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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-K

For the fiscal year ended December 31, 2004

or

For the transition period from              to             

Commission File Number 001-32241

FREESCALE SEMICONDUCTOR, INC.

(Exact name of registrant as specified in its charter)

6501 William Cannon Drive West

Austin, Texas

(Address of principal executive offices)

(512) 895-2000

(Registrant’s telephone number)

Securities registered pursuant to Section 12(b) of the Act:

Securities registered pursuant to Section 12(g) of the Act:

None

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  ¨    No  x.

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.  ¨

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Act).    Yes  ¨    No  x.

The aggregate market value of voting and non-voting Class A common equity held by non-affiliates of the registrant as of January 31, 2005 was approximately $1.549 billion (based on closing sale price of $17.10 per share as reported for the New York Stock Exchange-Composite Transactions).

The aggregate market value of voting and non-voting Class B common equity held by non-affiliates of the registrant as of January 31, 2005 was approximately $4.052 billion (based on closing sale price of $17.47 per share as reported for the New York Stock Exchange-Composite Transactions).

The number of shares outstanding of each of the issuer’s classes of common stock as of the close of business on January 31, 2005:

DOCUMENTS INCORPORATED BY REFERENCE

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PART I

“Freescale” (which may be referred to as the “Company”, “we”, “us” or “our”) means Freescale Semiconductor, Inc. and its subsidiaries, or one of our segments, as the context requires. “Freescale” is a registered trademark of Freescale Semiconductor, Inc.

Item 1: Business

General

Our Company

Freescale Semiconductor, Inc. (NYSE: FSL, FSL.B) is a global leader in the design and manufacture of embedded semiconductors for the automotive, consumer, industrial, networking and wireless markets. Freescale became a publicly traded company in July 2004 after more than 50 years as part of Motorola, Inc. We are based in Austin, Texas, and have design, research and development, manufacturing or sales operations in more than 30 countries. We are one of the largest semiconductor companies in the world. Coincident with the separation from Motorola in December of 2004, we joined the S&P 500 index, the Philadelphia Semiconductor Index, also known as the SOXX, and the Russell 1000 Index. Our net sales for the year ended December 31, 2004 were $5.7 billion, and for the year ended December 31, 2003 were $4.9 billion.

A common attribute of our success in each of the target markets that we serve is our ability to offer families of embedded processors. In their simplest forms, embedded processors provide the basic intelligence for electronic devices and can be programmed to address specific applications or functions. Examples of our embedded processors include microcontrollers, digital signal processors and communications processors.

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

Our Industry

Semiconductors are the key building blocks used to create electronic products and systems. Semiconductors perform a variety of functions, such as processing data, storing information and converting or controlling signals. With advances in semiconductor technology, the functionality and performance of semiconductors has increased while the size, weight, power requirements and unit costs have decreased. The result of these advances has been to increase the proliferation of electronic content in an increasing array of products. According to the Semiconductor Industry Association, the semiconductor market grew from $18 billion in 1983 to $213 billion in 2004, representing a compound annual growth rate of 12.5%.

Recent Trends in the Semiconductor Industry

Worldwide sales of semiconductors were $213 billion in 2004, an increase of 28% from the $166 billion recorded in 2003. The 2004 semiconductor sales established an all-time record level, surpassing the previous record set in 2000 of $204 billion.

Strong growth in sales of personal computers and wireless handsets were among the major drivers of the record semiconductor sales in 2004. Strong PC sales, a 15% increase to 177 million units according to IDC,

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contributed to a very strong 61% increase in sales of DRAMS (a product we do not offer) with microprocessor sales up 11%. iSuppli reports that wireless handset sales increased to 674 million units in 2004, up 19% from 2003 levels. Handset growth contributed to strong digital signal processor sales which increased by 27% in 2004. The automotive semiconductor market grew 12% in 2004, according to Gartner, driving microcontroller growth of 25%.

The Asia-Pacific region paced the world in semiconductor sales in 2004 with growth of 41% according to the Semiconductor Industry Association. At $89 billion, the Asia Pacific semiconductor market was nearly double the size of Japan, the second largest market, whose sales of $46 billion were up 18%. Semiconductor sales in Europe grew 22%, with semiconductor sales in the Americas region up 21%.

For 2005, the consensus outlook is for the semiconductor market to experience little or no growth. Continuing efforts to reduce excess inventories across the entire supply chain and expanding supply suggested by declining capacity utilization rates will combine to create a challenging environment for us and the semiconductor industry in 2005.

Our Strengths

Given the trends that are currently having an impact on the semiconductor industry, we believe that flexible manufacturing resources, a strong intellectual property position, a global presence, broad product lines, software programmable products and platform-level products will be key competitive differentiators. We believe that we have many of the attributes that will be necessary for long-term success in the industry, including the following:

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Our Strategy

We intend to enhance our position as a leading global semiconductor company by continuing to apply the following strategy:

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Products and Applications

We design, develop, manufacture and market a broad range of semiconductor products that are based on our core capabilities in embedded processing. In addition, we offer customers differentiated products that complement our embedded processors and provide connectivity, such as sensors, RF semiconductors, and power management and other analog and mixed-signal semiconductors. Our capabilities enable us to offer customers a broad range of product offerings, from individual devices to platform-level products that combine semiconductors with software for a given application.

We are organized into three primary business groups: Transportation and Standard Products Group (TSPG), Networking and Computing Systems Group (NCSG), and Wireless and Mobile Solutions Group (WMSG). These groups are primarily applications-focused, although TSPG also includes standard products sold into a wide variety of end markets.

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The following table gives an overview of some of the principal products and applications of each of our three primary business groups:

Business Segments

Transportation and Standard Products Group (TSPG)

TSPG Overview

TSPG is a global leader in the design, manufacturing and marketing of the key components of embedded control systems. These components include embedded processors (microcontrollers, embedded microprocessors and digital signal processors), sensors and analog and mixed-signal integrated circuits. We provide comprehensive product offerings, including development tools, application support, training, documentation and platforms, enabling our customers to rapidly go to market.

Embedded control systems are found in a number of applications. For example, TSPG products can serve as the “brains” of automotive control systems, from wipers that respond to the intensity of rainfall to engine management systems that have significantly reduced exhaust emissions and fuel consumption while giving drivers enhanced performance. TSPG products can make printers operate more quickly and can wirelessly communicate mouse clicks to a computer. TSPG products can monitor food temperature in fast food restaurants and temperature in industrial equipment. They are found in homes in places such as remote controls, microwave ovens, thermostats and toys.

Primary application areas for TSPG products are:

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In 2004, over 70% of TSPG’s sales were generated from automotive applications.

TSPG Market Opportunity

We believe that the automotive industry, which currently represents the largest portion of TSPG sales, is an attractive market given its consistent long-term growth profile, its longer product life cycles and its lower degree of variability when compared to most other semiconductor markets. Semiconductor growth in this market is driven only to a small degree by vehicle production and is instead primarily driven by the increasing electronic content in vehicles, particularly in the areas of safety, powertrain management, comfort and entertainment features. Also driving growth in this market is the replacement of mechanical systems with electronically controlled systems. Examples are the replacement of manually operated car windows, the replacement of hydraulic power steering with electric power steering, and, in the future, the replacement of hydraulic brakes with electronic “brake-by-wire” systems.

