connection with our Reorganization of Business Program; and (iii) $6 million in connection with non-cash asset impairment charges.

Loss on Extinguishment or Modification of Long-Term Debt, Net During 2012, we recorded a charge of $32 million associated with (i) the Q1 2012 Debt Refinancing Transaction, which included both the extinguishment and modification of existing debt and the issuance of the 2012 Term Loan, and (ii) the redemption of a portion of our 8.875% Unsecured Notes. This charge consisted of call premiums, the write-off of unamortized deferred financing costs and other costs not eligible for capitalization. (Capitalized terms referenced in this section are defined and discussed in "Liquidity and Capital Resources-Financing Activities.") In 2011, we recorded a charge of $97 million associated with the extinguishment of debt and the amendment to the Credit Facility, both of which were accomplished primarily in connection with the completion of the IPO. This charge consisted of expenses associated with the amendment to the Credit Facility, the IPO Debt Redemption and the Q3 2011 Debt Refinancing Transaction including call premiums of $74 million, the 54 -------------------------------------------------------------------------------- Table of Contents write-off of remaining unamortized deferred financing costs of $19 million and other costs not eligible for capitalization. These charges also included a $1 million loss related to the additional open-market repurchases of $26 million of our senior unsecured notes during 2011.

In 2010, we recorded a charge of $432 million attributable to the write-off of remaining original issue discount and unamortized deferred financing costs along with other charges not eligible for capitalization, associated with the 2010 Debt Refinancing Transactions and the A&E Arrangement. These charges were partially offset by a $15 million gain, net related to the additional open-market repurchases of $213 million of our senior unsecured notes during the first nine months of 2010.

Other Expense, Net Net interest expense in 2012 included interest expense of $519 million, partially offset by interest income of $9 million. Net interest expense in 2011 included interest expense of $572 million, partially offset by interest income of $9 million. The $53 million decrease in interest expense in 2012 compared to 2011 was attributable to (i) the extinguishment of nearly $1 billion of indebtedness during 2011 in connection with the IPO, (ii) the refinancing of long-term debt during the first quarter of 2012 and (iii) the redemption of $200 million in long-term debt during the second half of 2012. Net interest expense in 2010 included interest expense of $591 million, partially offset by interest income of $8 million. The $19 million decrease in interest expense in 2011 compared to 2010 was attributable to the extinguishment of approximately $1 billion in long-term debt during the course of 2011 in connection with the IPO.

During 2012, we recorded losses in other, net of $17 million attributable to the realized results and changes in the fair value associated with our interest rate swap agreements. Additionally, we recorded losses of $4 million 2012 related primarily to foreign currency fluctuations. During 2011, we recorded gains in other, net of $4 million primarily attributable to foreign currency fluctuations along with changes in the fair value of our interest rate swaps, caps and gold swap contracts. During 2010, we recognized pre-tax losses in other, net of $14 million due to the change in the fair value of our interest rate swaps and interest rate caps. We also recorded a $3 million pre-tax loss in other, net, related to one of our investments accounted for under the equity method. (Refer to Item 7A: "Quantitative and Qualitative Disclosures About Market Risk" for further discussion.) Income Tax Expense In 2012, we recorded an income tax provision of $2 million, inclusive of a $34 million net tax benefit attributable to discrete events. The discrete tax benefits relate principally to the reversal of reserves for unrecognized tax benefits from foreign audit activity and statute lapses as well as tax benefits from deferred tax positions in China. The discrete tax benefits were partially offset by net tax expense related to withholding taxes on intellectual property royalties. In 2011, we recorded an income tax provision of $28 million, inclusive of a $2 million net tax benefit related to discrete events. These discrete events consisted principally of the release of valuation allowances on certain deferred tax assets which the Company believes will more likely than not be realized and the tax benefit from the reversal of reserves for unrecognized tax benefits related to foreign audit settlements, partially offset by withholding tax on intellectual property royalties. In 2010, we recorded an income tax benefit of $25 million, including a $23 million net benefit related to discrete events associated primarily with the release of valuation allowances related to certain deferred tax assets of our foreign subsidiaries and the release of income tax reserves associated with statute expirations and other items.

Although the Company is a Bermuda entity with a statutory income tax rate of zero, the earnings of many of the Company's subsidiaries are subject to taxation in the U.S. and other foreign jurisdictions. Our annual effective tax rate was different from the Bermuda statutory rate of zero in 2012 due to (i) income tax expense (benefit) incurred by subsidiaries operating in jurisdictions that impose an income tax, (ii) the mix of earnings and losses across various taxing jurisdictions, (iii) a foreign capital investment incentive providing for enhanced tax deductions associated with capital expenditures in one of our foreign manufacturing facilities and (iv) the effect of valuation allowances and uncertain tax positions. We record minimal tax expense on our U.S. earnings 55-------------------------------------------------------------------------------- Table of Contents due to valuation allowances recorded on substantially all the Company's U.S. net deferred tax assets, as we have incurred cumulative losses in the United States.

Our effective tax rate is impacted by the mix of earnings and losses by taxing jurisdictions.

Reorganization of Business and Other Chief Executive Leadership Transition During 2012, a $13 million net charge was recorded in reorganization of business and other related to the change in the executive leadership of the Company. The majority of this amount was a charge related to indemnification and other provisions included in Gregg Lowe's (our current president and CEO) employment agreement along with other costs associated with his hiring. We also recognized costs related to the successful transition of duties of our former Chairman of the Board and CEO.

2012 Strategic Realignment Following the appointment of Gregg Lowe as president and CEO, we completed a strategic review with the overall objective of identifying opportunities that would accelerate revenue growth and improve profitability and have shifted our research and development investment and sales force to reflect our changing strategic focus. We recorded a charge of $52 million to reorganization of business and other comprised of a non-cash accelerated amortization charge along with cash costs for employee termination benefits and other exit costs incurred in connection with re-allocating research and development resources and re-aligning sales resources.

The following table displays a roll-forward from January 1, 2012 to December 31, 2012 of the employee separation and exit cost accruals established related to the 2012 Strategic Realignment: Accruals at 2012 Accruals at January 1, Amounts December 31, (in millions, except headcount) 2012 Charges Adjustments Used 2012 Employee Separation Costs Supply chain $ - 8 - (2 ) $ 6 Selling, general and administrative - 14 - (3 ) 11 Research and development - 16 - (3 ) 13 Total $ - 38 - (8 ) $ 30 Related headcount - 660 - (390 ) 270 Exit and Other Costs $ - 3 - (1 ) $ 2 In 2012, we recorded $38 million in cash charges for severance costs of which $8 million were paid to employees separated as part of the 2012 Strategic Realignment. The accrual of $30 million at December 31, 2012 reflects the estimated liability to be paid to employees separated during 2012 and the remaining 270 employees to be separated through the end of 2013 based on current exchange rates. Additionally, during 2012 we recorded $3 million in exit and other costs primarily related to additional compensation for employees who were deemed crucial to the implementation of the 2012 Strategic Realignment plan.

During 2012, we paid $1 million of these exit costs.

Accelerated Amortization Charges In connection with the re-allocation of research and development resources under the 2012 Strategic Realignment, we will no longer pursue certain products and technologies. As a result, we have recorded a charge of $11 million to reorganization of business and other based on the reassessment of useful lives and related acceleration of remaining amortization for certain of our purchased licenses which have no future benefit due to being directly related to programs we have cancelled.

56 -------------------------------------------------------------------------------- Table of Contents Sendai, Japan Fabrication Facility and Design Center On March 11, 2011, a 9.0-magnitude earthquake off the coast of Japan caused extensive infrastructure, equipment and inventory damage to our 150 millimeter fabrication facility and design center in Sendai, Japan. The design center was vacant and being marketed for sale at the time of the earthquake. The fabrication facility was previously scheduled to close in the fourth quarter of 2011. The extensive earthquake damage to the facility and the interruption of basic services, coupled with numerous major aftershocks and the resulting environment, prohibited us from returning the facility to an operational level required for wafer production in a reasonable time frame. As a result, the Sendai, Japan fabrication facility ceased operations at the time of the earthquake, and we were unable to bring the facility back up to operational condition due to the extensive damage to our facilities and equipment. During 2012, we recorded a $90 million benefit attributable to finalizing our business interruption insurance recoveries which was partially offset by $9 million of expenses related to on-going closure costs and costs associated with the dissolution of the Sendai, Japan entity. We also recorded a benefit of $9 million related to proceeds received in connection of the sale of the Sendai, Japan design center. Additionally in 2012, the remaining $3 million of contract termination exit costs previously accrued in connection with the site closure were paid.

Reorganization of Business Program We have executed a series of restructuring initiatives under the Reorganization of Business Program that streamlined our cost structure and re-directed some research and development investments into expected growth markets. The closure of our Toulouse, France manufacturing facility occurred during the third quarter of 2012. The only remaining actions relating to the Reorganization of Business Program are the disposal or sale of the land and buildings located in Sendai, Japan and the decommissioning of the land and buildings at our Toulouse, France manufacturing facility along with payment of the remaining separation and exit costs.

At each reporting date, we evaluate our accruals for exit costs and employee separation costs, which consist primarily of separation benefits (principally severance and relocation payments), to ensure that our accruals are still appropriate. In certain circumstances, accruals are no longer required because of efficiencies in carrying out our plans or because employees previously identified for separation resign unexpectedly and do not receive severance or are redeployed due to circumstances not foreseen when the original plans were initiated. We reverse accruals to earnings when it is determined they are no longer required.

The following table displays a roll-forward from January 1, 2012 to December 31, 2012 of the employee separation and exit cost accruals established related to the Reorganization of Business Program: Accruals at Adjustments 2012 Accruals at January 1, & Currency Amounts December 31, (in millions, except headcount) 2012 Charges Impact Used 2012 Employee Separation Costs Supply chain $ 106 - 1 (30 ) $ 77 Selling, general and administrative 8 - (6 ) - 2 Research and development 14 - (12 ) - 2 Total $ 128 - (17 ) (30 ) $ 81 Related headcount 720 - - (200 ) 520 Exit and Other Costs $ 6 2 (2 ) (6 ) $ - The $30 million used reflects cash payments made to employees separated as part of the Reorganization of Business Program in 2012. We have adjusted our anticipated future severance payments by $14 million to incorporate the currency impact in the above presentation. These adjustments reflect the strengthening of the U.S. dollar against the Euro partially offset by the weakening of the U.S.

dollar against the Japanese Yen since the charges were originally recorded in 2009. Additionally, we reversed $3 million related to the finalization of 57-------------------------------------------------------------------------------- Table of Contents the closure of the Sendai, Japan manufacturing facility. The accrual of $81 million at December 31, 2012 reflects the estimated liability to be paid to the remaining 520 employees through 2014 based on current exchange rates.

