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OCLARO, INC. - 10-Q - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS(Edgar Glimpses Via Acquire Media NewsEdge) This Quarterly Report on Form 10-Q and the documents incorporated herein by reference contain forward-looking statements, within the meaning of Section 21E of the Securities Exchange Act of 1934, as amended, and Section 27A of the Securities Act of 1933, as amended, about our future expectations, plans or prospects and our business. You can identify these statements by the fact that they do not relate strictly to historical or current events, and contain words such as "anticipate," "estimate," "expect," "project," "intend," "will," "plan," "believe," "should," "outlook," "could," "target," "model," "may" and other words of similar meaning in connection with discussion of future operating or financial performance. We have based our forward looking statements on our management's beliefs and assumptions based on information available to our management at the time the statements are made. There are a number of important factors that could cause our actual results or events to differ materially from those indicated by such forward-looking statements, including (i) our dependence on a limited number of customers for a significant percentage of our revenues, (ii) our ability to maintain strong relationships with certain customers, (iii) the effects of fluctuating product mix on our results, (iv) our ability to timely develop, commercialize and ramp into volume new products, (vi) competition and pricing pressure, (vii) our ability to meet or exceed our gross margin expectations, (viii) our ability to maintain or increase our cash reserves and obtain debt or equity-based financing on terms acceptable to us or at all, (ix) our future performance and our ability to effectively restructure our operations and business following the sale of our Zurich and Amplifier businesses in accordance with our business plan, (x) our ability to respond to evolving technologies and customer requirements and demands, (xi) our ability to effectively compete with companies that have greater name recognition, broader customer relationships and substantially greater financial, technical and marketing resources than we do, (xii) our ability to effectively and efficiently transition to an outsourced back-end assembly and test model, (xiii) our ability to timely capitalize on any increase in market demand, (xiv) the potential inability to realize the expected benefits of asset dispositions, (xv) the sale of businesses which may or may not arise in connection with executing our restructuring plans, including without limitation the pending divestiture of Oclaro's industrial and consumer business to Ushio Opto, (xvi) our ability to reduce costs and operating expenses, (xvii) increased costs related to downsizing and compliance with regulatory and legal requirements in connection with such downsizing, (xviii) the risks associated with our international operations, (xix) the impact of continued uncertainty in world financial markets and any resulting reduction in demand for our products, (xx) the outcome of tax audits or similar proceedings, (xxi) the outcome of pending litigation against the company, and other factors described in other documents we periodically file with the SEC. We cannot guarantee any future results, levels of activity, performance or achievements. You should not place undue reliance on forward-looking statements. Moreover, we assume no obligation to update forward-looking statements or update the reasons actual results could differ materially from those anticipated in forward-looking statements. Several of the important factors that may cause our actual results to differ materially from the expectations we describe in forward-looking statements are identified in the sections captioned "Management's Discussion and Analysis of Financial Condition and Results of Operations" and "Risk Factors" in this Quarterly Report on Form 10-Q and the documents incorporated herein by reference. As used herein, "Oclaro," "we," "our," and similar terms include Oclaro, Inc. and its subsidiaries, unless the context indicates otherwise. OVERVIEW We are one of the leading providers of optical components, modules and subsystems for the core optical transport, service provider, wireless backhaul, enterprise and data center markets. Leveraging over three decades of laser technology innovation, photonic integration, and subsystem design, we provide differentiated solutions for optical networks and high-speed interconnects driving the next wave of streaming video, cloud computing, voice over IP, Software as a Service ("SaaS") and other bandwidth-intensive and high-speed applications. We have research and development ("R&D") and chip fabrication facilities in the U.K., Italy and Japan. We have in-house and contract manufacturing sites in the U.S., China, Malaysia and Thailand, with design, sales and service organizations in most of the major regions around the world. Our customers include ADVA Optical Networking ("ADVA"); Alcatel-Lucent; Ciena Corporation ("Ciena"); Cisco Systems, Inc. ("Cisco"); Coriant GmbH ("Coriant"); Huawei Technologies Co. Ltd ("Huawei"); Juniper Networks, Inc. ("Juniper"); Telefonaktiebolaget LM Ericsson ("Ericsson") and ZTE Corporation ("ZTE"). 