The industrial, consumer and computer peripheral industries also represent significant growth opportunities for TSPG. Our TSPG strategy is to expand our portfolio of both general purpose and application specific products for the industrial, consumer and computer peripheral markets. The diverse customer and application base this creates is a strength of TSPG’s business.

Our key competitors in this group include Analog Devices, Inc., Bosch, Fujitsu Ltd., Infineon, Microchip Technology Incorporated, NEC Corporation, Philips Electronics, Renesas, STMicroelectronics and Texas Instruments.

TSPG Principal Products

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TSPG Strengths

We believe our key competitive strengths include:

TSPG Growth Drivers

We are focused on three initiatives that we believe will drive our future revenue growth:

Networking and Computing Systems Group (NCSG)

NCSG Overview

NCSG designs, manufactures and markets embedded processors and complementary connectivity products for the wired and wireless networking and computing markets. We offer semiconductors that facilitate the transmission, switching and processing of data and voice signals within communications systems. Our products support multiple communications standards and protocols, security features, network processing and broadband access devices. These products are used in four major types of equipment:

Our PowerQUICC^™ family of communications processors is one of the key offerings of NCSG, typically generating between 30% and 40% of NCSG sales.

NCSG Market Opportunity

The communications semiconductor market is driven largely by demand for high-speed access to communications networks. As the number and types of devices accessing communications networks continues to expand and as multimedia applications, which use larger amounts of network capacity, proliferate, the demand for bandwidth and high-speed communications equipment is expected to grow. An example of the type of

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application driving greater network access rates is WLAN access points that require both processing and advanced security features at the point of access to protect the data being transmitted as well as the integrity of the network being accessed.

Our key competitors in this group include Agere, Broadcom Corporation, Conexant Systems Inc., Intel, International Business Machines Corporation, Marvell Technology Group Ltd., PMC-Sierra, Inc., Texas Instruments and Vitesse Semiconductor Corporation.

NCSG Principal Products

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NCSG Strengths

We believe our key competitive strengths include:

NCSG Growth Drivers

We are focused on four initiatives that we believe will drive our future revenue growth:

Wireless and Mobile Solutions Group (WMSG)

WMSG Overview

WMSG designs, manufactures and markets platform-level products and semiconductors used in the design and manufacturing of wireless mobile devices such as cellular phones, smartphones, personal digital assistants (PDAs), two-way messaging devices, global positioning systems, mobile gaming devices and wireless consumer electronics. Our strategy focuses on enabling the proliferation of wireless platforms, applications processors and radio frequency devices. Currently, over 90% of our sales in this group are derived from cellular handsets, with Motorola being our largest end customer, representing 74%, 69% and 73% of WMSG’s 2004, 2003, and 2002 sales, respectively.

As part of our separation from Motorola, we entered into a multi-year purchase and supply agreement through the end of 2006. Under this agreement, Motorola has committed, on behalf of its cellular subscriber businesses, to purchase from us substantially all of its cellular baseband semiconductor requirements (other than cellular baseband products based on code division multiple access technologies which we do not design) for cellular handsets designed by Motorola and manufactured by or for Motorola through 2006. Under this

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agreement, Motorola will also treat us as a preferred supplier for other semiconductor components required by its cellular subscriber businesses for cellular handset manufacturing. In addition, Motorola has agreed to continue to encourage its original design manufacturers to purchase cellular baseband products and other semiconductors from us in connection with their production of cellular handsets for Motorola. Motorola’s obligations are subject to our ability to continue to supply our products on a competitive basis with respect to pricing, timing and features and other customary conditions with respect to capacity, delivery, quality and development.

WMSG Market Opportunity

Much of the growth in this market is expected to be driven by the growing adoption of 3G cellular handsets, which require increased semiconductor content for enhanced multimedia functionality and access to high-bandwidth data networks. We intend to expand our customer base for handsets beyond Motorola focusing on the current leading handset vendors around the world, as well as developing relationships with several of China’s largest original equipment manufacturers and original design manufacturers to help them create faster time-to-market products.

Our key competitors in this group include Infineon, Philips Electronics, QUALCOMM, RF Microdevices, Inc., Skyworks Solutions, Inc., STMicroelectronics and Texas Instruments.

WMSG Principal Products

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WMSG Strengths

We believe our key competitive strengths include:

WMSG Growth Drivers

We are focused on three initiatives that we believe will drive our future revenue growth:

Customers, Sales and Marketing

We sell our products worldwide to original equipment manufacturers, to original design manufacturers and to contract manufacturers through our own sales force, agents and distributors. As of December 31, 2004, our internal sales force included over 800 sales, sales support personnel and field applications engineers. Our direct sales force is aligned by customer end markets in order to bring dedicated expertise and knowledge to our customers.

We also maintain a network of distributors that have the global infrastructure and logistics capabilities to handle several thousand other customers. Our main global distributors are Arrow Electronics, Inc., Avnet, Inc. and Future Electronics, Inc., complemented by a number of specialty regional distributors who have special relationships with their customers based on their respective collections of product offerings.

We have 69 sales offices located in 24 countries. We believe that it is important to have a large number of sales offices to closely align ourselves with the development efforts of our customers, as well as to be able to respond quickly to customer requirements.

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We generally target customers who are leaders in industries in which our products are used as well as companies that we believe will be future leaders in these industries. Motorola is currently our largest end customer, comprising approximately 28%, 23%, and 26% of 2004, 2003 and 2002 sales. No other end customer represented more than 10% of our sales for these periods.

Research and Development

Research and development is critical to our success, and we are committed to maintaining consistent levels of research and development expenditures. Our research and development spending has been approximately $1.0 billion for each of the past three years. Our research and development activities focus on both product and process development. Our product design engineering activities, which constitute the majority of our research and development expenditures, are primarily aligned with our three business groups and the areas of focus for these investments are described within the relevant business sections. Our process technology development resources are shared across our three business groups and, in addition, we have shared resources for development in selected areas, such as embedded memory technology, packaging technology and system-on-a-chip design methodology. We believe that this approach allows us to apply our investments in process technology and other selected areas across a broad portfolio of products.

We participate in alliances or other arrangements with external partners in the area of process technology, manufacturing technology and materials development to reduce the cost of development and accelerate access to new technologies. For example, our jointly-funded alliance with STMicroelectronics and Philips Electronics in Crolles, France is focused on the development of advanced CMOS process technology from 90 nanometers down to 32 nanometers on 300 millimeter wafers. This cooperation includes the development of analog, memory, SOI and radio frequency capabilities to be implemented in CMOS to enable the production of integrated system-on-a-chip products. TSMC also participates in the process technology development aspects of the Crolles alliance, with the objective of maintaining electrical alignment of base CMOS technologies in Crolles and in TSMC, which provides us flexibility for potential volume manufacturing supply at TSMC. In addition, we have joint development activities with TSMC for adding flash memory technology to basic CMOS for microcontroller manufacture, as well as developing a high-performance 65-nm SOI front-end process. We are members of Sematech Inc. and the Semiconductor Research Corporation for advanced process development research, a founder member of EUV LLC, a consortium promoting advanced lithography research, and we also collaborate on a number of projects with universities globally. We have several research projects with IMEC (Leuven, Belgium), and collaborative research programs with CEA-LETI (Grenoble, France).

As of December 31, 2004, our total research and development staff consisted of approximately 5,500 employees working at 50 sites around the world. Our research and development locations include facilities in the United States, Hong Kong, Brazil, China, India, Japan, Romania, Israel, Australia, the United Kingdom, France and Germany.