Additionally, during 2012 we (i) recorded and paid $2 million in exit costs related to the termination of various supply agreements in connection with the closure of our Toulouse, France manufacturing facility and (ii) restructured a lease agreement where we had previously recorded charges for vacant office space resulting in an adjustment of $2 million and payments of $4 million during the year.

Other Contingencies and Disposition Activities During 2012, we recorded benefits totaling $16 million primarily related to the expiration of indemnification obligations under a contract previously executed outside the ordinary course of business and the expiration of contractual obligations associated with the wind down of our cellular handset business.

Additionally, we incurred $18 million of on-going closure and decommissioning costs associated with the closure our Toulouse, France manufacturing facility and a net $5 million contract termination charge related to our corporate aircraft lease agreement.

Year Ended December 31, 2011 IPO-Related Costs During 2011 and in connection with the IPO, we recorded $71 million of cash costs primarily attributable to the termination of management agreements with affiliates and advisors of the Sponsors.

Sendai, Japan Fabrication Facility and Design Center During 2011, we reported $11 million in net charges associated with non-cash asset impairment and inventory charges and cash costs for employee termination benefits, contract termination and other on-going closure costs, which were partially offset by insurance received in connection with the March 2011 earthquake that occurred off the cost of Japan.

The following table displays a roll-forward from January 1, 2011 to December 31, 2011 of the employee termination benefits and exit cost accruals established related to the closing of our fabrication facility in Sendai, Japan: Accruals at 2011 Accruals at January 1, Amounts December 31, (in millions, except headcount) 2011 Charges Adjustments Used 2011 Employee Separation Costs Supply chain $ - $ 12 $ (3 ) $ (9 ) $ - Selling, general and administrative - - - - - Research and development - - - - - Total $ - $ 12 $ (3 ) $ (9 ) $ - Related headcount - 480 (100 ) (380 ) - Exit and Other Costs $ - $ 12 $ (2 ) $ (7 ) $ 3 We recorded $12 million in employee termination benefits associated with the closure of the Sendai, Japan fabrication facility in 2011. The $9 million used reflects cash payments made to employees separated as part of this action in 2011. We reversed $3 million of employee termination benefits as a result of 100 employees previously identified as eligible for such benefits who either were temporarily redeployed due to circumstances not foreseen when the original plan was approved or have forfeited these benefits in connection with establishing other employment outside the Company. In addition, we also recorded $10 million of exit costs related to the termination of various supply contracts. During 2011, $7 million of these exit costs were paid.

58-------------------------------------------------------------------------------- Table of Contents Asset Impairment Charges, Disposition Activities and Other Costs As a result of the significant structural and equipment damage to the Sendai, Japan fabrication facility and the Sendai, Japan design center, we recorded $49 million in non-cash asset impairment charges in 2011. We also had raw materials and work-in-process inventory that were destroyed or damaged either during the earthquake or afterwards due to power outages, continuing aftershocks and other earthquake-related events. As a result, we recorded a non-cash inventory net charge of $14 million directly attributable to the impact of the earthquake in 2011. We also recorded a benefit of $10 million in connection with the sale of certain tools and equipment previously impaired and a $2 million benefit related to the settlement of the majority of our Sendai, Japan subsidiary's pension plan liability. In addition, we incurred $36 million of on-going closure costs due to inactivity subsequent to the March 11, 2011 earthquake.

Insurance Recoveries During 2011, we recorded a $95 million benefit for insurance recoveries based on an agreement with our insurance carriers regarding the impact of the property and inventory damage to our Sendai, Japan facilities and related business interruption losses as a result of the March 11, 2011 earthquake.

Reorganization of Business Program The following table displays a roll-forward from January 1, 2011 to December 31, 2011 of the employee separation and exit cost accruals established related to the Reorganization of Business Program: Accruals at 2011 Accruals at January 1, Amounts December 31, (in millions, except headcount) 2011 Charges Adjustments Used 2011 Employee Separation Costs Supply chain $ 157 - - (51 ) $ 106 Selling, general and administrative 12 - - (4 ) 8 Research and development 16 - - (2 ) 14 Total $ 185 - - (57 ) $ 128 Related headcount 1,420 - - (700 ) 720 Exit and Other Costs $ 15 2 (3 ) (8 ) $ 6 The $57 million used reflects cash payments made to employees separated as part of the Reorganization of Business Program in 2011. Severance accruals for employees at our Sendai, Japan facility related to the original Reorganization of Business Program are reflected in the table above, refer to the prior section, "Sendai, Japan Fabrication Facility and Design Center," for other charges associated with this facility in 2011 as a result of the earthquake in Japan. In addition, in connection with our Reorganization of Business Program, we recorded $2 million of exit costs associated with the sale and leaseback of our facility in Tempe, Arizona that were not eligible for deferral. This amount was offset by a $3 million benefit related to exit costs associated primarily with underutilized office space previously vacated and subsequently sublet in connection with our Reorganization of Business Program. During 2011, $8 million of these exit costs were paid.

Liquidity and Capital Resources Cash and Cash Equivalents Of the $711 million of cash and cash equivalents at December 31, 2012, $148 million is attributable to our U.S. subsidiaries and $563 million is attributable to our foreign subsidiaries. The repatriation of the funds of these foreign subsidiaries could be subject to delay and potential tax consequences, principally with respect to withholding taxes paid in foreign jurisdictions.

59 -------------------------------------------------------------------------------- Table of Contents Operating Activities We generated cash flow from operations of $350 million, $99 million and $394 million in 2012, 2011 and 2010, respectively. The improvement in cash flow from operations in 2012 is attributable to (i) proceeds from the sale and license of intellectual property, some of which has not yet been recognized as revenue, (ii) proceeds from the Sendai, Japan earthquake-related business interruption insurance recoveries, (iii) lower payments for incentive compensation, (iv) lower interest expense costs attributable to our 2012 debt redemption and refinancing transactions and (v) costs associated with the completion of our IPO in the second quarter of 2011. These items are partially offset by payments associated with the closure of our Sendai, Japan and Toulouse, France fabrication facilities, including the cost of inventory builds to support end-of-life products produced at these facilities.

The decrease in cash generated from operations in 2011 as compared to 2010 is attributable to (i) costs associated with the closure of our Sendai, Japan and Toulouse, France facilities, including inventory builds to support end-of-life products produced at these facilities, (ii) expenses associated with the completion of our IPO in the second quarter of 2011 and (iii) higher interest expense costs attributable to our 2010 debt refinancing activities. This decrease in cash flows from operations was partially offset by $52 million in business interruption and inventory insurance recoveries received in 2011 in connection with earthquake damage to our Sendai, Japan wafer fabrication facility.

Our days purchases outstanding (excluding the impact of purchase accounting on cost of sales in 2011 and 2010) decreased to 50 days at December 31, 2012 from 55 days at December 31, 2011 and 57 days at December 31, 2010 reflecting the timing of payments on our payables. Our days sales outstanding decreased to 36 days at December 31, 2012 from 41 days at December 31, 2011, primarily reflecting lower receivables and fluctuations in the timing of collections of such receivables. Our days sales outstanding remained relatively flat at 35 days at December 31, 2010. Our days of inventory on hand (excluding the impact of purchase accounting on inventory and cost of sales in 2011 and 2010) decreased to 122 days at December 31, 2012 from 126 days at December 31, 2011. The decrease in days of inventory on hand from the prior year is due to drain of build-ahead inventory in connection with the Toulouse, France and Sendai, Japan manufacturing facilities closures. Our days of inventory on hand at December 31, 2011 increased from 97 days at December 31, 2010 as a result of the challenging macroeconomic environment and inventory builds associated with the closure of our 150 millimeter manufacturing facilities.

Investing Activities Our net cash utilized for investing activities was $176 million, $89 million and $320 million in 2012, 2011 and 2010, respectively. Our investing activities are driven primarily by (i) capital expenditures, which were $123 million, $135 million and $281 million for 2012, 2011 and 2010, respectively, and represented 3% of net sales for both 2012 and 2011 and 6% of net sales for 2010, and (ii) payments for purchased licenses and other assets, which were $73 million, $62 million and $96 million for 2012, 2011 and 2010, respectively. The increase in the cash utilized for investing activities from 2011 to 2012 was predominantly the result of the benefit in the prior year from the receipt of $57 million in cash for the sale of our Tempe, Arizona facility (of which we are now leasing a portion) along with proceeds from property and casualty insurance recoveries. In addition to the benefit in 2011 from the Tempe transaction, the decrease in cash utilized for investing activities from 2010 to 2011 was also impacted by $10 million in cash proceeds received for the sale of certain equipment from our Sendai, Japan manufacturing facility and $37 million in insurance proceeds received in connection with property damage to our Sendai, Japan facilities.

Financing Activities Our net cash utilized for financing activities was $232 million, $290 million and $383 million in 2012, 2011 and 2010, respectively. Cash flows related to financing activities in 2012 included (i) the repayment of $500 million of the Senior Subordinated Notes in connection with the Q1 2012 Debt Refinancing Transaction, along with call premiums of $25 million, (ii) the repayment of $200 million of 8.875% Unsecured Notes in 60-------------------------------------------------------------------------------- Table of Contents connection the Q3 and Q4 2012 Debt Redemptions, along with call premiums of $2 million and (iii) $7 million in capital lease and scheduled principal payments.

These payments were partially offset by the receipt of $481 million of proceeds from the issuance of the 2012 Term Loan, net of related amendment, consent and other fees totaling $14 million. Additionally, cash provided by financing activities included $21 million of proceeds from the exercise of stock options and the ESPP. (Refer to Note 6 "Share and Equity-Based Compensation", for further information on ESPP.) Cash flows related to financing activities in 2011 included the receipt of approximately $838 million in net cash proceeds upon completion of the IPO and the over-allotment exercise and $724 million in net cash proceeds in connection with the issuance of the 8.05% Unsecured Notes. These cash inflows were offset by the utilization of $1,853 million related to payments for principal and call premiums in connection with the IPO Debt Redemption, the Over-Allotment Debt Redemption and the Q3 2011 Debt Refinancing Transaction, as well as open-market repurchases of senior unsecured notes and scheduled capital lease payments.

Cash flows related to financing activities in 2010 included the utilization of (i) $297 million in cash for open-market repurchases of senior unsecured notes and scheduled debt and capital lease payments and (ii) $82 million in cash for costs incurred in connection with refinancing transactions. In addition, the $2,798 million of proceeds from the issuance of indebtedness were substantially offset by the prepayments of a portion of the Credit Facility and senior unsecured notes as part of the refinancing transactions.