25-------------------------------------------------------------------------------- Table of Contents RECENT DEVELOPMENTS On August 5, 2014, Oclaro Japan, Inc. our wholly-owned subsidiary ("Oclaro Japan"), entered into a Master Separation Agreement ("MSA") with Ushio Opto Semiconductors, Inc. ("Ushio Opto") and Ushio, Inc. ("Ushio"), whereby Ushio Opto agreed to acquire the industrial and consumer business of Oclaro Japan located at its Komoro, Japan facility (the "Komoro Business"), by means of an absorption-type demerger under the Japanese Companies Act (such transaction, the "Transaction"). On October 27, 2014, the sale was completed. Consideration for the Transaction consisted of 1.85 billion Japanese yen (approximately $17.1 million based on the exchange rate on October 27, 2014) in cash, of which 1.6 billion Japanese yen (approximately $14.8 million based on the exchange rate on October 27, 2014) was paid at the closing and 250 million Japanese yen (approximately $2.3 million) was paid into escrow and will be released to Oclaro Japan upon the earlier of six months after the closing or the completion by Oclaro Japan of certain transition services, subject to a net asset valuation adjustment post-closing and after deduction for any indemnification amounts determined to be owed to Ushio Opto prior to release of the funds from escrow. RESULTS OF OPERATIONS On September 12, 2013 we announced the sale of our Zurich Business to II-VI, along with an exclusive option to purchase our Amplifier Business. On October 10, 2013, we entered into an Asset Purchase Agreement with II-VI for the sale of our Amplifier Business, which subsequently closed on November 1, 2013. We have classified the financial results of the Zurich and Amplifier Businesses as discontinued operations for all periods presented. The following presentations relate to continuing operations only and accordingly excludes the financial results of the Zurich and Amplifier Businesses, unless otherwise indicated. The following table sets forth our condensed consolidated results of operations for the periods indicated, along with amounts expressed as a percentage of revenues, and comparative information regarding the absolute and percentage changes in these amounts: 26-------------------------------------------------------------------------------- Table of Contents Three Months Ended Increase September 27, 2014 September 28, 2013 Change (Decrease) (Thousands) % (Thousands) % (Thousands) % Revenues $ 89,241 100.0 $ 96,648 100.0 $ (7,407 ) (7.7 ) Cost of revenues 74,832 83.9 85,430 88.4 (10,598 ) (12.4 ) Gross profit 14,409 16.1 11,218 11.6 3,191 28.4 Operating expenses: Research and development 13,913 15.6 18,087 18.7 (4,174 ) (23.1 ) Selling, general and administrative 15,414 17.3 20,950 21.7 (5,536 ) (26.4 ) Amortization of other intangible assets 418 0.5 424 0.4 (6 ) (1.4 ) Restructuring, acquisition and related (income) expense, net 1,730 1.9 2,877 3.0 (1,147 ) (39.9 ) Loss on sale of property and equipment 397 0.4 452 0.5 (55 ) (12.2 ) Total operating expenses 31,872 35.7 42,790 44.3 (10,918 ) (25.5 ) Operating loss (17,463 ) (19.6 ) (31,572 ) (32.7 ) 14,109 (44.7 ) Other income (expense): Interest income (expense), net (104 ) (0.1 ) (553 ) (0.6 ) 449 (81.2 ) Gain (loss) on foreign currency transactions, net (2,010 ) (2.3 ) 1,777 1.9 (3,787 ) n/m (1) Other income (expense), net 555 0.6 521 0.5 34 6.5 Total other income (expense) (1,559 ) (1.7 ) 1,745 1.8 (3,304 ) n/m (1) Loss from continuing operations before income taxes (19,022 ) (21.3 ) (29,827 ) (30.9 ) 10,805 (36.2 ) Income tax provision 954 1.1 302 0.3 652 215.9 Loss from continuing operations (19,976 ) (22.4 ) (30,129 ) (31.2 ) 10,153 (33.7 ) Income (loss) from discontinued operations, net of tax (378 ) (0.4 ) 63,407 65.6 (63,785 ) n/m (1) Net income (loss) $ (20,354 ) (22.8 ) $ 33,278 34.4 $ (53,632 ) n/m (1) (1) Not meaningful. Revenues Revenues for the three months ended September 27, 2014 decreased by $7.4 million, or 8 percent, compared to the three months ended September 28, 2013. Compared to the three months ended September 28, 2013, revenues from sales of our 40 Gb/s and 100 Gb/s transmission modules increased by $4.6 million, or 12 percent; revenues from sales of our 10 Gb/s transmission modules decreased by $12.3 million, or 24 percent; and revenues from sales of our industrial and consumer products increased by $0.3 million, or 4 percent. This product mix shift reflects the continued growth in the market for higher speed products that are smaller in size and have lower power consumption. For the three months ended September 27, 2014, Coriant GmbH ("Coriant") accounted for 26 percent, Cisco Systems, Inc. ("Cisco") accounted for 13 percent and Huawei Technologies Co., Ltd. ("Huawei") accounted for 11 percent of our revenues. For the three months ended September 28, 2013, Coriant accounted for 17 percent and Cisco accounted for 15 percent of our revenues. Gross Profit Gross profit is calculated as revenues less cost of revenues. Gross margin rate is gross profit reflected as a percentage of revenues. 