Manufacturing

Our goal is to optimize our manufacturing capacity through a balanced use of internal capabilities, external manufacturing and alliances. We currently manufacture a substantial portion of our products at our own facilities. However, in the past several years, as part of our asset-light strategy, we consolidated several factories which reduced our number of total manufacturing facilities from 22 to nine, including seven fabs, and reduced the number of manufacturing employees by 8,700.

As part of our asset-light strategy, we utilize a balance of internal and external manufacturing resources for standard CMOS processes and high-volume products. This allows us to maximize cash flow and minimize the risk associated with market fluctuations. For specialty technologies, such as silicon germanium, we will continue to source nearly all of this volume internally. We have relationships with several wafer foundries and assembly and test subcontractors to meet our external sourcing needs. In June 2002, we announced a strategic manufacturing relationship with TSMC for greater access and flexibility of supply.

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For advanced technology, we have a five-year jointly funded alliance with STMicroelectronics and Philips Electronics for 300 millimeter wafer fabrication in Crolles, France. We own equipment in this facility as a result of our investment.

We operate nine owned manufacturing facilities, of which seven are wafer fabrication facilities and the remaining two are assembly and test facilities. The locations of these facilities, the types of products they produce and technologies that they support are described in the table below. These facilities are certified to the ISO-9000/14001 international quality standards plus the TS16949 standard for the automotive industry.

Manufacturing Facilities

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Our manufacturing processes require many raw materials, such as silicon wafers, mold compound, packaging substrates and various chemicals and gases, and the necessary equipment for manufacturing. We obtain these materials and equipment from a large number of suppliers located throughout the world. These suppliers deliver products to us on a just-in-time basis, and we believe that they have sufficient supply to meet our current needs, although it is possible that we could experience inadequate supply due to a sudden worldwide surge in demand. In addition, we sole source a number of our supplies. Should an unexpected event occur at one of these suppliers, our business, financial condition and results of operations could be adversely affected.

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

Our business continuity plan covers issues related to continuing operations (e.g., continuity of manufacturing and supply to customers), crisis management of our business sites (e.g., prevention and recovery from computer, data, hardware and software loss) and information protection. We perform annual risk assessments at each site, review over 1,200 activities, scenarios, risks and actual events, and conduct annual test drills. Generally, we maintain multiple sources of supply of qualified technologies. We also audit our suppliers’ compliance with their plans.

Competition

We operate in a highly competitive market. While few companies compete with us in all of our product areas, our competitors range from large, international companies offering a full range of products to smaller companies specializing in narrow markets within the semiconductor industry. The competitive environment is also changing as a result of increased alliances between competitors, and we expect that this will continue to evolve through alliances, strategic acquisitions or other agreements among our competitors. Our competitors may have greater financial, personnel and other resources than we have in a particular market or overall. We expect competition in the markets in which we participate to continue to increase as existing competitors improve or expand their product offerings or as new participants enter our markets. Increased competition may result in reduced profitability and reduced market share.

We compete in our different product lines primarily on the basis of price, technology offered, product features, quality and availability, warranty, quality and availability of service, time-to-market and reputation. Our ability to develop new products to meet customer requirements and to meet customer delivery schedules are also critical factors. New products represent the most important opportunity to overcome the increased competition and pricing pressure inherent in the semiconductor industry.

Our primary competitors are other integrated device manufacturers, such as Infineon, Intel Corporation, Renesas Technology Corporation, STMicroelectronics and Texas Instruments Incorporated. However, our key competition varies to some degree in each of our groups.

Backlog

Our backlog was $1.3 billion at December 31, 2004, $1.2 billion at December 31, 2003 and $1.1 billion at December 31, 2002. Motorola represented approximately 34%, 33% and 28% of that backlog on each of those respective dates. Orders are placed by customers for delivery for up to as much as 12 months in the future, but for purposes of calculating backlog, only the next 13 weeks’ requirements are reported. An order is removed from the backlog only when the product is shipped, the order is cancelled or the order is rescheduled beyond the

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13-week delivery window used for backlog reporting. In the semiconductor industry, backlog quantities and shipment schedules under outstanding purchase orders are frequently revised in response to changes in customer needs. 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, we believe that most of our order backlog is cancelable. For these reasons, the amount of backlog as of any particular date may not be an accurate indicator of future results.

Employees

As of December 31, 2004, we employed approximately 22,200 full-time employees, compared to approximately 22,300 full-time employees at December 31, 2003 and 24,800 at December 31, 2002. Approximately 5,500 were dedicated to research and development, 14,100 to manufacturing, 1,500 to selling and marketing and 1,100 to general and administrative functions. By geography, 42% of our employees are located in the United States, 36% in the Asia/Pacific region, 21% in Europe and 1% in all other locations. We believe that our continued success will depend on our ability to attract and retain highly qualified personnel.

Directors and Executive Officers

Set forth below is information concerning our directors and executive officers.

Our Non-Employee Directors

H. Raymond Bingham has served as one of our Directors since the completion of our initial public offering in July 2004. Mr. Bingham has been Executive Chairman of the Board of Directors of Cadence Design Systems, Inc., a supplier of electronic design automation software and services, since May 2004. Prior to being named Executive Chairman, he was a Director, President and Chief Executive Officer of Cadence since April 1999. Mr. Bingham previously served as the Executive Vice President and Chief Financial Officer of Cadence from 1993 to April 1999. Mr. Bingham is also a Director of KLA-Tencor Corporation and Oracle Corporation.

Stephen P. Kaufman has served as one of our Directors since the completion of our initial public offering in July 2004. Mr. Kaufman has been a Senior Lecturer of Business Administration at the Harvard Business School

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since January 2001. From 1986 to July 2000, he served as Chief Executive Officer of Arrow Electronics, Inc., a distributor of electronic components and computer-related products, and from 1992 to June 2002 he served as Chairman of the Board. Prior to joining Arrow, he served in executive capacities with Midland-Ross Corporation, a manufacturer of electrical, electronic and aerospace products and thermal systems. Prior to Midland-Ross, he was a partner of McKinsey & Co., an international management consulting firm. Mr. Kaufman is also a director of Harris Corporation and KLA-Tencor.

Dr. Kevin Kennedy has served as one of our Directors since the completion of our initial public offering in July 2004. Dr. Kennedy has been Chief Executive Officer of JDS Uniphase, a manufacturer of optical products for communications, commercial and consumer applications since September 1, 2003, and has served as a Director of JDS Uniphase as well as Chairman of its Corporate Development Committee since October 2001. Dr. Kennedy served as a Director and Chief Operating Officer of Openwave Systems from August 2001 to 2003. Prior to joining Openwave, Dr. Kennedy spent seven years at Cisco Systems, a manufacturer of computer networking systems, last as Senior Vice President of the Service Provider Line of Business and Software Technologies Division. Dr. Kennedy is also a Director of Openwave Systems and Rambus, Inc.

Antonio M. Perez has served as one of our Directors since December 2004. Mr. Perez has been President and Chief Operating Officer of Eastman Kodak Company since April 2003, and has served as a director of Kodak since October 2004. Just prior to joining Kodak, Mr. Perez served as an independent consultant for large investment firms, providing counsel on the effect of technology shifts on financial markets. From June 2000 to December 2001, Mr. Perez was President and Chief Executive Officer of Gemplus International. Mr. Perez previously spent 25 years with Hewlett-Packard Company, where he served as president of its Consumer Business, president of its inkjet imaging business, corporate vice president and a member of HP’s Executive Council. He also held a variety of positions in research and development, sales, manufacturing, marketing and management with HP, both in Europe and the U.S.

