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MEMORANDUM

PRIVILEGED AND CONFIDENTIAL ATTORNEY-CLIENT PRIVILEGE / ATTORNEY WORK PRODUCT

CALDERWOOD & HARKNESS LLP 600 Lexington Avenue, 30th Floor New York, New York 10022

This memorandum is prepared in connection with Calderwood & Harkness LLP's representation of Optiwave Semiconductor Corp. in the proposed offering of $250,000,000 aggregate principal amount of 2.75% Convertible Senior Notes due 2028 and related capped call transactions. Privileged and confidential.

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I. Executive Summary and Purpose

The purpose of this memorandum is to analyze the principal tax, regulatory, and structural considerations arising from the capped call transactions that Optiwave Semiconductor Corp. ("OWS" or the "Company") proposes to enter into concurrently with the issuance of its 2.75% Convertible Senior Notes due 2028 (the "Notes"). This memorandum is intended to serve as a comprehensive internal working document for the deal team and to identify key negotiation points, open issues, and action items in connection with the capped call overlay structure.

The capped call transactions are designed to offset potential dilution to OWS common stock, par value $0.001 per share (Nasdaq: OWS), upon conversion of the Notes, or, alternatively, to offset cash payments that OWS would otherwise be required to make in excess of the aggregate principal amount of the Notes upon conversion. By entering into the capped call transactions, OWS effectively raises the economic dilution point from the initial conversion price of approximately $94.50 per share to the cap price of $110.07 per share. In practical terms, the capped call transactions provide OWS with a hedging mechanism that substantially reduces the dilutive impact of the Notes on OWS's existing stockholders within the range between the initial conversion price and the cap price.

Two dealer counterparties have been identified for the capped call transactions: Ridgepoint Capital Markets LLC ("Ridgepoint") and Northvane Financial Products LP ("Northvane"). The notional amount of the capped call transactions will be allocated between the two counterparties on a 60/40 basis, with Ridgepoint receiving 60% of the notional and Northvane receiving 40% of the notional. The aggregate premium cost for the capped call transactions is $28,750,000, of which Ridgepoint's share is $17,250,000 and Northvane's share is $11,500,000. This cost will be funded from the gross proceeds of the Notes offering.

This memorandum covers five principal areas of analysis:

1. U.S. Federal Income Tax Treatment. The characterization of the capped call transactions from OWS's perspective, including the proper treatment of the premium paid and the consequences of settlement.

2. Section 1032 Analysis. The application of Section 1032 of the Internal Revenue Code to OWS upon settlement of the capped calls in shares of its own common stock.

3. Constructive Sale Risk Under Section 1259. Whether the combination of the convertible Notes and the capped call transactions gives rise to constructive sale treatment under Section 1259 of the Internal Revenue Code with respect to OWS's common stock.

4. Dodd-Frank and Regulatory Implications. The application of the Dodd-Frank Wall Street Reform and Consumer Protection Act, including security-based swap regulation by the SEC and related CFTC considerations, to OWS and the dealer counterparties.

5. ISDA Documentation Structure and Key Negotiation Points. The framework for documenting the capped call transactions under the 2002 ISDA Master Agreement and the principal elections, terms, and negotiation points in the Schedule and Confirmation.

This memorandum should be read in conjunction with the separate Calderwood & Harkness LLP memorandum dated April 10, 2023 (prepared by Claire Dempsey and Leonard Cross), which analyzes the accounting treatment of the Notes and the capped call transactions under ASC 470-20 / ASU 2020-06, as well as the general U.S. federal income tax treatment of the Notes themselves. The April 10, 2023 memorandum addresses the accounting classification of the Notes as a single liability instrument following the adoption of ASU 2020-06 and the equity classification of the capped call transactions under ASC 815-40. This memorandum does not duplicate that analysis but cross-references it where relevant.

II. Transaction Overview and Key Economic Terms

A. Structure of the Capped Call

The capped call transactions are privately negotiated call spread transactions on OWS common stock, to be entered into between OWS, on the one hand, and each of Ridgepoint and Northvane, on the other hand. Each capped call transaction is structured as a combination of two economically linked option positions: a purchased call option at a lower strike price and a written (sold) call option at an upper strike price (the "cap price"). Together, these two positions are economically equivalent to a call spread, sometimes referred to as a "bull call spread" or "capped call overlay."

The lower strike price of the purchased call option component is set equal to the initial conversion price of the Notes, which is approximately $94.50 per share. This initial conversion price is derived from the initial conversion rate of 10.5820 shares of OWS common stock per $1,000 principal amount of Notes (i.e., $1,000 ÷ 10.5820 ≈ $94.50). The upper strike price, or cap price, of the written call option component is $110.07 per share. The cap price represents a premium of approximately 50.0% over the reference price of $73.38 per share, which is expected to be set as the closing sale price of OWS common stock on the Nasdaq Stock Market on the pricing date for the Notes offering, anticipated to be May 23, 2023.