27-------------------------------------------------------------------------------- Table of Contents Our cost of revenues consists of the costs associated with manufacturing our products, and includes the purchase of raw materials, labor costs and related overhead, including stock-based compensation charges and the costs charged by our contract manufacturers for the products they manufacture for us. Charges for excess and obsolete inventory are also included in cost of revenues. Costs and expenses related to our manufacturing resources incurred in connection with the development of new products are included in research and development expenses. Our gross margin rate increased to approximately 16 percent for the three months ended September 27, 2014, compared to 12 percent for the three months ended September 28, 2013. Our 40G and above product mix of sales contributed the majority of this improvement. Favorable foreign currency exchange movements, lower warranty charges and the completion of our outsource transition costs combined to contribute an additional 2 percentage points of improvement. These improvements were offset by a 2 percentage point decrease resulting from out of period adjustments relating to our inventory valuation and purchase commitment accrual. Research and Development Expenses Research and development expenses consist primarily of salaries and related costs of employees engaged in research and design activities, including stock-based compensation charges related to those employees, costs of design tools and computer hardware, costs related to prototyping and facilities costs for certain research and development focused sites. Research and development expenses decreased to $13.9 million for the three months ended September 27, 2014 from $18.1 million for the three months ended September 28, 2013. The decline was primarily related to a decrease of $2.6 million as a result of our restructuring plan which was initiated during the first quarter of fiscal year 2014, a decrease of $1.1 million related to our decision to no longer develop the WSS product line, and a decrease of $0.4 million related to the impact of the depreciation of the Japanese yen. Selling, General and Administrative Expenses Selling, general and administrative expenses consist primarily of personnel-related expenses, including stock-based compensation charges related to employees engaged in sales, general and administrative functions, legal and professional fees, facilities expenses, insurance expenses and certain information technology costs. Selling, general and administrative expenses decreased to $15.4 million for the three months ended September 27, 2014, from $21.0 million for the three months ended September 28, 2013. The decline was primarily related to a decrease of $3.8 million as a result of our restructuring plan which was initiated during the first quarter of fiscal year 2014, a decrease of $1.5 million in audit and legal costs, and a decrease of $0.2 million related to the impact of the depreciation of the Japanese yen. Amortization of Other Intangible Assets Amortization of other intangible assets remained relatively flat during the three months ended September 27, 2014 as compared to the three months ended September 28, 2013. With the sale of our Komoro Business, we expect the amortization of intangible assets to be $0.9 million for fiscal year 2015, $0.8 million for each fiscal year 2016 through 2017, $0.7 million for fiscal year 2018, $0.1 million for fiscal year 2019 and $0.1 million thereafter, based on the current level of our other intangible assets as of September 27, 2014. 28-------------------------------------------------------------------------------- Table of Contents Restructuring, Acquisition and Related Costs During the first quarter of fiscal year 2014, we initiated a restructuring plan to simplify our operating footprint, reduce our cost structure and focus our research and development investment in the optical communications market where we can leverage our core competencies. During the three months ended September 27, 2014 and September 28, 2013, we recorded restructuring charges of $0.8 million and $0.2 million, respectively, in connection with this restructuring plan. The restructuring charges for the three months ended September 27, 2014 included $0.2 million related to workforce reductions and $0.6 million related to revised estimates related to lease cancellations and commitments. The restructuring charges for the three months ended September 28, 2013 related to workforce reductions in our research and development facility in Israel. During the three months ended September 27, 2014 and September 28, 2013, we made scheduled payments of $1.4 million and $2.0 million, respectively, to settle a portion of these restructuring liabilities. As of September 27, 2014, we had $1.4 million in accrued restructuring liabilities related to this restructuring plan. In connection with the acquisition of Opnext, we initiated a restructuring plan to integrate our acquisition of Opnext. During the three months ended September 27, 2014 and September 28, 2013, we recorded restructuring charges of zero and $0.9 million, respectively, in connection with this restructuring plan. The restructuring charges recorded in fiscal year 2014 included $0.9 million in external consulting charges and professional fees associated with reorganizing the infrastructure. During the three months ended September 28, 2013, we made scheduled payments of $2.0 million to settle these