B. Kenneth West has served as one of our Directors since the completion of our initial public offering in July 2004. Mr. West has been a Senior Consultant for Corporate Governance to TIAA-CREF, a major pension fund company, since 1995. He retired as Chairman of Harris Bankcorp, Inc. in 1995 where he had been employed since 1957. A former Director of Motorola, Mr. West currently serves as Chairman of the National Association of Corporate Directors (NACD) and as a Director of The Pepper Companies, Inc., a privately owned commercial construction company.

Our Executive Officers

The following sets forth information concerning our executive officers. All of our executive officers are appointed by our board of directors.

Michel Mayer has served as our Chairman and Chief Executive Officer since May 2004. From September 2001 to November 2003, Mr. Mayer served as general manager of IBM Microelectronics, the semiconductor business of International Business Machines Corporation (“IBM”). During that time period, Mr. Mayer also served on IBM’s Worldwide Management Council. Mr. Mayer served in various capacities with IBM from 1984 to 2001, including as general manager of IBM’s pervasive computing division and its networking hardware division, as well as in engineering and product management roles for IBM in both the U.S. and France. Mr. Mayer also serves as a director of the Semiconductor Industry Association.

Alan Campbell is our Senior Vice President and Chief Financial Officer. Mr. Campbell served as Senior Vice President and Director of Finance of the SPS division of Motorola, Inc. (“SPS”) from February 2003 to May 2004. From May 2001 to February 2003, he served as Corporate Vice President and Director of Finance of SPS. From October 2000 to May 2001, he served as Vice President and Director of Finance of SPS. Prior to that he served as Vice President and Director of Finance of SPS’s Technology and Manufacturing Group.

David M. Doolittle is our Senior Vice President, Human Resources. Mr. Doolittle served as Senior Vice President and Director of Human Resources of SPS from May 2002 to May 2004. Prior to May 2002, he was

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Corporate Vice President and Director, Human Resources of SPS for two years. Prior to that he was Vice President and Director of Human Resources of SPS’s Order Fulfillment Organization and for the Austin Region.

Franz Fink is our Senior Vice President and General Manager, Wireless and Mobile Systems Group. Mr. Fink served as Vice President and General Manager of SPS’ Wireless and Mobile Systems Group from April 2003 to May 2004. Prior to that, Mr. Fink served as Vice President and General Manager of the 32-bit Embedded Controller Division in SPS’ Transportation and Standard Products Group.

Paul E. Grimme is our Senior Vice President and General Manager, Transportation and Standard Products Group. Mr. Grimme served as Corporate Vice President and General Manager of the Transportation and Standard Products Group of SPS from July 2003 to May 2004. Prior to that, Mr. Grimme served as Corporate Vice President and General Manager of the 8/16 bit division of the Transportation and Standard Products Group of SPS.

Janelle S. Harris is our Senior Vice President of Business Operations and has held this newly-created position since February 2005. Ms. Harris served as Senior Vice President for Global Channel Sales, from April 2004 to February 2005. Ms. Harris served as Corporate Vice President and Director, Global Channel Sales for SPS, from February 2003 through March 2004, and prior to that, as Vice President and Director, Global Channel Sales for SPS from September 2000 through January 2003.

Alexander Pepe is our Senior Vice President of Manufacturing and has held this position since February 2005. Mr. Pepe served as Vice President and General Manager of the Transportation and Standard Products Group’s 32-bit Embedded Controller Division from June 2003 to February 2005. Prior to that, Mr. Pepe served as Vice President and Assistant General Manager of the Wireless Broadband Systems Group of SPS from January 2003 to June 2003. Prior to that, Mr. Pepe served as Vice President Strategy, Technology and Manufacturing of SPS from April 2001 to January 2003, and as Vice President, Die Manufacturing Wireless Broadband Systems Group/Networking and Computing Systems Group from December 1999 to April 2001.

David Perkins is our Senior Vice President and General Manager, Networking and Computing Systems Group. Mr. Perkins served as Corporate Vice President and General Manager of the Networking and Computing Systems Group of SPS from February 2002 to May 2004. Mr. Perkins served as President and CEO of Metrowerks from 1999 to 2002. Prior to becoming an executive officer of Metrowerks in 1995, Mr. Perkins was a partner at Coopers & Lybrand.

Sumit Sadana is our Senior Vice President, Strategy, and has held this position since December 2004. Prior to that, Mr. Sadana served as Vice President of IBM’s electronic design technology solutions business from April 2004 to October 2004. Prior to that, Mr. Sadana served as IBM’s Director of Strategy, Technology Group from January 2001 to April 2004, and as operations manager for IBM Technology Group’s Networking Business from February 2000 to December 2000.

Dr. Claudine Simson is our Chief Technology Officer, with global research and development responsibility for semiconductor process, design and system technologies. Dr. Simson is also leading our corporate standards function and driving Innovation and Intellectual Property generation across the company. Dr. Simson served as Corporate Vice President and Chief Technology Officer of Motorola - Semiconductor Product Sector from March 2003 to May 2004. Prior to joining Motorola, Dr. Simson was Chief Technology Officer at IPVALUE Management, based in Palo Alto, CA, after spending 24 years with Nortel Networks where she was senior executive in technology research and development. Dr. Simson is the recipient of three honorary doctorates and of the Order of France for the worldwide advancement of Science & Technology. She is Fellow of the Royal Society of Canada (Academy of Science) and Fellow of the Fields Institute for Mathematical Research (which delivers the Fields Medal, equivalent to the Nobel Prize for Mathematics).

John D. Torres is our Senior Vice President and General Counsel. Mr. Torres served as a Vice President in Motorola’s Corporate Law Department and Law Director for SPS from April 2001 to May 2004. From October

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2000 to March 2001, he served in Motorola’s Corporate Law Department as Law Director for SPS. From February 2000 to September 2000, he served in Motorola’s Corporate Law Department as Commercial Law Director for SPS. From May 1996 to January 2000, he served in Motorola’s Corporate Law Department as Senior Counsel supporting Motorola’s Satellite Communications Group.

Item 2: Properties

Our principal executive offices are located at 6501 William Cannon Drive West, in Austin, Texas. We also operate manufacturing facilities, design centers and sales offices throughout the world, some of which are currently shared facilities with Motorola. As of December 31, 2004, we owned 14 facilities, 4 of which are located in North America and 10 of which are located in other countries. In the aggregate, we lease 105 facilities, 45 of which are located in the Americas and 60 of which are located in other countries. Our total square footage consists of 13 million square feet, of which 10.7 million square feet is owned and 2.3 million square feet is leased. Our remaining lease terms range from monthly leases to 21 years.

The following table describes our facilities:

As part of our overall strategy to reduce operating costs and improve our financial performance, a number of facilities have either been sold or are currently for sale. Since January 2003, facilities in Irvine, California, Mesa, Arizona, Sendai, Japan, South Queensferry, Scotland, and Tianjin, China were sold. Facilities, or portions thereof, including land, in Austin, Texas and West Creek, Virginia are currently for sale.

We believe that all of our facilities and equipment are in good condition, are well maintained and are able to operate at present levels.