The economic effect of the capped call transactions is as follows: if the market price of OWS common stock exceeds the initial conversion price of approximately $94.50 per share but remains at or below the cap price of $110.07 per share at the time of conversion of the Notes or expiration of the capped calls, the capped calls will deliver value to OWS equal to the difference between the stock price and the initial conversion price (on a per-share basis), thereby fully offsetting the dilutive effect of conversion within that range. If the stock price exceeds the cap price, the capped calls will deliver value equal to the difference between the cap price and the initial conversion price ($110.07 − $94.50 = $15.57 per share, subject to adjustment), and OWS will experience dilution only with respect to the portion of the stock price that exceeds the cap price. In effect, the capped call transactions raise the effective conversion price of the Notes from approximately $94.50 per share to $110.07 per share for dilution purposes.

The expiration date of the capped call transactions is June 1, 2028, which matches the maturity date of the Notes. The capped calls are subject to earlier exercise or termination in connection with conversion of the Notes, early redemption by OWS, or the occurrence of certain termination events specified in the ISDA documentation, as discussed in greater detail in Section V below.

B. Notional Allocation and Cost

The total aggregate principal amount of the Notes offering is $250,000,000, with an additional 15% over-allotment option granted to the initial purchasers in the amount of $37,500,000, resulting in a total potential principal amount of $287,500,000 if the over-allotment option is exercised in full. The capped call transactions are being sized to cover the full principal amount of the Notes, including the over-allotment portion, such that if the over-allotment option is exercised in full, the capped call notional will equal $287,500,000.

The allocation of the capped call notional between the two dealer counterparties is as follows:

The aggregate capped call cost of $28,750,000 will be funded from the gross proceeds of the Notes offering. The use of proceeds section of the Offering Memorandum will identify the capped call premium as a specified use of proceeds, and the funds flow memorandum for the closing (currently anticipated for May 30, 2023) will include wire transfer instructions for the premium payments to each of Ridgepoint and Northvane.

It should be noted that the notional allocation reflects the relative roles of the counterparties in the overall transaction. Ridgepoint, as the lead initial purchaser and sole bookrunning manager for the Notes offering, is allocated a larger share of the capped call notional, which is consistent with market practice and reflects its central role in structuring and pricing the offering. The implications of Ridgepoint's dual role are discussed in Section VI.C below.

C. Settlement Mechanics

The capped call transactions are designed to mirror the conversion settlement mechanics of the Notes. Under the terms of the Indenture (to be entered into between OWS and Broadmere Trust Company, N.A., as Trustee), OWS will have the right to elect the settlement method for conversions of the Notes. It is anticipated that OWS will elect "net share settlement," pursuant to which OWS will pay cash in an amount equal to the principal amount of the converting Notes and deliver shares of OWS common stock (or cash, or a combination thereof) for the conversion value in excess of the principal amount.

The capped call Confirmations will contain settlement provisions that correspond to the conversion settlement method elected by OWS under the Indenture. Specifically, upon conversion of the Notes (or upon expiration of the capped calls if no conversion has occurred), the capped calls will deliver to OWS shares of OWS common stock (or, at OWS's election, cash) in an amount equal to the value by which the per-share stock price exceeds the lower strike price, capped at the upper strike price. The number of shares deliverable will be calculated based on the applicable number of options and the relevant stock price during a valuation period that tracks the conversion settlement valuation period under the Indenture.

This mirroring of settlement mechanics is critical to the effectiveness of the capped call structure as a dilution-offset mechanism. If OWS elects net share settlement under the Indenture and receives shares from the counterparties under the capped calls, OWS can use the shares received from the counterparties to satisfy, in whole or in part, its obligation to deliver shares to converting noteholders, thereby avoiding the issuance of additional shares from its authorized but unissued share pool and mitigating net dilution.

The anti-dilution adjustments applicable to the capped call strike prices and the number of options will track the anti-dilution adjustments set forth in the Indenture. This is essential to ensure that the capped call hedge remains aligned with the conversion terms of the Notes throughout the life of the instruments. The Confirmation will specify that adjustments to the lower strike price, the upper strike price (cap price), and the number of options will be made in accordance with the same formulas and upon the occurrence of the same triggering events (e.g., stock dividends, stock splits, spin-offs, tender offers, and make-whole fundamental changes) as the adjustments to the conversion rate and conversion price under the Indenture.

III. U.S. Federal Income Tax Analysis — OWS Perspective

A. Characterization of the Capped Call Transactions

A threshold question for the U.S. federal income tax analysis is the proper characterization of the capped call transactions. Two principal characterizations are available: (i) integration with the Notes as a single financial instrument, or (ii) treatment as separate prepaid forward contracts on OWS common stock. The characterization has significant consequences for the tax treatment of both the Notes and the capped calls.

Integration Approach. Under the integration approach, the capped call transactions would be treated as part of the debt instrument for purposes of Section 163 of the Internal Revenue Code and the original issue discount ("OID") rules set forth in Sections 1271 through 1275. If the capped calls were integrated with the Notes, the combined instrument could be viewed as a contingent payment debt instrument or as a debt instrument with modified conversion terms, which would affect the calculation of the yield to maturity and the OID accruals on the Notes. Integration treatment could also affect the characterization of the premium paid by OWS as a component of the borrowing cost of the Notes, potentially enabling some portion of the premium to be treated as deductible interest expense over the life of the Notes.