restructuring liabilities. As of September 27, 2014, we had no further accrued restructuring liabilities related to this restructuring plan. During fiscal year 2012, we initiated a restructuring plan in connection with the transfer of a portion of our Shenzhen, China manufacturing operations to Venture Corporation Limited ("Venture"). This transition is scheduled to occur in a phased and gradual transfer of certain products, which is scheduled to be completed in fiscal year 2015. In connection with this transition, during the three months ended September 27, 2014 and September 28, 2013, we recorded restructuring charges related to employee separation charges of $0.9 million and $1.0 million, respectively. During the three months ended September 27, 2014 and September 28, 2013, we made scheduled payments of $1.3 million and $0.5 million,, respectively, to settle a portion of these restructuring liabilities. As of September 27, 2014, we had $0.2 million in accrued restructuring liabilities related to this restructuring plan. We expect to incur an additional $3.0 million to $9.0 million, in aggregate, in restructuring charges over the course of fiscal year 2015 in connection with these restructuring plans. Other Income (Expense) Other income (expense) was $1.6 million in expense for the three months ended September 27, 2014 as compared to $1.7 million in income for the three months ended September 28, 2013. This decrease in other income (expense) was primarily related to recording a $2.0 million foreign currency transaction loss during the three months ended September 27, 2014, as compared to recording a $1.8 million foreign currency transaction gain during the three months ended September 28, 2013. The $2.0 million foreign currency transaction loss during the three months ended September 27, 2014 was predominantly a result of revaluing intercompany receivables denominated in Japanese yen. The decrease in other income (expense) was partially offset as a result of recording $0.4 million in lower interest expense during the current quarter as compared to the three months ended September 28, 2013 as a result of the conversion of the 7.50% Exchangeable Senior Secured Second Lien Notes due 2018 ("Convertible Notes") into common stock in the second quarter of fiscal year 2014 and the repayment of the credit facility and Term Loan in the first quarter of fiscal year 2014. Income Tax Provision For the three months ended September 27, 2014 and September 28, 2013, our income tax provision of $1.0 million and $0.3 million, respectively, related primarily to our foreign operations. Income from Discontinued Operations, Net of Tax During the three months ended September 27, 2014 we recorded a loss from discontinued operations from the Zurich and Amplifier Businesses of $0.4 million, During the three months ended September 28, 2013, we recorded a gain on the sale of the 29-------------------------------------------------------------------------------- Table of Contents Zurich Business of $62.8 million and income from discontinued operations from the Zurich and Amplifier Businesses of $63.4 million, including the gain on sale of the Zurich Business. The following table sets forth the results of the discontinued operations of our Zurich and Amplifier Businesses and the year-over-year increases (decreases) in our results: Three Months Ended September 28, September 27, 2014 2013 Change (Thousands) Revenues $ - $ 42,212 $ (42,212 ) Cost of revenues 163 32,308 (32,145 ) Gross profit (163 ) 9,904 (10,067 ) Operating expenses 215 7,484 (7,269 ) Other income (expense), net - 61,150 (61,150 ) Income (loss) from discontinued operations before income taxes (378 ) 63,570 (63,948 ) Income tax provision - 163 (163 ) Income (loss) from discontinued operations $ (378 ) $ 63,407 $ (63,785 ) RECENT ACCOUNTING STANDARDS See Note 2, Recent Accounting Standards, to our condensed consolidated financial statements included elsewhere in this Quarterly Report on Form 10-Q for information regarding the effect of new accounting pronouncements on our condensed consolidated financial statements. APPLICATION OF CRITICAL ACCOUNTING POLICIES The discussion and analysis of our financial condition and results of operations is based on our condensed consolidated financial statements contained elsewhere in this Quarterly Report on Form 10-Q, which have been prepared in accordance with accounting principles generally accepted in the United States ("U.S. GAAP"). The preparation of our financial statements requires us to make estimates and judgments that affect our reported assets and liabilities, revenues and expenses and other financial information. Actual results may differ significantly from those based on our estimates and judgments or could be materially different if we used different assumptions, estimates or conditions. In addition, our financial condition and results of operations could vary due to a change in the application of a particular accounting policy. We identified our critical accounting policies in our Annual Report on Form 10-K for the year ended June 28, 2014 (2014 Form 10-K) related to revenue recognition and sales returns, inventory valuation, business combinations, impairment of goodwill and other intangible assets, accounting for stock-based compensation and income taxes. It is important that the