We have in the past refinanced Freescale Inc.'s indebtedness by issuing new indebtedness and amending the terms of Freescale Inc.'s senior credit facilities, as described in more detail below. The refinancing activities have not been as a result of any default under those debt agreements. Rather, we have refinanced Freescale Inc.'s indebtedness to take advantage of market opportunities to improve our capital structure by extending the maturities of the indebtedness, reducing the total outstanding principal amount of our indebtedness by repaying debt at a discount, and increasing flexibility under existing covenants for business planning purposes. Although Freescale Inc.'s lenders have agreed to such amendments and participated in such refinancings in the past, there can be no assurance that its lenders would participate in any future refinancings or agree to any future amendments. In addition, certain of Freescale Inc.'s lenders may object to the validity of the terms of any such amendment or refinancing. For example, in 2009, a group of lenders under the Credit Facility filed a complaint against Freescale Inc. challenging the debt exchange transaction under the Credit Facility. The transaction was completed, but the litigation remained outstanding. As part of the on-going litigation, this group of lenders sought to enjoin Freescale Inc. from completing the Amend and Extend Arrangement ("A&E Arrangement") in the first quarter of 2010. The A&E Arrangement allowed Freescale Inc. to issue new debt with extended maturities and use the proceeds to prepay debt with maturities in the more immediate future. Additionally, it allowed Freescale Inc. to amend the Credit Facility to allow for additional future debt refinancing or extension transactions.

Freescale Inc. reached an agreement to settle the pending litigation and was able to complete the A&E Arrangement. Freescale Inc. may be subject to similar actions in connection with future refinancings or amendments, which may impact the terms and conditions or timing thereof, preclude Freescale Inc. from completing any such transaction or subject Freescale Inc. to significant additional costs. In the event of a decline in our operating performance and an inability to access other resources, including through such refinancings or amendments, we could face substantial liquidity problems and may be required to dispose of material assets or operations to meet our debt service and other obligations.

Fourth Quarter 2012 Debt Redemption On November 23, 2012, Freescale Inc. delivered to the holders of its Senior Unsecured 8.875% Notes due 2014 ("8.875% Unsecured Notes") notice that it would redeem $100 million aggregate principal amount of the notes at par value, plus accrued and unpaid interest up to, but not including, the redemption date. These notes became callable at par on December 15, 2012. The redemption date was December 26, 2012, on which Freescale Inc. utilized $100 million of cash on hand to redeem $100 million of 8.875% Unsecured Notes and pay accrued interest of less than $1 million. In connection with the redemption, we recorded a charge of $1 million in the accompanying audited Consolidated Statement of Operations associated with the write-off of unamortized 61-------------------------------------------------------------------------------- Table of Contents deferred financing costs. (Refer to Note 2 "Loss on Extinguishment or Modification of Long-Term Debt, Net", for further information on the debt transactions discussed in this section.) Third Quarter 2012 Debt Redemption On August 13, 2012, Freescale Inc. delivered to the holders of its 8.875% Unsecured Notes notice that it would redeem $100 million aggregate principal amount of the notes at the redemption price of 102.219% of the outstanding aggregate principal amount being redeemed, plus accrued and unpaid interest up to, but not including, the redemption date. The redemption date was September 12, 2012, on which Freescale Inc. utilized $104 million of cash on hand to redeem $100 million of 8.875% Unsecured Notes, and pay related call premiums of $2 million along with accrued interest of $2 million. In connection with the redemption, we recorded a charge of $3 million in the accompanying audited Consolidated Statement of Operations associated with the call premiums and write-off of unamortized deferred financing costs.

First Quarter 2012 Debt Refinancing Transaction On February 28, 2012, Freescale Inc. received the requisite consents from its lenders to amend the senior secured credit facility ("Credit Facility") which, among other things, allowed for the issuance of a new term loan and eliminated the remaining incremental borrowing capacity previously available under the Credit Facility. As a result, on February 28, 2012, Freescale Inc. closed the transaction referred to as the "Q1 2012 Debt Refinancing Transaction" and announced the amendment of the Credit Facility and the issuance of $500 million aggregate principal amount of a senior secured term loan due February 28, 2019 ("2012 Term Loan"). The 2012 Term Loan was issued with an original issue discount and was recorded at its fair value of $495 million on the accompanying audited Consolidated Balance Sheet. The net proceeds of this issuance, along with approximately $59 million of cash on hand, were used on March 29, 2012 to redeem $500 million of the senior subordinated 10.125% notes due 2016 ("Senior Subordinated Notes"), and pay related call premiums of $25 million, accrued interest of $15 million and amendment, consent and other fees totaling $14 million in the aggregate. In connection with the transaction, we recorded a charge of $28 million in the accompanying audited Consolidated Statement of Operations associated with the call premiums, write-off of unamortized deferred financing costs and other expenses not eligible for capitalization.

IPO and Over-Allotment Debt Redemptions In the second quarter of 2011, Freescale Ltd. contributed the net proceeds from the IPO to Freescale Inc. to prepay and redeem $887 million of outstanding debt in a transaction referred to as the "IPO Debt Redemption." On June 1, 2011, we prepaid the $532 million remaining outstanding balance under the original revolving credit facility and issued 30-day notices of redemption announcing our intent to redeem portions of the senior unsecured 10.75% notes due 2020 ("10.75% Unsecured Notes") and the senior unsecured 9.125%/9.875% PIK-election notes due 2014 ("PIK-Election Notes"). Upon the expiration of this 30-day period on July 1, 2011, we completed the IPO Debt Redemption by redeeming $262 million of the 10.75% Unsecured Notes and $93 million of the PIK-Election Notes, as well as paying related call premiums of $32 million and accrued interest of $13 million, with the initial IPO proceeds along with cash on hand.

On June 9, 2011, the underwriters of our IPO partially exercised their over-allotment option to purchase an additional 5,567,000 common shares at $18.00 per share. The over-allotment transaction closed on June 14, 2011, at which time we issued a 30-day notice of redemption announcing our intent to redeem a portion of the senior secured 10.125% notes due 2018 ("10.125% Secured Notes"). Subsequently, upon the expiration of this 30-day period on July 14, 2011, we used $96 million of net proceeds received in the over-allotment transaction, along with cash on hand, to redeem $87 million of the 10.125% Secured Notes and pay related call premiums of $9 million and accrued interest of $3 million, in a transaction referred to as the "Over-Allotment Debt Redemption." In connection with these transactions, we recorded a charge of $53 million in the accompanying audited Consolidated Statement of Operations associated with the call premiums, write-off of unamortized deferred financing costs and other expenses not eligible for capitalization.

62-------------------------------------------------------------------------------- Table of Contents Second Quarter Debt Issuance and Third Quarter 2011 Debt Refinancing Transactions On June 10, 2011, Freescale Inc. issued $750 million aggregate principal amount of 8.05% senior unsecured notes due February 1, 2020 ("8.05% Unsecured Notes") with the intention to use the proceeds, along with existing cash, to redeem the remaining outstanding balance of the PIK-Election Notes and a portion of the 8.875% Unsecured Notes, and to pay related call premiums and accrued interest, in a transaction referred to as the "Q2 2011 Debt Issuance." On June 10, 2011, Freescale Inc. also issued 30-day notices of redemption announcing their intent to redeem the aforementioned senior unsecured notes. The Q2 2011 Debt Issuance was completed in compliance with Credit Facility as well as the indentures governing the senior secured, senior unsecured, and senior subordinated notes (collectively, the "Senior Notes"). The 8.05% Unsecured Notes were recorded at fair value, which was equal to the gross cash proceeds received from the issuance. Upon the expiration of this 30-day period on July 11, 2011, we used the net proceeds from the issuance of the 8.05% Unsecured Notes, along with existing cash, to redeem $162 million of PIK-Election Notes and $588 million of the 8.875% Unsecured Notes, and to pay related call premiums of $33 million and accrued interest of $5 million, in a transaction referred to as the "Q3 2011 Debt Refinancing Transactions." In connection with the transaction, we recorded a charge of $43 million in the accompanying audited Consolidated Statement of Operations associated with the call premiums and write-off of unamortized deferred financing costs. Additionally, the $750 million aggregate principal amount of 8.05% Unsecured Notes was separately accounted for as an issuance of debt.

First Quarter 2011 Amendment to the Credit Facility On March 4, 2011 and in connection with the IPO, Freescale Inc. entered into an amendment to the Credit Facility to, among other things, allow for the replacement of its existing revolving credit facility thereunder with a new revolving credit facility (the "Replacement Revolver"). We received commitments of $425 million for the Replacement Revolver, which became available, and the amendments became effective, on June 1, 2011, at which time Freescale Inc. had satisfied certain conditions. The Replacement Revolver's available capacity is reduced by outstanding letters of credit.

Open-Market Bond Repurchases During 2011, Freescale Inc. repurchased $11 million of the 8.05% Unsecured Notes and $15 million of the 10.75% Unsecured Notes at a $1 million loss. During 2010, Freescale Inc. repurchased $120 million of its 8.875% Unsecured Notes, $78 million of its PIK-Election Notes and $15 million of its senior unsecured floating rate notes due 2014 ("Floating Rate Notes") at a $15 million gain, net.

Credit Facility At December 31, 2012, Freescale Inc.'s Credit Facility included (i) the $2,215 million extended maturity term loan ("Extended Term Loan"), (ii) the 2012 Term Loan and (iii) the Replacement Revolver, including letters of credit and swing line loan sub-facilities, with a committed capacity of $425 million. The interest rate on the 2012 Term Loan and the Extended Term Loan at December 31, 2012 was 6.0% and 4.46%, respectively. (The spread over LIBOR with respect to the 2012 Term Loan and the Extended Term Loan was 4.75% and 4.25%, respectively.

As noted below, the 2012 Term Loan has a LIBOR floor of 1.25%.) The spread over LIBOR with respect to the Replacement Revolver is 3.75%. At December 31, 2012, the Replacement Revolver's available capacity was $408 million, as reduced by $17 million of outstanding letters of credit.