We have a concentration of manufacturing (including assembly and test) in Asia, primarily in China, Japan, Malaysia and Taiwan, either in our own facilities or in the facilities of third parties. If manufacturing in the region were disrupted, our overall production capacity could be significantly reduced.

See “Manufacturing Facilities” in Item 1: Business for a more detailed description of our properties.

Item 3: Legal Proceedings

Intellectual Property Matters

Protection of our patent portfolio and other intellectual property rights is very important to our operations and has become even more important under our new business model discussed above. We intend to continue to license our intellectual property to third parties. We have a broad portfolio of over 4,900 patent families and numerous licenses, covering manufacturing processes, packaging technology, software systems and circuit

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design. A patent family includes all of the equivalent patents and patent applications that protect the same invention, covering different geographical regions. These patents are typically valid for 20 years from the date of filing. We do not believe that any individual patent, or the expiration thereof, is or would be material to any of our business groups.

Legal Proceedings

From time to time we are involved in legal proceedings arising in the ordinary course of business, including tort and contractual disputes, claims before the United States Equal Employment Opportunity Commission and other employee grievances, and intellectual property litigation and infringement claims. Intellectual property litigation and infringement claims could cause us to incur significant expenses or prevent us from selling our products. Under our agreements with Motorola, we will indemnify Motorola for certain liabilities related to our business and have assumed certain of these liabilities.

One intellectual property litigation matter is now pending against Micron Technology. On January 8, 2004, Motorola filed a complaint asserting infringement of ten patents against Micron Technology in the United States District Court for the Western District of Texas, Austin Division, seeking, among other remedies, unspecified monetary damages and injunctive relief. Those patents have been assigned to the Company and the Company has been added to the lawsuit. On March 15, 2004, Micron Technology answered and counterclaimed by asserting 17 patents against Motorola, and by seeking, among other remedies, unspecified monetary damages and injunctive relief. On March 30, 2004, Micron Technology filed a separate patent infringement suit asserting infringement of seven other patents against Motorola in a different federal court, the United States District Court for the Western District of Wisconsin, again seeking, among other remedies, unspecified monetary damages and injunctive relief. Motorola answered the complaint and counterclaimed by accusing Micron Technology of infringing five of the same patents that are the subject of the Texas lawsuit seeking, among other remedies, unspecified monetary damages and injunctive relief. On June 10, 2004, the court in the Wisconsin case ordered that the Wisconsin case be transferred to the United States District Court for the Western District of Texas, and that action has now been consolidated with the Austin case. Under the agreements with Motorola, the Company has defense and indemnity obligations to Motorola for the Austin case. While a trial date has not been set, under the current scheduling order trial will not occur until mid-2006.

If we are unsuccessful in resolving any of these proceedings, our operations may be interrupted or we may incur additional costs that could adversely affect our financial condition. However, we do not believe we will be unsuccessful in resolving these proceedings.

Other than as described above, we do not believe that there is any litigation pending that could have, individually or in the aggregate, a material adverse effect on our financial position, results of operations, or cash flow.

Environmental Matters

Our operations are subject to a variety of environmental laws and regulations in each of the jurisdictions in which we operate governing, among other things, air emissions, wastewater discharges, the use, handling and disposal of hazardous substances and wastes, soil and groundwater contamination and employee health and safety. As with other companies engaged in similar industries, environmental compliance obligations and liability risks are inherent in many of our manufacturing and other activities. In the United States certain environmental remediation laws, such as the federal “Superfund” law, can impose the entire cost of site clean-up, regardless of fault, upon any one among a number of statutory categories of parties, including companies that owned, operated or sent wastes to a site. In some jurisdictions, environmental requirements could become more stringent in the future which could affect our ability to obtain or maintain necessary authorizations and approvals or result in increased environmental compliance costs.

Motorola has been identified as a Potentially Responsible Party at the two facilities identified below, and has been engaged in investigations, administrative proceedings, and/or cleanup processes with respect to past

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chemical releases into the environment at those facilities. Under our agreements with Motorola, we will indemnify Motorola for liabilities related to our business, including the matters described below, and have assumed these liabilities. Our potential future liability at such sites (excluding costs spent to date) may adversely affect our results of operations.

52nd Street Facility, Phoenix, AZ. In 1983, a trichloroethane leak from a solvent tank led to the discovery of trichloroethylene and other organic compounds in the groundwater underlying a former Motorola facility on 52nd Street in Phoenix, Arizona, which is a federal National Priorities List Superfund site. The Superfund site has been divided into operable units by the Environmental Protection Agency (EPA). The first operable unit required Motorola to investigate and perform on-site soil and groundwater remediation at and in the vicinity of the 52nd Street facility. EPA issued a record of decision for the second operable unit in July 1994. That decision led to a consent decree involving Motorola that resulted in the design of a remediation plan targeted at containing and cleaning up solvent groundwater contamination downgradient of the first operable unit. That remedy is now being implemented by Motorola and another potentially responsible party. The EPA has not announced a final remedy for either the first operable unit or the second operable unit which leaves open the possibility that there could be additional cleanup costs associated with either operable unit. We are actively working with federal and state agencies to perform remedial action consistent with what we believe to be the appropriate level of responsibility. The EPA has performed some preliminary investigation into a third operable unit, which is an area extending beyond the boundaries of the area delineated in the second operable unit. A number of additional potentially responsible parties, including Motorola, have been identified at the third operable unit. We believe our responsibility for the third operable unit conditions to be negligible. We are also attempting to resolve the extent of our liability with these agencies and other responsible parties for the entire site.

56th Street Facility, Phoenix, AZ. In 1985, the EPA initiated an inquiry concerning our 56th Street facility in Phoenix, Arizona following the discovery of organic compounds in certain local area wells. The Arizona Department of Environmental Quality assumed primary responsibility for this matter. We voluntarily undertook negotiations with the state to remediate the groundwater contamination, and are currently managing the remediation under the Arizona Department of Environmental Quality’s Water Quality Assurance Revolving Fund Program.

Item 4: Submission of Matters to a Vote of Security Holders

Not applicable.

PART II

Item 5: Market for Registrant’s Common Equity and Related Stockholder Matters

Our Class A common stock and Class B common stock are listed on the New York Stock Exchange under the trading symbols “FSL” and “FSL.B”, respectively. As of January 31, 2005 there were 12 stockholders of record of Freescale Class A common stock. As of January 31, 2005 there were 68,329 stockholders of record of Freescale Class B common stock.

The remainder of the response to this Item incorporates by reference Note 13, “Quarterly and Other Financial Data (unaudited)” of the Notes to Consolidated Financial Statements in “Item 8: Financial Statements and Supplementary Data”.

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Item 6: Selected Financial Data

Freescale Semiconductor, Inc. and Subsidiaries

Five Year Financial Summary

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Item 7: Management’s Discussion and Analysis of Financial Condition and Results of Operations

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 in the periods ended December 31, 2004, 2003 and 2002. This commentary should be read in conjunction with our consolidated and combined financial statements and the notes in “Item 8: Financial Statements and Supplementary Data”.

This report contains “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995. Forward-looking statements may be identified by words such as expects, anticipates, plans, beliefs, estimates, will or words of similar meaning and include statements regarding the plans and expectations for the first quarter, the year and the future. These forward-looking statements are found at various places throughout this report and in the documents incorporated herein by reference. We undertake no obligation to update or revise any forward-looking statement, whether as a result of new information, future developments or otherwise. Although we believe that our expectations are based on reasonable assumptions, we can give no assurance that our goals will be achieved. Important factors that could cause our actual results to differ from estimates or projections contained in the forward-looking statements are described under “Trends, Risks and Uncertainties” in Item 7.