discussion of our operating results be read in conjunction with the critical accounting policies discussed in our 2014 Form 10-K. LIQUIDITY AND CAPITAL RESOURCES The condensed consolidated statement of cash flows and the discussion below on cash flows from operating, investing and financing activities have not been adjusted for the effects of the discontinued operations. Cash Flows from Operating Activities Net cash used in operating activities for the three months ended September 27, 2014 was $5.7 million, primarily resulting from a net loss of $20.4 million, partially offset by non-cash adjustments of $6.6 million and a $8.1 million increase in cash due to changes in operating assets and liabilities. The $6.6 million increase in cash resulting from non-cash adjustments primarily consisted of $5.1 million in depreciation and amortization, $1.3 million of expense related to stock-based compensation, a loss of $0.4 million on the disposal of property and equipment, partially offset by $0.2 million from the amortization of a deferred gain from sales-leaseback transaction. The $8.1 million increase in cash due to changes in operating assets and liabilities was comprised of a $13.9 million increase in accrued expenses and other liabilities and a $2.5 million decrease in accounts 30-------------------------------------------------------------------------------- Table of Contents receivable, partially offset by a $6.6 million increase in inventories, a $1.6 million decrease in accounts payable and a $0.1 million increase in prepaid expenses and other current assets. Net cash used by operating activities for the three months ended September 28, 2013 was $17.6 million, primarily resulting from a net income of $33.3 million adjusted for non-cash adjustments of $48.7 million and a $2.1 million decrease in cash due to changes in operating assets and liabilities. The $2.1 million decrease in cash due to changes in operating assets and liabilities was comprised of a $16.0 million increase in accounts payable, a $0.4 million decrease in inventories and a $0.3 million decrease in other non-current assets, partially offset by a $15.7 million increase in prepaid expenses and other current assets, a $2.2 million decrease in accrued expenses and other liabilities and a $0.8 million increase in accounts receivable. The $48.7 million decrease in cash resulting from non-cash adjustments primarily consisted of a $62.8 million gain on the sale of the Zurich Business, $0.5 million from the amortization of deferred gain from sales-leaseback transactions, partially offset by $8.8 million in depreciation and amortization, $4.2 million related to the amortization and writeoff of the issuance costs of the term loan, and $1.2 million of expense related to stock-based compensation. Cash Flows from Investing Activities Net cash used in investing activities for the three months ended September 27, 2014 was $4.3 million, primarily consisting of $4.7 million used in capital expenditures, partially offset by $0.4 million reduction in restricted cash. Net cash provided by investing activities for the three months ended September 28, 2013 was $94.4 million, primarily consisting of $90.6 million proceeds from the sale of Zurich Business, $5.0 million from the sale of an exclusive option to purchase the Amplifier Business and a $0.2 million reduction in restricted cash, which were partially offset by $1.4 million used in capital expenditures. Cash Flows from Financing Activities Net cash used in financing activities for the three months ended September 27, 2014 was $1.1 million, primarily consisting of $1.1 million in payments on capital lease obligations. Net cash used in financing activities for the three months ended September 28, 2013 was $66.3 million, primarily consisting of $65.0 million in repayments on a term loan and our revolving credit facility and $1.3 million in payments on capital lease obligations. Credit Line and Notes As of September 27, 2014, we had a $40.0 million revolving credit facility with Silicon Valley Bank. As of September 27, 2014, there were no amounts outstanding under this credit facility. See Note 6, Credit Line and Notes, for additional information regarding this credit facility. Prior to establishing our credit facility with Silicon Valley Bank, we maintained a credit facility with Wells Fargo Capital Finance, Inc. ("Wells Fargo") and certain other lenders, which was terminated on March 14, 2014. All amounts outstanding under this credit facility were repaid during fiscal year 2014. See Note 6, Credit Line and Notes, for additional information regarding this credit facility. Future Cash Requirements As of September 27, 2014, we held $94.0 million in cash and short-term investments, comprised of $89.3 million in cash and cash equivalents, $4.7 million in restricted cash and $0.1 million of short-term investments; and we had working capital of $162.1 million. On September 12, 2013, we completed the sale of our Zurich Business under which we expect to receive $6.0 million in additional proceeds which are subject to hold-back by II-VI until December 31, 2014 to address any post-closing adjustments or claims. On November 1, 2013, we completed the sale of our Amplifier Business under which we expect to receive $4.0 million in additional proceeds which are subject to hold-back by II-VI until December 31, 2014 to address any post-closing claim. Based on our current cash and cash equivalent balances, we believe that we have sufficient funds to support our operations through the next 12 months, including costs associated with the implementation of our restructuring activities. 