2012 Term Loan At December 31, 2012, $496 million was outstanding under the 2012 Term Loan, which will mature on February 28, 2019. The 2012 Term Loan bears interest, at Freescale Inc.'s option, at a rate equal to a margin over either (i) a base rate equal to the higher of either (a) the prime rate of Citibank, N.A. or (b) the federal funds rate, plus one-half of 1%; or (ii) a LIBOR rate based on the cost of funds for deposit in the currency of borrowing for the relevant interest period, adjusted for certain additional costs. The Second Amended and 63-------------------------------------------------------------------------------- Table of Contents Restated Credit Agreement as of February 28, 2012 ("Second Amended and Restated Credit Agreement") provides that the spread over LIBOR with respect to the 2012 Term Loan is 4.75%, with a LIBOR floor of 1.25%. Under the Second Amended and Restated Credit Agreement, Freescale Inc. is required to repay a portion of the 2012 Term Loan in quarterly installments in aggregate annual amounts equal to 1% of the initial $500 million outstanding balance. There is an early maturity acceleration clause associated with the 2012 Term Loan such that principal amounts under the loan will become due and payable on December 15, 2017, if, at December 1, 2017, (i) Freescale, Inc.'s total leverage ratio is greater than 4:1 at the September 30, 2017 test period and (ii) the aggregate principal amount of the 10.125% Secured Notes or the senior secured 9.25% notes due 2018 ("9.25% Secured Notes") exceeds $500 million, individually or collectively.

Additionally, the 2012 Term Loan contains a provision whereby Freescale Inc. can call the loan at 101% of the principal amount within twelve months from the date of issuance. At December 31, 2012, the 2012 Term Loan was recorded on the accompanying audited Consolidated Balance Sheet at a $5 million discount, which is subject to accretion to par value over the term of the loan using the effective interest method.

The obligations under the Second Amended and Restated Credit Agreement are unconditionally guaranteed by the same parties and in the same manner as under the credit agreement that was in effect prior to the Q1 2012 Debt Refinancing Transaction as further discussed below. In addition, the Second Amended and Restated Credit Agreement contains the same prepayment provisions as the previous credit agreement except as indicated above.

Senior Notes Freescale Inc. had an aggregate principal amount of $3,674 million in Senior Notes outstanding at December 31, 2012, consisting of (i) $663 million of 10.125% Secured Notes, (ii) $1,380 million of 9.25% Secured Notes, (iii) $57 million of Floating Rate Notes, (iv) $98 million of 8.875% Unsecured Notes, (v) $473 million of 10.75% Unsecured Notes, (vi) $739 million of 8.05% Unsecured Notes and (vii) $264 million of Senior Subordinated Notes. With regard to our fixed rates notes, interest is payable semi-annually in arrears as follows: (i) every March 15th and September 15th commencing on September 15, 2010 for the 10.125% Secured Notes; (ii) every April 15th and October 15th commencing on October 15, 2010 for the 9.25% Secured Notes; (iii) every February 1st and August 1st commencing February 1, 2011 for the 10.75% Unsecured Notes; (iv) every February 1stand August 1st commencing on February 1, 2012 for the 8.05% Unsecured Notes; and, (v) every June 15th and December 15th commencing on June 15, 2007 for the 8.875% Unsecured Notes and the Subordinated Notes. The Floating Rate Notes bear interest at a rate, reset quarterly, equal to three-month LIBOR (which was 0.31% on December 31, 2012) plus 3.875% per annum, which is payable quarterly in arrears on every March 15th, June 15th, September 15th and December 15th commencing March 15, 2007.

Guarantees and Right of Payment The obligations under the Credit Facility are unconditionally guaranteed by certain of the Parent Companies and, subject to certain exceptions, each of our material domestic wholly-owned "Restricted Subsidiaries," as defined in the Credit Facility agreement. As of December 31, 2012, Freescale Inc. had no material domestic wholly owned Restricted Subsidiaries. All obligations under the Credit Facility, and the guarantees of those obligations, are secured by substantially all the following assets of Freescale Inc. and each guarantor, subject to certain exceptions: (i) a pledge of 100% of the capital stock of each of Holdings III, Holdings IV and Holdings V, a pledge of 100% of the capital stock of Freescale Inc., 100% of the capital stock of our subsidiary SigmaTel, Inc. and 65% of the voting stock (and 100% of the non-voting stock) of each of our material wholly owned foreign subsidiaries, in each case that are directly owned by Freescale Inc. or one of the guarantors; and (ii) a security interest in, and mortgages on, substantially all tangible and intangible assets of each of Holdings IV, Holdings V and Freescale Inc. In addition, in the event that Freescale Inc. (i) transfers foreign subsidiaries to, or forms new foreign subsidiaries under, Holdings III or another foreign entity (but not any entity directly or indirectly owned by a U.S. entity) or (ii) transfers assets to such foreign subsidiaries, Freescale Inc. will be required to pledge 100% of the voting stock of those wholly owned foreign subsidiaries so transferred or formed, and such foreign subsidiaries would be required to guarantee our obligations under the senior secured credit 64-------------------------------------------------------------------------------- Table of Contents agreement. There are prepayment requirements under the Credit Facility in certain circumstances and subject to certain exceptions. These potential prepayment requirements include (i) 50% of annual excess cash flow as defined in the senior secured credit agreement, subject to an incremental, full step-down based upon attaining certain leverage ratios; (ii) 100% of net cash proceeds of all non-ordinary course assets sales or other dispositions by Holdings III and its restricted subsidiaries if the net cash proceeds are not reinvested in the business; and (iii) 100% of the net proceeds of any issuance or incurrence of debt by Holdings III or any of its restricted subsidiaries, other than debt permitted under our Credit Facility. The foregoing mandatory prepayments will be applied to scheduled installments of the Extended Term Loan in direct order of maturity.

The 10.125% Secured Notes are governed by the indenture dated as of February 19, 2010 (the "10.125% Indenture"), and the 9.25% Secured Notes are governed by the indenture dated as of April 13, 2010 (the "9.25% Indenture"). The Guarantors also guarantees, jointly and severally, the 10.125% Secured Notes and 9.25% Secured Notes on a senior secured basis. (Refer to Note 14, "Supplemental Guarantor Condensed Consolidating Financial Statements" for the definition of Guarantors.) The 8.05% Unsecured Notes are governed by the Indenture dated as of June 10, 2011 (the "8.05% Indenture"); the 10.75% Unsecured Notes are governed by the indenture dated as of September 30, 2010 (the "10.75% Indenture"); and, the Floating Rate Notes, the 8.875% Unsecured Notes and the Senior Subordinated Notes are governed by two indentures dated as of December 1, 2006, as supplemented and amended. While the 8.05% Unsecured Notes, the 10.75% Unsecured Notes, the Floating Rate Notes and the 8.875% Unsecured Notes are guaranteed, jointly and severally, on a senior unsecured basis by the Guarantors, the Senior Subordinated Notes are guaranteed with a guarantee that ranks junior in right of payment to all of the other senior indebtedness of each Guarantor.

Relative to our overall indebtedness, the 10.125% Secured Notes and the 9.25% Secured Notes rank in right of payment (i) pari passu to our existing senior secured indebtedness, (ii) senior to senior unsecured indebtedness to the extent of the value of any underlying collateral, but otherwise pari passu to such senior unsecured indebtedness, and (iii) senior to all senior subordinated indebtedness. The Floating Rate Notes, the 8.875% Unsecured Notes, the 10.75% Unsecured Notes and the 8.05% Unsecured Notes rank in right of payment (i) junior to senior secured indebtedness to the extent of the value of any underlying collateral, but otherwise pari passu to such senior secured indebtedness, (ii) pari passu to our existing senior unsecured indebtedness, and (iii) senior to all senior subordinated indebtedness. The Senior Subordinated Notes are unsecured senior subordinated obligations and rank junior in right of payment to all other of our senior secured and unsecured indebtedness.

Redemption Freescale Inc. may redeem, in whole or in part, the 10.125% Secured Notes at any time prior to March 15, 2014 at a redemption price equal to 100% of the principal balance, plus accrued and unpaid interest, if any, plus the applicable "make-whole" premium, as defined in the 10.125% Indenture. Freescale Inc. may redeem, in whole or in part, the 10.125% Secured Notes at any time after March 15, 2014 at a redemption price equal to 100% of the principal balance, plus accrued and unpaid interest, if any, plus a premium declining over time as set forth in the 10.125% Indenture. In addition, at any time on or prior to March 15, 2013, Freescale Inc. may redeem up to 35% of the aggregate principal amount of the 10.125% Secured Notes with the proceeds of certain equity offerings at a redemption price equal to 110.125% of the aggregate principal amount, plus accrued and unpaid interest, if any, as described in the 10.125% Indenture. If Freescale Inc. experiences certain change of control events, holders of the 10.125% Secured Notes may require Freescale Inc. to repurchase all or part of their 10.125% Secured Notes at 101% of the principal balance, plus accrued and unpaid interest.

Freescale Inc. may redeem, in whole or in part, the 9.25% Secured Notes at any time prior to April 15, 2014 at a redemption price equal to 100% of the principal balance, plus accrued and unpaid interest, if any, plus the applicable "make-whole" premium, as defined in the 9.25% Indenture. Freescale Inc. may redeem, in whole or in part, the 9.25% Secured Notes at any time on or after April 15, 2014 at a redemption price equal to 100% of the principal balance, plus accrued and unpaid interest, if any, plus a premium declining over time as set forth in the 9.25% Indenture. In addition, until April 15, 2013, Freescale Inc. may redeem up to 35% of the aggregate 65-------------------------------------------------------------------------------- Table of Contents principal amount of the 9.25% Secured Notes with the proceeds of certain equity offerings at a redemption price equal to 109.25% of the aggregate principal amount, plus accrued and unpaid interest, if any, as described in the 9.25% Indenture. If Freescale Inc. experiences certain change of control events, holders of the 9.25% Secured Notes may require Freescale Inc. to repurchase all or part of their 9.25% Secured Notes at 101% of the principal balance, plus accrued and unpaid interest.

Freescale Inc. may redeem, in whole or in part, the Floating Rate Notes at any time on or after December 15, 2008 and the 8.875% Unsecured Notes at any time on or after December 15, 2010. In each case, the redemption price equals a fixed percentage of the related notes' principal balance ranging from 100% to 104.6%, depending upon the series of notes redeemed and the redemption date, plus accrued and unpaid interest.

Freescale Inc. may redeem, in whole or in part, the 10.75% Unsecured Notes at any time prior to August 1, 2015 at a redemption price equal to 100% of the principal balance, plus accrued and unpaid interest, if any, plus the applicable "make-whole" premium, as defined in the 10.75% Indenture. Freescale Inc. may redeem, in whole or in part, the 10.75% Unsecured Notes, at any time on or after August 1, 2015 at a redemption price equal to 100% of the principal balance, plus accrued and unpaid interest, if any, plus a premium declining over time as set forth in the 10.75% Indenture. In addition, at any time on or prior to August 1, 2013, Freescale Inc. may redeem up to 35% of the aggregate principal balance of 10.75% Unsecured Notes with the proceeds of certain equity offerings at a redemption price equal to 110.75% of the aggregate principal amount, plus accrued and unpaid interest, if any, as described in the 10.75% Indenture. If Freescale Inc. experiences certain change of control events, holders of the 10.75% Unsecured Notes may require Freescale Inc. to repurchase all or part of their 10.75% Unsecured Notes at 101% of the principal balance, plus accrued and unpaid interest.