Overview

Our Business. Freescale Semiconductor, Inc. is a leading global semiconductor company focused on providing embedded processing and connectivity products to large, high-growth markets. We currently focus on providing products to the automotive, networking and wireless communications industries. Examples of embedded processors include microcontrollers, digital signal processors and communications processors. In addition to our embedded processors, we also offer a portfolio of complementary devices that facilitate connectivity between products, across networks and to real-world signals, such as sound, vibration and pressure. These complementary devices include sensors, radio frequency semiconductors, power management and other analog and mixed-signal integrated circuits. Through the combination of our embedded processors and complementary products, we are further able to offer our customers platform-level products, which incorporate both semiconductors and software. We believe that the ability to offer platform-level products will become increasingly important to long-term success in many markets within the semiconductor industry.

Our Business Groups. We operate our business through our three primary segments: the Transportation and Standard Products Group (TSPG), the Networking and Computing Systems Group (NCSG) and the Wireless and Mobile Solutions Group (WMSG). TSPG provides products for the automotive electronics, industrial and other markets. NCSG supplies products to the wired and wireless infrastructure and computing markets. WMSG provides products for wireless mobile devices. In addition to these three segments, we have an Other business segment that includes all of our other operations, including our Metrowerks software business.

Our Separation from Motorola. We were incorporated in Delaware on December 3, 2003 in preparation for the ultimate distribution by Motorola, Inc. (“Motorola”) of substantially all of its semiconductor businesses’ assets and liabilities to the Company. The Company completed the contribution and transfer by Motorola of these assets (the “Contribution”) in the second quarter of 2004 and an initial public offering (“IPO”) of the Company’s Class A common stock on July 21, 2004. Prior to the IPO, Freescale was a wholly owned subsidiary of Motorola. From the completion of the IPO and partial exercise of the underwriters’ over-allotment on July 23, 2004, until the distribution by Motorola of its remaining ownership in our Company, Motorola owned all of our outstanding shares of Class B common stock, representing 67.5% of the outstanding shares of our common stock and 91.2% of the total voting power of our common stock. After the IPO and partial over-allotment exercise, there was a total of 400 million shares of common stock outstanding, including 130 million Class A and 270 million Class B

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shares. On December 2, 2004, Motorola distributed its remaining ownership in the company, to its shareholders through a special dividend of all Class B common stock.

Revenues and Expenses. Our revenues are derived from the sale of our embedded processing and connectivity products and the licensing of our intellectual property. Our business segments include both product and intellectual property revenues associated with the activities of each of the respective segments.

We currently manufacture a substantial portion of our products internally at our seven 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 market value. For the purposes of segment reporting, cost of sales for each segment reflects standard costs, adjustments to inventory balances and valuation and an allocation of manufacturing variances incurred on a plant-by-plant basis. The primary user of each wafer fabrication facility is allocated the capacity and inefficiency variances for the facility. The exceptions to this are (1) our MOS-13 wafer fabrication facility, for which manufacturing variances are divided among all our business segments based upon usage, and (2) start-up facilities such as the Crolles facility which are allocated to the Other segment. Assembly and final test costs are allocated to the business segments on an actual cost basis.

Our gross margin is greatly influenced by our utilization. Utilization refers only to our wafer fabrication facilities and is based on the capacity of the installed equipment. As our utilization rate increases, there is significant operating leverage in our business as our fixed manufacturing costs are spread over increased output. Our utilization rate was 84% for 2004 and 68% for both 2003 and 2002. We believe that our optimal utilization level is in the 85% to 90% range. Given our expectations for long-term growth in our key end markets, combined with our focus on product areas in which we currently have or believe that we will have a leading position, we believe that we will be able to achieve our target utilization levels in the future.

Direct expenses incurred by a segment are included in that segment’s results. Shared research and development, sales and marketing, and general and administrative costs are allocated to each segment based upon the specific activities being performed for each segment, where possible. Remaining costs are charged using a specifically identifiable methodology or other reasonable basis of allocation. Certain corporate expenses are in the Other segment.

Our Challenges That Lie Ahead. Going forward, our business will be highly dependent on demand for electronic content in automobiles, networking and wireless infrastructure equipment, cellular handsets and other electronic devices. In addition, we operate in an industry that is highly cyclical and subject to constant and rapid technological change, product obsolescence, price erosion, evolving standards, short product life-cycles and wide fluctuations in product supply and demand. Through our efforts to reduce and streamline our cost structure, we believe that we are better equipped to respond to changes in market conditions and improve our financial performance.

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Results of Operations

(in millions)

Percentage of Net Sales

Year Ended December 31, 2004 Compared to Year Ended December 31, 2003

Net Sales

Our net sales were $5.7 billion in 2004, up 16% from $4.9 billion in 2003. Our orders were $5.8 billion in 2004, up 16% from $5.0 billion in 2003. The increase in net sales was primarily due to an 18% volume increase

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on flat pricing, principally driven by increased demand in the wireless market. The order growth was also principally driven by increased demand in the wireless market.

By segment, our net sales in 2004 compared to 2003 increased $188 million, or 8%, in TSPG, increased by $156 million, or 12%, in NCSG, increased by $497 million, or 44%, in WMSG, and increased by $10 million, or 18%, in Other, (which includes our Metrowerks business, sales of wafers to other semiconductor companies and other miscellaneous businesses).

Intellectual property revenue represented approximately 2% of net sales in 2004 and 3% of net sales in 2003.

Gross Margin

Our gross margin increased to $2.1 billion, or 37.4% of net sales, in 2004 compared to a gross margin of $1.4 billion, or 29.1% of net sales, in 2003. The increase in gross margin was primarily due to the increase in factory utilization rates and the incremental net sales of $851 million. Our utilization rate in 2004 reached 84% compared to 68% in 2003 due to increased manufacturing levels. In addition, depreciation expense reductions from prior facility closures and cost reduction actions initiated prior to 2004 contributed incremental cost savings of $24 million in 2004 and $167 million in 2003. On October 19, 2004, the Company announced further plans to streamline its operations. As a result, we recorded net charges of $33 million included in Cost of sales. Additional annualized savings of $28 million are expected from these actions.

Selling, General and Administrative

Our selling, general and administrative expenses were $799 million, or 14.0% of net sales, in 2004, compared to $649 million, or 13.3% of net sales, in 2003. The increase in selling, general and administrative expenses were primarily due to increased employee incentives of $130 million offset by a net $22 million reduction in expenses for corporate functions previously provided by Motorola.

Also impacting our selling, general and administrative expenses was the recognition of investment incentives related to our China wafer fabrication facility of $40 million in the first quarter of 2003 which did not recur in 2004. In 2002, we established a provision associated with the potential obligation to reimburse the Chinese government for various exemptions previously received on VAT and duty on imported materials. In the first quarter of 2004, our exemption was extended to Semiconductor Manufacturing International Corporation (SMIC), the acquirer of our China wafer fabrication facility, and $54 million originally accrued for potential liabilities was reversed resulting in a reduction to selling, general and administrative expenses.