31-------------------------------------------------------------------------------- Table of Contents In the event we need additional liquidity beyond our current expectations, such as to fund future growth or strengthen our balance sheet or to fund the cost of restructuring activities, we may find it necessary to lower our operating income break-even level and undertake additional cost cutting measures. We will continue to explore other sources of additional liquidity. These additional sources of liquidity could include one, or a combination, of the following: (i) issuing equity securities, (ii) incurring indebtedness secured by our assets, (iii) issuing debt and/or convertible debt securities, or (iv) selling product lines, other assets and/or portions of our business. There can be no guarantee that we will be able to raise additional funds on terms acceptable to us, or at all. We have incurred significant operating losses from continuing operations and generated negative cash flows from operations for fiscal year 2014. Recoverability of a major portion of the recorded asset amounts shown in the accompanying balance sheet is dependent upon us having sufficient resources to operate our business. In addition to the availability of our cash resources as of September 27, 2014, the continued operation of our business is dependent upon our achieving cash flows expected to be generated from the execution of our current operating plan, including anticipated restructuring plans, together with amounts expected to be available under our Credit Agreement and from the sale of our Komoro, Japan industrial and consumer business. The transaction is more fully discussed in Note 5, Business Combinations and Dispositions. The financial statements do not include any adjustments relating to the recoverability and classification of recorded asset amounts or amounts and classification of liabilities that might be necessary should we be unable to continue in existence. In addition, we have been operating in China for an extended period of time and have accumulated significant intercompany balances with our related entities. Our ability to repay or collect these balances may be restricted by Chinese laws and, as a result, we may be unable to successfully pay down or collect on these balances. As a consequence, we may be assessed additional taxes in China if we are unable to claim bad debt deductions or incur debt forgiveness income from the cancellation of these intercompany balances. Additionally, if we are found not to have complied with the various local laws surrounding cross border payments, we may incur penalties and fines for non-compliance. Any such taxes, penalties and/or fines could be significant in amount and, as a result, could have a material adverse effect on our financial condition, including our cash and cash equivalent balances. For additional information on the risks we face related to future cash requirements, see Item 1A. Risk Factors under "- Risks Related to Our Business - We have a history of large operating losses and we may not be able to achieve profitability in the future and maintain sufficient levels of liquidity," and Note 1, Basis of Preparation, included elsewhere in this Quarterly Report on Form 10-Q. As of September 27, 2014, $66.1 million of the $89.3 million of our cash and cash equivalents was held by our foreign subsidiaries. If these funds are needed for our operations in the United States, we could be required to accrue and pay U.S. taxes to repatriate these funds. However, our intent is to permanently reinvest these funds outside of the U.S., except for our Shanghai, China; Korean; and Japanese entities where closure will eventually follow our decision to exit certain businesses in fiscal year 2015. Off-Balance Sheet Arrangements We indemnify our directors and certain employees as permitted by law, and have entered into indemnification agreements with our directors and executive officers. We have not recorded a liability associated with these indemnification arrangements, as we historically have not incurred any material costs associated with such indemnification obligations. Costs associated with such indemnification obligations may be mitigated by insurance coverage that we maintain, however, such insurance may not cover any, or may cover only a portion of, the amounts we may be required to pay. In addition, we may not be able to maintain such insurance coverage in the future. We also have indemnification clauses in various contracts that we enter into in the normal course of business, such as indemnification in favor of customers in respect of liabilities they may incur as a result of purchasing our products should such products infringe the intellectual property rights of a third party. We have not historically paid out any material amounts related to these indemnifications; therefore, no accrual has been made for these indemnifications. 32-------------------------------------------------------------------------------- Table of Contents |