Freescale Inc. may redeem, in whole or in part, the 8.05% Unsecured Notes at any time prior to June 1, 2015 at a redemption price equal to 100% of the principal balance, plus accrued and unpaid interest, if any, plus the applicable "make-whole" premium, as defined in the 8.05% Indenture. Freescale Inc. may redeem, in whole or in part, the 8.05% Unsecured Notes, at any time on or after June 1, 2015 at a redemption price equal to 100% of the principal balance, plus accrued and unpaid interest, if any, plus a premium declining over time as set forth in the 8.05% Indenture. In addition, at any time on or prior to June 1, 2014, Freescale Inc. may redeem up to 35% of the aggregate principal balance of 8.05% Unsecured Notes with the proceeds of certain equity offerings at a redemption price equal to 108.05% of the aggregate principal amount, plus accrued and unpaid interest, as described in the 8.05% Indenture. If Freescale Inc. experiences certain change of control events, holders of the 8.05% Unsecured Notes may require Freescale Inc. to repurchase all or part of their 8.05% Unsecured Notes at 101% of the principal balance, plus accrued and unpaid interest.

Freescale Inc. may redeem, in whole or in part, the Senior Subordinated Notes at any time on or after December 15, 2011. The redemption price is at a fixed percentage of the notes' principal balance ranging from 100% to 105.1%, depending upon the redemption date, plus accrued and unpaid interest as described in the indenture governing these notes.

Covenant Compliance Freescale Inc.'s Credit Facility and indentures governing the senior notes (the "Indentures") contain restrictive covenants that limit the ability of our subsidiaries to, among other things, incur or guarantee additional indebtedness or issue preferred shares, pay dividends and make other restricted payments, impose limitations on the ability of our restricted subsidiaries to pay dividends or make other distributions, create or incur certain liens, make certain investments, transfer or sell assets, engage in transactions with affiliates and merge or consolidate with other companies or transfer all or substantially all of our assets. Under the Credit Facility, Freescale Inc. must comply with conditions precedent that must be satisfied prior to any borrowing.

As of December 31, 2012, Freescale Inc. was in compliance with the covenants under the Credit Facility and the Indentures but did not meet the ratios thereunder: the total leverage ratio of 6.5:1, the senior secured first lien leverage ratio of 3.50:1, the fixed charge coverage ratio of 2.0:1 or the consolidated secured debt ratio of 66-------------------------------------------------------------------------------- Table of Contents 3.25:1. As of December 31, 2012, Freescale Inc.'s total leverage ratio was 6.81:1, senior secured first lien leverage ratio was 4.82:1, the fixed charge coverage ratio was 1.79:1 and the consolidated secured debt ratio was 5.67:1.

Accordingly, we are currently restricted from making restricted payments and incurring liens on assets securing indebtedness, except as otherwise permitted by the Credit Facility and the Indentures. The fact that we do not meet these ratios does not result in any default under the Credit Facility or the Indentures.

Hedging Transactions Freescale Inc. has entered into interest rate swap agreements and has previously used interest rate cap agreements with various counterparties as a hedge of the variable cash flows of our variable interest rate debt. (Refer to Note 3, "Fair Value Measurement" and Note 5, "Risk Management" for further details of these interest rate swap and cap agreements.) Debt Service We are required to make debt service principal payments under the terms of our debt agreements. As of December 31, 2012, future obligated debt service principal payments are $5 million in 2013, $160 million in 2014, $5 million in 2015, $2,484 million in 2016, $5 million in 2017 and $3,726 million thereafter.

Adjusted EBITDA Adjusted EBITDA is calculated in accordance with the Second Amended and Restated Credit Agreement and the indentures governing Freescale Inc.'s senior notes.

Adjusted EBITDA is net (loss) earnings adjusted for certain non-cash and other items that are included in net (loss) earnings. Freescale Inc. is not subject to any maintenance covenants under its existing debt agreements and is therefore not required to maintain any minimum specified level of Adjusted EBITDA or maintain any ratio based on Adjusted EBITDA or otherwise. However, our ability to engage in specified activities is tied to ratios under Freescale Inc.'s debt agreements based on Adjusted EBITDA, in each case subject to certain exceptions.

Our subsidiaries are unable to incur any indebtedness under the indentures and specified indebtedness under the Credit Facility, pay dividends, make certain investments, prepay junior debt and make other restricted payments, in each case not otherwise permitted by our debt agreements, unless, after giving effect to the proposed activity, the fixed charge coverage ratio (as defined in the applicable indenture) would be at least 2:1 and the senior secured first lien leverage ratio (as defined in the Credit Facility) would be no greater than 3.5:1. Also, our subsidiaries may not incur certain indebtedness in connection with acquisitions unless, prior to and after giving effect to the proposed transaction, the total leverage ratio (as defined in the Credit Facility) is no greater than 6.5:1, except as otherwise permitted by the Credit Facility. In addition, except as otherwise permitted by the applicable debt agreement, we may not designate any subsidiary as unrestricted or engage in certain mergers unless, after giving effect to the proposed transaction, the fixed charge coverage ratio would be at least 2:1 or equal to or greater than it was prior to the proposed transaction and the senior secured first lien leverage ratio would be no greater than 3.5:1. We are also unable to have liens on assets securing indebtedness without also securing the notes unless the consolidated secured debt ratio (as defined in the applicable indenture) would be no greater than 3.25:1 after giving effect to the proposed lien, except as otherwise permitted by the indentures. Accordingly, we believe it is useful to provide the calculation of Adjusted EBITDA to investors for purposes of determining our ability to engage in these activities. Freescale Inc. was in compliance with the covenants under the Credit Facility and the Indentures but did not meet the ratios thereunder: the total leverage ratio of 6.5:1, the senior secured first lien leverage ratio of 3.50:1, the fixed charge coverage ratio of 2.0:1 or the consolidated secured debt ratio of 3.25:1. As of December 31, 2012, Freescale Inc.'s total leverage ratio was 6.81:1, senior secured first lien leverage ratio was 4.82:1, the fixed charge coverage ratio was 1.79:1 and the consolidated secured debt ratio was 5.67:1. Accordingly, we are currently restricted from making restricted payments and incurring liens on assets securing indebtedness, except as otherwise permitted by the Credit Facility and the Indentures. The fact that we do not meet these ratios does not result in any default under the Credit Facility or the indentures.

67-------------------------------------------------------------------------------- Table of Contents Adjusted EBITDA is a non-U.S. GAAP measure. Adjusted EBITDA does not represent, and should not be considered an alternative to, net (loss) earnings, operating (loss) earnings, or cash flow from operations as those terms are defined by accounting principles generally accepted in the United States of America, (U.S.

GAAP) and does not necessarily indicate whether cash flows will be sufficient to fund cash needs. Although Adjusted EBITDA and similar measures are frequently used as measures of operations and the ability to meet debt service requirements by other companies, our calculation of Adjusted EBITDA is not necessarily comparable to such other similarly titled captions of other companies. The calculation of Adjusted EBITDA in the indentures and the Credit Facility allows us to add back certain charges that are deducted in calculating net (loss) earnings. However, some of these expenses may recur, vary greatly and are difficult to predict. Further, our debt instruments require that Adjusted EBITDA be calculated for the most recent four fiscal quarters. We do not present Adjusted EBITDA on a quarterly basis. In addition, the measure can be disproportionately affected by quarterly fluctuations in our operating results, and it may not be comparable to the measure for any subsequent four-quarter period or any complete fiscal year.

The following is a reconciliation of net loss earnings, which is a U.S. GAAP measure of our operating results, to Adjusted EBITDA, as calculated pursuant to Freescale Inc.'s debt agreements for the most recent four fiscal quarter period as required by such agreements.

Year Ended December 31, (in millions) 2012 Net loss $ (102 ) Interest expense, net 510 Income tax expense 2 Depreciation and amortization 257 Non-cash share-based employee compensation (a) 43 Fair value adjustment on interest rate and commodity derivatives (b) 17 Loss on extinguishment or modification of long-term debt, net (c) 32 Reorganization of business and other (d) (15 ) Cost savings (e) 78 Other terms (f) 17 Adjusted EBITDA $ 839 (a) Reflects non-cash, share-based compensation expense under the provisions of ASC Topic 718, "Compensation-Stock Compensation." (b) Reflects the change in fair value of our interest rate and commodity derivatives which were not designated as cash flow hedges under the provisions of ASC Topic 815, "Derivatives and Hedging." (c) Reflects losses on extinguishments and modification of our long-term debt.

(d) Reflects items related to our reorganization of business programs and other charges.

(e) Reflects cost savings that we expect to achieve from initiatives commenced prior to December 31, 2009 under our reorganization of business programs that are in process or have already been completed.

(f) Reflects adjustments required by our debt instruments, including business optimization expenses, relocation expenses and other items.

68 -------------------------------------------------------------------------------- Table of Contents Contractual Obligations We own most of our major facilities, but we do lease certain office, factory and warehouse space and land, as well as data processing and other equipment primarily under non-cancelable operating leases.

Summarized in the table below are our obligations and commitments to make future payments in connection with our debt, minimum lease payment obligations (net of minimum sublease income), software, service, supply and other contracts, and product purchase commitments as of December 31, 2012.

Payments Due by Period (in millions) 2013 2014 2015 2016 2017 Thereafter Total Debt obligations (including short-term debt) (1) $ 5 $ 160 $ 5 $ 2,484 $ 5 $ 3,726 $ 6,385 Capital lease obligations (2) 1 - - - - - 1 Operating leases (3) 34 26 18 15 14 8 115 Software licenses 36 22 8 1 - - 67 Service and other obligations 45 40 26 15 10 - 136 Foundry commitments (4) 55 - - - - - 55 Purchase commitments 21 - - - - - 21 Total cash contractual obligations (5) $ 197 $ 248 $ 57 $ 2,515 $ 29 $ 3,734 $ 6,780 (1) Reflects the principal payments on the Credit Facility and the notes. These amounts exclude estimated cash interest payments of approximately $476 million in 2013, $476 million in 2014, $465 million in 2015, $455 million in 2016, $334 million in 2017 and $433 million thereafter (based on currently applicable interest rates in the case of variable interest rate debt).

(2) Excludes interest of less than $1 million on capital lease obligations of $1 million at December 31, 2012.

(3) Sublease income on operating leases is approximately $3 million in 2013 and less than $1 million in 2014. Currently there is no sublease income scheduled beyond 2014.