Research and Development

Our research and development expenses, including our ongoing joint development efforts at the wafer fabrication facility in Crolles, France, totaled $965 million, or 16.9% of net sales, in 2004, compared with $1.0 billion, or 20.7% of net sales, in 2003. The decrease was primarily due to the impact of cost reduction activities implemented late in the third quarter of 2003, which contributed $32 million of savings.

Reorganization of Businesses

The reorganization of business programs initiated prior to 2004 were finalized, fully expensed and paid by the end of the third quarter of 2004.

A new reorganization of business program was announced on October 19, 2004 to streamline operations and reduce selling, general and administrative expenses. As a result, we recorded net charges of $79 million, of which $33 million was included in cost of sales and $46 million was recorded under reorganization of businesses in the

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accompanying statements of operations related to employee separation costs incurred in the fourth quarter of 2004. The Company expects to record an additional $10 million reorganization of business charges in the first quarter of 2005 related to this program. These actions are expected to generate $63 million in annualized net cost savings, $28 million of which is expected to be in cost of sales and $35 million in Selling, general and administrative and Research and development expenses.

Reorganization of businesses charges totaled $36 million in 2004 reflecting the $46 million charge in the fourth quarter offset by a total of $10 million in net reversals of previous accruals due to lower than expected employee separation costs and the completion of decommissioning activities at closed facilities for less cost than originally estimated. Reorganization of businesses charges totaled $63 million in 2003 primarily related to the impairment of specific facilities located in Arizona and Texas, partially offset by the reversals of exit costs and the decommissioning costs which were no longer needed due to the sale of a facility, as well as asset impairments previously established to cover assets held for sale which were placed back in service.

Separation Expenses

Separation expenses were $74 million in 2004 compared to zero in 2003. These incremental, non-recurring costs were directly related to the Contribution and subsequent separation from Motorola and include transaction taxes, professional fees, information technology and other services. Motorola funded $30 million in separation expenses in 2004 after the Contribution, which was accounted for as a capital contribution. The separation expenses were offset by a $15 million net gain on curtailments, associated with the culmination of our employees’ participation in Motorola sponsored employee benefit plans. We expect to incur total separation expenses of approximately $10 million in 2005.

Net Interest Expense

Our net interest expense was $31 million in 2004 compared to $114 million in 2003. Net interest expense in 2004 included interest expense of $51 million, which was partially offset by interest income of $20 million. Net interest expense in 2003 included interest expense of $115 million, which was partially offset by interest income of $1 million. Our interest expense represented the amount allocated from Motorola until the second quarter of 2004. This allocation was based on the relative historical percentage of our net assets included in Motorola’s consolidated financial statements, excluding debt.

Gains on Sales of Investments and Businesses

Our gains on sales of investments and businesses totaled $41 million in 2004, compared to $106 million in 2003. The net gain in 2004 was primarily due to the sale of a portion of our investment in SMIC, and the net gain in 2003 was primarily related to the sale of our ON Semiconductor note receivable and stock. Under the terms and provisions of the master separation and distribution agreement, which identified the assets contributed and transferred by Motorola to us, the remaining investment in SMIC common shares ($390 million at April 3, 2004) was retained by Motorola.

Other

Other expenses totaled $13 million and $7 million in 2004 and 2003, respectively, and were primarily due to equity losses in income of non-consolidated investments, other than temporary impairment of investments held in private companies accounted for as cost basis investments and foreign exchange losses.

Effective Tax Rate

Our effective tax rate was 20% for 2004, representing a $52 million net tax expense, compared to a (15)% effective tax rate in 2003, representing a $47 million net tax expense. Our effective tax rate is less than the

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statutory rate of 35% primarily due to (1) valuation allowances being recorded against the deferred tax assets in the United States and for certain foreign subsidiaries and (2) the mix of earnings and losses by taxing jurisdiction and foreign tax rate differentials.

Earnings (Loss)

We had earnings before income taxes of $263 million in 2004, compared to a loss of $319 million in 2003. After taxes, we had net earnings of $211 million in 2004, compared to a net loss of $366 million in 2003.

The increase in earnings before income taxes in 2004 was primarily due to an $851 million increase in net sales from 2003 and the resulting impact on gross margin, an $83 million decrease in net interest expense and $56 million in savings from prior cost reduction actions in Cost of sales and Research and development partially offset by increases in selling, general and administrative expenses.

Year Ended December 31, 2003 Compared to Year Ended December 31, 2002

Net Sales

Our net sales were $4.9 billion in 2003, down 2.0% from $5.0 billion in 2002. Our orders were $5.0 billion in 2003, down 3.8% from $5.2 billion in 2002. The decline in net sales was primarily due to a 12% reduction in volume, which was partially offset by a 9% increase in average selling prices, driven largely by product mix.

By segment, our net sales in 2003 compared to 2002 increased $66 million, or 2.9%, in TSPG, declined by $55 million, or 4.0%, in NCSG, declined by $117 million, or 9.4%, in WMSG, and declined by $31 million, or 36.0%, in Other, (which includes our Metrowerks business, sales of wafers to other semiconductor companies and other miscellaneous businesses).

Intellectual property revenue represented approximately 3% of net sales in 2003 and 4% of net sales in 2002.

Gross Margin

Our gross margin increased to $1.4 billion, or 29.1% of net sales, in 2003, compared to a gross margin of $1.2 billion, or 24.8% of net sales, in 2002. The increase in gross margin was primarily due to the impact of cost reduction and factory closure activities. Cost reductions contributed $167 million to our gross margin improvement. Depreciation expense decreased by $200 million due to factory closures, asset impairments and the decline in capital expenditures. These savings were partially offset by a reduction in sales of $137 million and an increase in other manufacturing costs.

Our utilization rate was 68% in both 2003 and 2002. Utilization remained flat from 2002 to 2003, despite improvements in utilization rates in 2003 resulting from wafer fabrication facility closures in 2002 and 2003 which were offset by lower unit sales volume. Additionally, the utilization rate in 2002 improved as a result of increasing inventory levels in advance of factory closures.

At December 31, 2003, we had reduced our total manufacturing facilities to 10, as compared to 12 manufacturing facilities as of December 31, 2002.

Selling, General and Administrative

Our selling, general and administrative expenses were $649 million, or 13.3% of net sales, in 2003, compared to $604 million, or 12.1% of net sales, in 2002. The increase in selling, general and administrative expenses was primarily related to an increase in the allocated expenses from Motorola, which were $362 million in 2003 compared to $304 million in 2002, primarily due to our allocation of employment benefit expenses

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incurred at the Motorola level, and a reduction in investment incentives received in China which were $92 million in 2002 and $40 million in 2003. These increases were partially offset by a charge taken in 2002 related to a potential obligation to repay $80 million relating to incentives previously received in China, and cost savings from our cost reduction activities, primarily driven by a 6% reduction in general and administrative headcount.

Research and Development

Our research and development expenses were $1.0 billion for both 2003 and 2002, or 20.7% of net sales in 2003, compared to 19.9% of net sales in 2002. The increase as a percentage of net sales was primarily due to the impact of lower net sales in 2003 compared with 2002.

Additional cost reduction actions were initiated starting late in the third quarter of 2003 to consolidate research and development design centers globally, which is expected to result in improved research and development effectiveness. These initiatives are expected to produce $41 million in annualized savings.