(4) Foundry commitments associated with our strategic manufacturing relationships are based on volume commitments for work in progress and forecasted demand based on 18-month rolling forecasts, which are adjusted monthly.

(5) As of December 31, 2012, we had reserves of $173 million recorded for uncertain tax positions, including interest and penalties. We are not including this amount in our long-term contractual obligations table presented because of the difficulty in making reasonably reliable estimates of the timing of cash settlements, if any, with the respective taxing authorities.

Future Financing Activities Our primary future cash needs on a recurring basis will be for debt service obligations, capital expenditures and working capital. In addition, we expect to spend approximately $110 million through the end of 2013 and approximately $10 million thereafter in connection with the 2012 Strategic Realignment and the closure of the Toulouse, France manufacturing facility; however, the timing of these payments depends on many factors, including the timing of redeployment of existing resources and compliance with local employment laws, and actual amounts paid may vary based on currency fluctuation. We believe that our cash and cash equivalents balance as of December 31, 2012 of $711 million and cash flows from operations will be sufficient to fund our debt service obligations, working capital needs, capital expenditures, severance and facility closure costs and other business requirements for at least the next 12 months. In addition, our ability to borrow under the Replacement Revolver was $408 million as of December 31, 2012, as reduced by $17 million of outstanding letters of credit.

If our cash flows from operations are less than we expect or we require funds to consummate acquisitions of other businesses, assets, products or technologies, we may need to incur additional debt, sell or monetize certain existing assets or utilize our cash and cash equivalents. In the event additional funding is required, there can be no assurance that future funding will be available on terms favorable to us or at all. Furthermore, our debt agreements contain restrictive covenants that limit our ability to, among other things, incur additional debt and 69 -------------------------------------------------------------------------------- Table of Contents sell assets. We are highly leveraged, and this could adversely affect our ability to raise additional capital to fund our operations, limit our ability to react to changes in the economy or our industry, expose us to interest rate risk to the extent of our variable rate debt and prevent us from meeting our obligations under one or more of our debt agreements. Increases in interest rates could also adversely affect our financial condition. In the absence of sufficient operating results and resources to service our debt, or as the result of the inability to complete appropriate refinancings and amendments of our debt, we could face substantial liquidity problems and may be required to seek the disposal of material assets or operations to meet our debt service and other obligations. If we cannot make scheduled payments on our indebtedness, we will be in default under one or more of our debt agreements and, as a result, we would need to take other action to satisfy our obligations or be forced into bankruptcy or liquidation.

As market conditions warrant, or as repurchase obligations under the agreements governing our Credit Facility and notes may require, we and our major equity holders may from time to time repurchase or redeem debt securities issued by Freescale Inc. through redemptions under the terms of the indentures, in privately negotiated or open-market transactions, by tender offer or otherwise, or issue new debt in order to refinance or prepay amounts outstanding under the Credit Facility or the existing senior notes or for other permitted purposes.

On February 8, 2013, Freescale Inc. was advised by the lead arranger under its proposed new senior secured term loan facility that sufficient orders have been received by the arrangers to allocate and close the proposed new term loan facility. The proposed new term loan facility provides for two term loan tranches in an aggregate principal amount of approximately $2.74 billion, consisting of a $350 million term loan that will mature in December 2016 and a $2.39 billion term loan that will mature in March 2020. The maturity of the 2020 term loan may be accelerated to December 2017 under specified circumstances.

The proceeds anticipated from the proposed new term loan facilities are intended to be used to refinance Freescale's outstanding term loans under the Credit Facility and to pay a portion of the related fees and expenses. Freescale expects to use cash on hand to pay any remaining fees and expenses. The refinancing is expected to, among other things, (i) reduce principal amount of indebtedness currently due in 2016, (ii) extend to 2020 the maturities of our indebtedness currently due in 2019 and a portion of our indebtedness currently due in 2016 and (iii) increase our cash interest expense by approximately $6 million annually based on current interest rates. The proposed new term loan facilities will be effected as an amendment to, or an amendment and restatement of, the Credit Facility subject to customary conditions.

These transactions are currently scheduled to close on March 1, 2013, subject to customary closing conditions, at which time we expect the 2016 loan will be issued at par and the 2020 loan will be issued with an original issue discount of $24 million, subject to accretion to par value over the term of the facility. There can be no assurance that Freescale Inc. will be successful in obtaining the proposed new term loan facility on the terms discussed above, on reasonably acceptable terms or at all.

Off-Balance Sheet Arrangements We use customary off-balance sheet arrangements, such as operating leases and letters of credit, to finance our business. None of these arrangements has or is likely to have a material effect on our results of operations, financial condition or liquidity.

Significant Accounting Policies and Critical Estimates The preparation of our financial statements in accordance with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements, as well as the reported amounts of net sales and expenses during the reporting period.

70-------------------------------------------------------------------------------- Table of Contents Our management bases its estimates and judgments on historical experience, current economic and industry conditions and on various other factors that are believed to be reasonable under the circumstances. This forms the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions. Our management believes the following accounting policies to be those most important to the portrayal of our financial condition and those that require the most subjective judgment: • valuation of long-lived assets; • restructuring activities; • accounting for income taxes; • inventory valuation methodology; • product sales and intellectual property revenue recognition and valuation; and • share-based compensation.

If actual results differ significantly from management's estimates and projections, there could be a material negative impact on our financial statements.

Valuation of Long-Lived Assets The net book values of these tangible and intangible long-lived assets at December 31, 2012 and 2011 were as follows: Year Ended Year Ended December 31, December 31, (in millions) 2012 2011 Property, plant and equipment $ 715 $ 772 Intangible assets 64 84 Total net book value $ 779 $ 856 We assess the impairment of investments and long-lived assets, which include our goodwill, identifiable intangible assets and property, plant and equipment (PP&E), whenever events or changes in circumstances indicate that the carrying value may not be recoverable. During 2012, we recorded an $11 million accelerated amortization charge associated with certain of our intangible assets to reorganization of business and other. (Refer to Note 2, "Other Financial Data" and Note 10, "Reorganization of Business and Other" in our accompanying audited consolidated financial statements for further discussion.) As of December 31, 2012 and 2011, no indications of impairment existed.

Identifiable Intangible Assets We determine the fair value of our intangible assets in accordance with ASC Topic 820, "Fair Value Measurements and Disclosures." Our impairment evaluation of identifiable intangible assets and PP&E includes an analysis of estimated future undiscounted net cash flows expected to be generated by the assets over their remaining estimated useful lives. If the estimated future undiscounted net cash flows are insufficient to recover the carrying value of the assets over the remaining estimated useful lives, we record an impairment loss in the amount by which the carrying value of the assets exceeds the fair value. We determine fair value based on either market quotes, if available, or discounted cash flows using a discount rate commensurate with the risk inherent in our current business model for the specific asset being valued. Examples of discounted cash flow methodologies utilized are the excess earnings method for purchased licenses and the royalty savings method for trademarks/tradenames.

71-------------------------------------------------------------------------------- Table of Contents When applying either the excess earnings method or the royalty savings method, the cash flows expected to be generated by the intangible asset are discounted to their present value equivalent using an appropriate weighted average cost of capital (WACC) for the respective asset being valued. The WACC is calculated by weighting the required returns on interest-bearing debt and common equity capital in proportion to their estimated percentages in the Company's expected capital structure. The WACC is adjusted to reflect the relative risk associated with the cash flows of the asset being valued.

The valuations of our purchased licenses are based on the excess earnings method, which incorporates our long-term net sales projections as a key assumption. The net sales attributable to purchased licenses is determined by adjusting our long-term net sales projections for the percentage of our total net sales allocated to purchased licenses in consideration of the estimated life of the underlying technologies. As technology in-process at the time the intangible asset was established and future technology begin to generate net sales, sales from purchased licenses are projected to decline. The net sales described above are reduced by production and operating costs. The resulting cash flows are tax-effected using an assumed market participant rate. We then adjust the cash flows for various contributory asset charges (working capital, fixed assets, technology royalty, trademark/tradename and assembled workforce).

The resulting cash flows are discounted and result in the estimated fair value of the respective intangible asset. We also incorporate an estimate of the future tax savings from amortization in the estimated fair value of purchased licenses.

We use the royalty savings method to value the trademark/tradename intangible asset. Our net sales projection over the expected remaining useful life of the trademarks/tradenames is a key assumption. We apply a royalty rate to the projected net sales. The royalty rate is based on product profitability, industry and markets served, trademark/tradename protection factors, and perceived licensing value. The resulting royalty savings are reduced by income taxes resulting from the annual royalty savings at a market participant corporate income tax rate to arrive at the after-tax royalty savings associated with owning the trademarks/tradenames. We also incorporate an estimate of the calculated future tax savings from the amortization of the trademarks/tradenames as an acquired intangible asset. Finally the present value of the estimated annual after-tax royalty savings for each year in the projection period and the present value of tax savings due to amortization are combined to estimate the fair value of the trademarks/tradenames.

The primary assumptions in each of these calculations are net sales and cost projections and the WACC utilized to discount the resulting cash flows. Our assumptions concerning net sales are impacted by global and local economic conditions in the various markets we serve. Our cost projections include production, research and development and selling, general and administrative costs to generate the net sales associated with the asset being valued. These cost projections are based upon historical and projected levels of each cost category based on our overall projections for the Company. During 2012, we recorded an $11 million non-cash accelerated amortization charge based on the reassessment of useful lives and related acceleration of remaining amortization for certain of our purchased licenses which have no future benefit due to being directly related to programs we have cancelled in connection with the 2012 Strategic Realignment. (Refer to Note 2, "Other Financial Data" and Note 10, "Reorganization of Business and Other" in our accompanying audited consolidated financial statements for further discussion.) As of December 31, 2012 and 2011, we determined that no other indicators of impairment existed with regard to our intangible assets.

PP&E Our impairment evaluation of PP&E includes an analysis of estimated future undiscounted net cash flows expected to be generated by the assets over their remaining estimated useful lives. If the estimated future undiscounted net cash flows are insufficient to recover the carrying value of the assets over the remaining estimated useful lives, we record an impairment loss in the amount by which the carrying value of the assets exceeds the fair value. We determine fair value based on either market quotes, if available, or discounted cash flows using a discount rate commensurate with the risk inherent in our current business model for the specific asset being valued. Major factors that influence our cash flow analysis are our estimates for future net sales and 72-------------------------------------------------------------------------------- Table of Contents expenses associated with the use of the asset. Different estimates could have a significant impact on the results of our evaluation. If, as a result of our analysis, we determine that our PP&E has been impaired, we will recognize an impairment loss in the period in which the impairment is determined. Any such impairment charge could be significant and could have a material negative effect on our results of operations. During 2011 and 2010, we recorded various non-cash asset impairment charges for PP&E of $49 million and $6 million, respectively, in reorganization of business and other. The 2011 impairment was the result of the significant structural and equipment damage to the Sendai, Japan fabrication facility and the Sendai, Japan design center from the March 2011 earthquake which occurred off the coast of Japan near this site. As of December 31, 2012 and 2011, we determined that no other indicators of impairment existed with regard to our PP&E. (Refer to Note 9, "Asset Impairment Charges" and Note 10, "Reorganization of Business and Other" to our accompanying audited consolidated financial statements for further discussion.) Restructuring Activities We periodically implement plans to reduce our workforce, close facilities, discontinue product lines, refocus our business strategies and consolidate manufacturing, research and design center and administrative operations. We initiate these plans in an effort to improve our operational effectiveness, reduce costs or simplify our product portfolio. Exit costs primarily consist of facility closure costs. Employee separation costs consist primarily of severance payments to terminated employees. At each reporting date, we evaluate our accruals for exit costs and employee separation costs to ensure that the accruals are still appropriate. In certain circumstances, accruals are no longer required because of efficiencies in carrying out the plans or because employees previously identified for separation resigned from our company unexpectedly and did not receive severance or were redeployed due to circumstances not foreseen when the original plans were initiated. We reverse accruals to earnings when it is determined they are no longer required.

Following the appointment of Gregg Lowe as president and CEO of Freescale, we completed a detailed review of our strategic direction with the overall objective of identifying opportunities that would accelerate revenue growth and improve profitability. We recorded cash and non-cash charges of $52 million in connection with re-allocating research and development resources and re-aligning sales resources. (Refer to Note 2, "Other Financial Data" and Note 10, "Reorganization of Business and Other" for more information on the transactions described in this section.) In 2008, we began executing a series of restructuring actions that are referred to as the "Reorganization of Business Program" which streamlined our cost structure and redirected some research and development investments into expected growth markets. We announced in the second quarter of 2009 our plans to exit our remaining 150 millimeter manufacturing facilities in Sendai, Japan and Toulouse, France, as the industry has experienced a migration from 150 millimeter technologies and products to more advanced technologies and products. The Sendai, Japan facility ceased operations in the first quarter of 2011 due to extensive damage following the March 11, 2011 earthquake off the coast of Japan.

The Toulouse, France manufacturing facility ceased operations in the third quarter of 2012 following the scheduled end of production at the site. As of December 31, 2012, the remaining actions to be completed are the disposal of the land and building located in Sendai, Japan and the decommissioning of the land and building located in Toulouse, France along with payment of the remaining separation and exit costs. Our severance and exit costs associated with the Reorganization of Business Program in 2012, 2011 and 2010 were not significant or approximated reversals of prior accruals.

Accounting for Income Taxes We recognize deferred tax assets and liabilities based on the differences between the financial statement carrying amounts and the tax bases of assets, liabilities and net operating loss and credit carryforwards. The recognition of deferred tax assets is reduced by a valuation allowance if it is more likely than not that the tax benefits will not be realized. We regularly review our deferred tax assets for recoverability and establish a valuation allowance based on historical income and losses, projected future income, the expected timing of the reversals of existing temporary differences and the implementation of tax-planning strategies.

73 -------------------------------------------------------------------------------- Table of Contents Valuation allowances of $1,089 million have been recorded on substantially all our U.S. deferred tax assets as of December 31, 2012, as we have incurred cumulative losses in the United States. We have not recognized tax benefits for these losses as we are precluded from considering the impact of future forecasted income pursuant to the provisions of ASC Topic 740, "Income Taxes" ("ASC Topic 740") in assessing whether it is more likely than not that all or a portion of our deferred tax assets may be recoverable. The Company computes cumulative losses for these purposes by adjusting pre-tax results (excluding the cumulative effects of accounting method changes and including discontinued operations and other "non-recurring" items such as restructuring or impairment charges) for permanent items. In certain foreign jurisdictions, we record valuation allowances to reduce our net deferred tax assets to the amount we believe is more likely than not to be realized after considering all positive and negative factors as to the recoverability of these assets. At December 31, 2012 valuation allowances of $67 million have also been recorded on certain deferred tax assets in foreign jurisdictions.

We have reserves for taxes, associated interest, and other related costs that may become payable in future years as a result of audits by tax authorities.

Although we believe that the positions taken on previously filed tax returns are fully supported, we nevertheless have established reserves recognizing that various taxing authorities may challenge certain positions, which may not be fully sustained. The tax reserves are reviewed quarterly and adjusted as events occur that affect our potential liability for additional taxes, such as lapsing of applicable statutes of limitations, proposed assessments by tax authorities, resolution of tax audits, negotiations between tax authorities of different countries concerning our transfer prices, identification of new issues, and issuance of new regulations or new case law. The amounts ultimately paid upon resolution of audits could be different from the amounts previously included in our income tax expense and therefore could have an impact on our tax provision, net income and cash flows. In the event that actual results differ from these estimates or we adjust these estimates in future periods, we may need to record additional income tax expense (benefit) or adjust valuation allowances.

We consider many factors when evaluating and estimating our tax positions and tax benefits, which may require periodic adjustments and which may not accurately anticipate actual outcomes. The first step is to evaluate the tax position for recognition by determining if the weight of available evidence indicates that it is more likely than not that the position will be sustained on audit, including resolution of related appeals or litigation processes, if any.

The second step is to measure the tax benefit as the largest amount which is more than 50% likely of being realized upon ultimate settlement. Whether the more-likely-than-not recognition threshold is met for a tax position is a matter of judgment based on the individual facts and circumstances of that position evaluated in light of all available evidence. As of December 31, 2012, we had reserves of $173 million for taxes, associated interest, and other related costs that may become payable in future years as a result of audits by tax authorities.

Inventory Valuation Methodology Inventory is valued at the lower of cost or estimated net realizable value. We write down our inventory for estimated obsolescence or unmarketable inventory in an amount equal to the difference between the cost of inventory and the estimated market value based upon assumptions about future demand and market conditions. If actual market conditions are less favorable than those we project, additional inventory write-downs may be required. Inventory impairment charges establish a new cost basis for inventory. In estimating obsolescence, we utilize our backlog information for the next 13 weeks as well as projecting future demand.

We balance the need to maintain strategic inventory levels to ensure competitive delivery performance to our customers with the risk of inventory obsolescence due to rapidly changing technology and customer requirements. We also consider pending cancellation of product lines due to technology changes, long life cycle products, lifetime buys at the end of supplier production runs, business exits and a shift of production to outsourcing.

As of December 31, 2012 and 2011, we recorded $58 million and $73 million, respectively, in reserves for inventory deemed obsolete or in excess of forecasted demand. The change in our reserves for inventory from 2011 to 2012 was due primarily to the scrapping of obsolete inventory and the subsequent sale of inventory for 74 -------------------------------------------------------------------------------- Table of Contents which reserves were previously recorded. If actual future demand or market conditions are less favorable than those projected by our management, additional inventory write-downs may be required.

Product Sales and Intellectual Property Revenue Recognition and Valuation We generally market our products to a wide variety of end users and a network of distributors. Our policy is to record revenue for product sales when title transfers, the risks and rewards of ownership have been transferred to the customer, the fee is fixed and determinable and collection of the related receivable is reasonably assured, which is generally at the time of shipment. We record reductions to sales associated with reserves for allowances for collectability, discounts, price protection, product returns and distributor incentive programs at the time the related sale is recognized. The establishment of such reserves is dependent on a variety of factors, including contractual terms, analysis of historical data, current economic conditions, industry demand and prevailing and the forecasted pricing environments. The process of evaluating these factors is highly subjective and requires significant estimates, including, but not limited to, forecasted demand, returns, industry pricing assumptions, distributor resales and inventory levels. In future periods, additional provisions may be necessary due to (i) a deterioration in the semiconductor pricing environment, (ii) reductions in anticipated demand for semiconductor products and/or (iii) lack of market acceptance for new products.

If these factors result in a significant adjustment to our reserves, they could significantly impact our future operating results.

Distributor reserves estimate the impact of credits granted to distributors under certain programs common in the semiconductor industry whereby distributors receive certain price adjustments to meet individual competitive opportunities, or are allowed to return or scrap a limited amount of product in accordance with contractual terms agreed upon with the distributor, or receive price protection credits when our standard published prices are lowered from the price the distributor paid for product still in its inventory. We continually monitor the actual claimed allowances against our estimates, and we adjust our estimates as appropriate to reflect trends in pricing environments and distributor resales and inventory levels. Distributor reserves are also adjusted when recent historical data do not represent anticipated future activity. In 2012, 2011 and 2010, 23% of our revenue was generated from sales of our products to distributors.

In revenue arrangements that include multiple deliverables, judgment is required to properly identify the accounting units of such multiple deliverable transactions and to determine the manner in which revenue should be allocated among those accounting units. Net sales from contracts with multiple deliverables are recognized as each deliverable is earned based on the relative fair value of each deliverable when there are no undelivered items that are essential to the functionality of the delivered items and when the amount is not contingent upon delivery of the undelivered items. More specifically, the deliverables under each arrangement are analyzed to determine whether they are separate units of accounting, and if so, the total arrangement consideration is allocated based on each deliverable's relative selling price using vendor-specific objective evidence ("VSOE"), third-party evidence ("TPE"), or estimated selling prices ("ESP"). When we are unable to establish selling price using VSOE or TPE, we use ESP in our allocation of arrangement consideration.

The objective of ESP is to determine the price at which we would transact a sale if the product or service was sold on a standalone basis. The ESP is determined by considering multiple factors including, but not limited to, our pricing practices, gross margin objectives, internal costs and industry specific information. Changes in any number of these factors may have a substantial impact on the selling price as assigned to each deliverable. These inputs and assumptions represent management's best estimates at the time of the transaction. Applicable receivables are discounted in accordance with U.S. GAAP.

We recognize revenue from the licensing of our intellectual property when persuasive evidence of an arrangement exists, delivery has occurred, the sales price is fixed or determinable and collection of resulting receivables is reasonably assured. Revenue from upfront payments for the licensing of our patents is recognized when the arrangement is mutually signed, if there is no future delivery or future performance obligation and all other criteria are met.

When patent licensing arrangements include royalties for future sales of the licensees' products using our licensed patented technology, revenue is recognized based on royalty reports received from 75-------------------------------------------------------------------------------- Table of Contents the licensee, provided that all other criteria have been met. Revenue from licensing our intellectual property approximated 5%, 3% and 2% of net sales in 2012, 2011 and 2010, respectively.