Reorganization of Businesses

Reorganization of businesses charges totaled $85 million in 2003, including a $63 million charge reflected in the combined statements of operations under Reorganization of businesses and a $22 million charge reflected in Cost of sales. These costs were primarily related to severance costs associated with a company-wide personnel reduction and fixed asset impairments relating to an Austin, Texas manufacturing facility. Reorganization of businesses charges totaled $1.2 billion in 2002, primarily related to fixed-asset impairments associated with the consolidation of manufacturing facilities in Arizona, China and Scotland.

Beyond 2003, we expect the reorganization of business programs specifically relating to employee severance that were implemented during 2003 to provide annualized cost savings of approximately $111 million.

Net Interest Expense

Our net interest expense was $114 million in 2003, compared to $163 million in 2002. Net interest expense in 2003 included interest expense of $115 million, which was partially offset by interest income of $1 million. Net interest expense in 2002 included interest expense of $167 million, which was partially offset by interest income of $4 million. In connection with the Contribution, the allocation of interest from Motorola ceased, and we commenced borrowing from Motorola under interest bearing arrangements until the IPO. Until the second quarter of 2004, our interest expense represented the amount allocated from Motorola. The prior allocation was based on the relative historical percentage of our net assets, included in Motorola’s consolidated financial statements, excluding debt. Following the IPO, our interest expense is primarily due to the debt issued in conjunction with our concurrent debt offering.

Gains on Sales of Investments and Businesses

Our gain on sales of investments and businesses totaled $106 million in 2003 compared to $15 million in 2002. The net gain in 2003 was primarily related to the sale of our ON Semiconductor note receivable and stock. The net gain in 2002 was primarily related to the reversal of accruals resulting from the expiration of the indemnification period related to the prior sale of the Semiconductor Components Group.

Other

Other expenses were $7 million in 2003 and were primarily comprised of the impairment of a cost-basis investment. Other expenses were $18 million in 2002, consisting primarily of $23 million in cost-basis investment impairment charges offset by $4 million in equity of net earnings of affiliated companies and $1 million in gains on foreign currency transactions.

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Effective Tax Rate

Our effective tax rate was (15)% in 2003, representing a $47 million net tax expense, compared to a (5)% effective tax rate, representing an $86 million net tax expense in 2002. Our effective tax rate is less than the statutory rate of 35% primarily due to (1) valuation allowances being recorded against the deferred tax assets in the United States and for certain foreign subsidiaries and (2) the mix of earnings and losses by taxing jurisdiction and foreign tax rate differentials. The change in our tax rate from 2002 to 2003 is primarily due to the change in the mix of earnings and losses by region and differences in foreign tax rates differentials.

The effective tax rate represents our tax rate on a separate return basis.

Loss

We incurred a loss before income taxes of $319 million in 2003, compared to $1.7 billion in 2002. After taxes, we incurred a net loss of $366 million in 2003, compared to $1.8 billion in 2002.

The increase in earnings before income taxes in 2003 was primarily due to (1) a $1.1 billion decrease in reorganization of businesses charges due to charges that occurred in 2002 that did not occur in 2003, (2) a $49 million decrease in net interest expense, (3) a $175 million improvement in our gross margin and (4) a $91 million increase in gains on sales of investments, which was partially offset by an increase of $12 million in our research and development expenses and a $45 million increase in selling, general and administrative expenses.

Segment Information

Our orders, net sales, and operating results for our primary segments for the years ended December 31, 2004, 2003 and 2002 are presented below. Order information as of any particular date may not be an accurate indicator of future results, as orders are subject to revision or cancellation to reflect changes in customer needs.

Transportation and Standard Products Group

TSPG designs, manufactures and markets key components of embedded control systems, which include processors (microcontrollers, embedded microprocessors and digital signal processors), sensors and analog and mixed-signal integrated circuits. TSPG’s largest market segment is the automobile electronics market, which represented over 70% of its sales in 2004. In 2004, TSPG net sales represented 44.9% of our net sales compared to 48.9% in 2003 and 46.2% in 2002.

Year Ended December 31, 2004 Compared to Year Ended December 31, 2003

In 2004, TSPG net sales were $2.6 billion, up 8% from $2.4 billion in 2003. TSPG orders for 2004 were $2.6 billion, up 12% from $2.3 billion in 2003. Net sales grew in all markets. The increase in orders was primarily due to higher demand in the automotive, industrial and consumer markets.

TSPG generated operating earnings of $231 million in 2004, compared to operating earnings of $162 million in 2003. The increase was primarily due to increased sales, higher manufacturing utilization and factory cost improvement, partially offset by increased selling, general and administrative expenses.

Year Ended December 31, 2003 Compared to Year Ended December 31, 2002

In 2003, segment net sales increased 3% to $2.4 billion, compared to $2.3 billion in 2002. Orders decreased 5% to $2.3 billion, compared to $2.5 billion in 2002. The increase in net sales was primarily due to growth in the automotive market, partially offset by the decline of 6% in the non-automotive industries served by the segment.

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The segment had operating earnings of $162 million in 2003, compared to operating earnings of $88 million in 2002. The increase was primarily due to an increase in gross margin, primarily attributed to benefits from factory consolidation and cost-reduction actions, as well as an increase in net sales and decreases in research and development and selling, general and administrative expenses.

Networking and Computing Systems Group

NCSG designs, manufactures and markets embedded processors and related connectivity products for the wired and wireless networking and computing markets. NCSG offers semiconductors that facilitate the transmission, switching and processing of data and voice signals within communications systems. In 2004, NCSG net sales represented 25.6% of our combined net sales, compared to 26.9% in 2003, and 27.2% in 2002.

Year Ended December 31, 2004 Compared to Year Ended December 31, 2003

In 2004, NCSG net sales were $1.5 billion, up 12% from $1.3 billion in 2003. NCSG orders in both 2003 and 2004 were $1.4 billion. The increase in net sales was primarily due to higher demand in the wireless infrastructure and networking markets partially offset by a decline in sales to the pervasive computing market.

NCSG generated operating earnings of $243 million in 2004, compared to operating earnings of $97 million in 2003. The increase in operating earnings was primarily due to increased sales, improved yields, favorable product mix and higher manufacturing utilization.

Year Ended December 31, 2003 Compared to Year Ended December 31, 2002

In 2003, segment net sales decreased 4% to $1.3 billion, compared to $1.4 billion in 2002. Orders increased 3% to $1.4 billion, compared to $1.3 billion in 2002. The decrease in net sales was primarily due to price pressures in the wireless infrastructure market and a decline in sales to the pervasive computing market. The increase in orders was primarily due to increases in new products for networking. This was partially offset by business exits and the decline in orders from the pervasive computing market.

The segment had operating earnings of $97 million in 2003, compared to an operating loss of $19 million in 2002. The increase was primarily due to improved manufacturing productivity, product sales mix, and a decrease in selling, general and administrative expenditures. This was partially offset by lower sales volume and an increase in research and development expenditures.

Wireless and Mobile Solutions Group

WMSG designs, manufactures and markets semiconductors for wireless mobile devices, such as cellular phones, smartphones, personal data assistants, two-way messaging devices, global positioning systems, mobile gaming devices and wireless consumer electronics. In 2004, approximately 74% of sales were to other Motorola businesses on an end customer basis. These percentage sales figures include sales made directly to Motorola and sales made to contract manufacturers that produce products for Motorola. In 2004, WMSG net sales represented 28.4% of our combined net sales, compared to 23.1% in 2003, and 24.9% in 2002.