We entered into several intellectual property revenue arrangements during 2012 that contained multiple deliverables. Certain of these arrangements may limit our ability to sell or license some of our intellectual property to other parties through the second quarter of 2013 and may reduce our intellectual property revenues that are not associated with these agreements. The total consideration to be received under these agreements is $287 million, of which $194 million was received in 2012. The remaining cash will be received over the next seven years, with $65 million anticipated to be received within the next twelve months. We expect to continue our efforts to monetize the value of our intellectual property in the future. These licensing agreements can also be linked with other contractual agreements and could represent multiple element arrangements under ASC Topic 605, "Revenue Recognition" or contain future performance provisions pursuant to SEC Staff Accounting Bulletin 104, "Revenue Recognition." The process of determining the appropriate revenue recognition in such transactions is highly complex and requires significant judgments and estimates.

Share-Based Compensation We account for awards granted under our share-based employee compensation plans using the fair-value recognition provisions of ASC Topic 718, "Compensation-Stock Compensation" ("ASC Topic 718"). These plans are more fully described in Note 6, "Employee Benefits and Incentive Plans" in the accompanying audited Consolidated Financial Statements and under the caption "Equity Compensation Plan Information" in our 2013 Proxy Statement.

Prior to our 2011 IPO We estimated fair values for non-qualified stock options granted prior to the IPO under the 2006 Management Incentive Plan and the 2007 Employee Incentive Plan during the applicable periods using the Black-Scholes option-pricing model with the weighted-average assumptions as indicated below: Quarter Ended Year Ended April 1, December 31, 2011 2010 Weighted average grant date fair value per share $ 7.43 $ 4.08 Weighted average assumptions used: Expected volatility 70.0 % 77.0 % Expected lives (in years) 6.25 6.25 Risk free interest rate 1.8 % 2.6 % Expected dividend yield - % - % In accordance with ASC Topic 718, the computation of the expected volatility assumptions used in the Black-Scholes calculations for grants was based on historical volatilities and implied volatilities of our peer group companies. We utilized the volatilities of peer group companies due to our lack of extensive history as a public company and the fact our current equity is not publicly traded. The peer group companies operate in the semiconductor industry and are of similar size. When establishing the expected life assumptions, we used the "simplified" method prescribed in ASC Topic 718 for companies that do not have adequate historical data. The risk-free interest rate is measured as the prevailing yield for a U.S. Treasury security with a maturity similar to the expected life assumption.

Prior to the completion of our IPO, given the absence of an active market for our common shares and the lack of any third-party transaction involving the common shares during the applicable periods, we estimated the fair value of our common shares for purposes of determining share-based compensation expense for the periods presented primarily based on the valuation analyses described below and an analysis of other relevant factors, including: • the level of operational risk and uncertainty surrounding forecasted cash flows; 76 -------------------------------------------------------------------------------- Table of Contents • our financial position, historical operating results, and expected growth in operations; • historical and forecasted EBIT and EBITDA measures; and • the lack of liquidity for the options and restricted stock units of our formerly private company.

The valuation analyses were prepared using the market-comparable approach and the income approach to estimate our aggregate enterprise fair value. To determine the estimated fair value of our equity, we reduced the resulting estimated enterprise fair value by the fair value of our outstanding debt. We prepared a contemporaneous valuation using the approach indicated above on an annual basis. We also monitored our valuations for indicators of potential changes in our estimated enterprise fair value and the estimated fair value of our equity on a quarterly basis.

The market-comparable approach indicates the fair value of a business based on a comparison of the subject company to comparable firms in similar lines of business that are publicly traded or which are part of a public or private transaction, as well as prior subject company transactions. Each comparable company was selected based on various factors, including, but not limited to, industry similarity, financial risk, company size, adequate financial data and actively traded stock price.

The income approach is a valuation technique that provides an estimate of the fair value of a business based on the cash flows that a business can be expected to generate over its remaining life. This approach begins with an estimation of the annual cash flows for each of the next ten years, which is then converted to a present value equivalent using a rate of return appropriate for the risk of achieving the business' projected cash flows. The present value of the estimated cash flows is then added to the present value equivalent of the residual value of the business at the end of the discrete ten year projection period to arrive at an estimate of the fair value of the business enterprise.

We prepared a financial forecast for each valuation to be used in the computation of the enterprise value for both the market-comparable approach and the income approach. The financial forecasts take into account past experience and future expectations. There is inherent uncertainty in these estimates.

We also consider the fact that our shareholders were restricted from transferring their common shares, subject to limited exceptions. The estimated fair value of our common shares at each valuation date reflected a non-marketability discount, partially based on the anticipated likelihood and timing of a future liquidity event. In the determination of fair value of the common shares, the non-marketability discount was 8% at the end of 2010. The discount was reduced in December 2010 based on the expectation of a potential liquidity event within the next 12 months. The resulting estimated fair value of common shares was: Three Months Year Ended Ended April 1, December 31, 2011 2010Weighted average grant date fair value per share $ 12.69 $ 6.40 The differences between the initial public offering price of $18.00 per share and the weighted average grant date fair value per share utilized in the first quarter of 2011 and that used in 2010 was due primarily to the continuing improvement in the market based valuations of our peer group and the continuing improvements in our operating results and was impacted by changes in the fair value of our outstanding debt during such periods. The indicators of improvements in market based valuations were demonstrated by the increase in the Philadelphia Semiconductor Index of approximately 26% as of April 21, 2011 compared to 8% compared to December 31, 2010; increases in the stock prices of our peer group ranging from 4% to 75% as of April 21, 2011 compared to December 31, 2010; and a peer group company initial public offering completed in the second half of 2010 that experienced an increase in its stock price of 139% and 60% as of April 21, 2011 compared to its initial public offering price and December 31, 2010, respectively. In addition, the differences between the initial public offering price of $18.00 per share and the weighted average grant date fair value per share utilized in the first quarter of 2011 and that used in 2010 was also impacted by the use of proceeds from our IPO and related 77-------------------------------------------------------------------------------- Table of Contents over-allotment option. We utilized the net proceeds, together with cash on hand, to reduce our outstanding debt by approximately 13%, which reduced our annual interest expense by approximately 10% compared to 2010. Both of these factors had significant impact on our equity value, which we were not able to take into consideration in our accounting for share-based compensation until the completion of our IPO and the related over-allotment option and the application of the net proceeds as intended. In addition, we continued to experience improvements in our financial operating performance (which ultimately impact our forecasts) as demonstrated by our net sales increasing 17% and our gross margin increasing 31% in the first quarter of 2011 as compared to the corresponding period in the prior year. We also experienced improvements in net sales of approximately 24%; an increase in adjusted operating earnings of 200%; and an increase in adjusted EBITDA of 51% in the fourth quarter of 2010 versus the corresponding period in the prior year.

There was inherent uncertainty in the forecasts and projections that were used in our common share valuations. If we had made different assumptions and estimates, the amount of our share-based compensation expense and net loss could have been different, and such differences could have been material. We performed a sensitivity analysis of the impact of an increase in the estimated fair value of our common shares on our share-based compensation expense under ASC Topic 718 for grants made in the first quarter of 2011 and during 2010. We granted 0.3 million options and 27 thousand restricted stock units during the first quarter of 2011 and 0.5 million options and 58 thousand stock units during 2010.

The impact of a $1 increase in the estimated fair value of our common shares from the respective estimated fair value of $12.69 per share for grants made during the first quarter of 2011 and $6.40 per share for grants made during 2010 would have resulted in an increase in share-based compensation expense of approximately $360,000 and $750,000 for the years ended December 31, 2011 and 2010, respectively. Using our IPO offering price of $18.00 per share for the sensitivity analysis, our share-based compensation expense would have increased by less than $1 million and $2 million for the years ended December 31, 2011 and 2010, respectively.

Using the initial public offering price of $18.00 per share, the aggregate intrinsic value of our vested outstanding stock options as of April 1, 2011 approximated $30 million and the aggregate intrinsic value of our unvested outstanding stock options as of April 1, 2011 approximated $91 million.

We believe that we used reasonable methodologies, approaches and assumptions consistent with the American Institute of Certified Public Accountants Practice Guide "Valuation of Privately-Held-Company Equity Securities Issued as Compensation" to determine the fair value of our common shares.

Following the completion of our IPO on June 1, 2011, for purposes of determining share-based compensation expense, we base the Black-Scholes weighted average grant date fair value of our common share-based awards on the closing market price of our common shares at the respective grant date of each award. (Refer to Note 6 to our accompanying audited Consolidated Financial Statements for further discussion of the valuation of these awards under the 2011 Omnibus Incentive Plan.) Subsequent to our 2011 IPO We estimated fair values for non-qualified stock options granted subsequent to the IPO under the 2011 Omnibus Plan using the Black-Scholes option-pricing model with the weighted-average assumptions as indicated below: Year Ended Year Ended December 31, December 31, 2012 2011Weighted average grant date fair value per share $ 6.93 $ 7.82 Weighted average assumptions used: Expected volatility 63.0 % 80.0 % Expected lives (in years) 5.00 4.75 Risk free interest rate 0.92 % 0.89 % Expected dividend yield - % - % 78 -------------------------------------------------------------------------------- Table of Contents Due to our continued lack of extensive history as a public company, we have continued to compute our volatility assumption based on historical volatilities and implied volatilities of our peer group companies (as noted above). When establishing the expected life assumption, we used the "simplified" method prescribed in ASC Topic 718 for companies that do not have adequate historical data. The risk-free interest rate is measured as the prevailing yield for a U.S.

Treasury security with a maturity similar to the expected life assumption.

Recent Accounting Pronouncements and Legislation Changes On January 2, 2013, President Obama signed into law the American Taxpayer Relief Act of 2012 (the "ATR Act") which included an extension of the federal research and development credit retroactively to 2012 and prospectively through 2013. The effects of the ATR Act are recognized in 2013. The renewal of this credit is not anticipated to change the Company's effective tax rate because the Company has incurred cumulative domestic losses, and has recorded valuation allowances against substantially all its domestic deferred tax assets.

The SEC adopted the conflict mineral rules under Section 1502 of the Dodd-Frank Wall Street Reform and Consumer Protection Act on August 22, 2012. The rules require public companies to disclose information about their use of specific minerals originating from and financing armed groups in the Democratic Republic of the Congo or adjoining countries. The conflict mineral rules cover minerals frequently used to manufacture a wide array of electronic and industrial products including semiconductor devices. The rules do not ban the use of minerals from conflict sources, but require public disclosure beginning with calendar year 2013. We have determined that we are subject to the rules and are evaluating our supply chain and continue to develop processes to assess the impacts and comply with the regulation.

[ Back To Technology News's Homepage ]