However, integration treatment is uncertain and, in our view, unlikely to be sustained given the structure of the transactions. The capped calls are entered into with counterparties (Ridgepoint and Northvane) that are separate from the noteholders. The capped calls are not embedded options within the Notes; they are independent, freestanding contracts documented under separate ISDA Master Agreements and Confirmations. The noteholders have no rights under, or recourse to, the capped call transactions, and the capped calls do not modify the conversion terms of the Notes as between OWS and the noteholders. The separate counterparty structure, separate documentation, and separate settlement mechanics all weigh against integration. Moreover, we are not aware of any published IRS guidance, revenue ruling, or judicial decision that mandates integration of separately documented capped call transactions with concurrently issued convertible notes for U.S. federal income tax purposes.

Prepaid Forward Contract Characterization. The more likely and customary characterization — consistent with prevailing market practice and the approach taken by issuers and their counsel in comparable convertible note offerings — is to treat the capped calls as separate prepaid forward contracts on OWS common stock. Under this characterization, OWS pays a fixed premium ($28,750,000 in aggregate, allocated between the two counterparties) in exchange for a contractual right to receive a future delivery of shares of OWS common stock (or, at OWS's election, cash) contingent on the price of OWS common stock at the time of exercise or expiration. The prepaid forward contract characterization is supported by the economic substance of the transactions: OWS makes a single upfront payment and receives a contingent future delivery, which is the hallmark of a prepaid forward or prepaid variable forward contract.

As separate contracts, the capped calls should not affect the tax treatment of the Notes as variable rate debt instruments (as analyzed in the separate April 10, 2023 memorandum). The OID calculations, the determination of stated interest, and the convertible debt treatment under Sections 163(l) and 1272 should be unaffected by the existence of the capped calls, provided the IRS does not seek to integrate the two instruments.

We note that the forthcoming tax memorandum from Leonard Cross to OWS, which is expected to be finalized by the closing date and ultimately dated May 29, 2023, will set forth the firm's conclusions on the tax characterization of the capped calls and the Notes for purposes of the Offering Memorandum tax disclosure. The Offering Memorandum will contain a summary of the material U.S. federal income tax considerations for holders of the Notes and will note the treatment of the capped calls as separate transactions that do not affect the tax treatment of the Notes.

B. Section 1032 Analysis

Section 1032 of the Internal Revenue Code provides that a corporation does not recognize gain or loss on the receipt of money or other property in exchange for its own stock, including treasury stock. This provision is fundamental to the tax treatment of corporate equity issuances and repurchases and has been interpreted broadly by the IRS and the courts to cover range transactions in which a corporation issues or receives its own stock.

The capped call transactions involve OWS paying a premium to the dealer counterparties and receiving, upon exercise or expiration, shares of its own common stock (which OWS then uses to satisfy its conversion obligations to the noteholders) or, at OWS's election, cash in lieu thereof. To the extent OWS receives shares of its own common stock upon settlement of the capped calls, Section 1032 should apply to the settlement and OWS should not recognize gain or loss on such receipt. This is true regardless of whether the fair market value of the shares received at settlement exceeds or is less than the premium paid by OWS for the capped calls. The Section 1032 nonrecognition rule applies to the receipt of the shares, and OWS's basis in the shares received should be their fair market value at the time of receipt (although this point has limited significance, as OWS will typically use the shares immediately to satisfy its conversion obligations).

The application of Section 1032 to capped call settlements in stock is well supported by the language of the statute and by longstanding IRS authority. The transaction is economically analogous to a corporation entering into a forward purchase contract for its own shares: the corporation pays a price (the premium) and receives its own shares at a future date. Section 1032 has been applied to forward contracts on a corporation's own stock in a number of published and private rulings, and the IRS has consistently concluded that the corporation does not recognize gain or loss on such transactions.

If OWS elects cash settlement from the counterparties rather than share settlement, the analysis changes. Section 1032 would not directly apply to a cash settlement, because OWS would not be receiving its own stock. In that case, the cash received by OWS from the counterparties would be treated as proceeds from the settlement of a financial contract, and OWS's gain or loss would be determined by comparing the cash received to its basis in the capped call contract (i.e., the premium paid, allocated to the settled portion). However, as a practical matter, if OWS elects cash settlement of the capped calls, the cash received would offset the cash that OWS is required to pay to converting noteholders in excess of the principal amount of the Notes, and OWS's overall tax position would be governed by the debt repayment rules under Sections 1271 through 1275, including the rules applicable to retirement of debt instruments.

Key conclusion: The Section 1032 analysis strongly supports the proposed capped call structure. To the extent OWS settles the capped calls in shares of its own common stock — which is the expected default settlement method — OWS should not recognize taxable income on settlement. This result is central to the economic rationale for the capped call overlay and is consistent with the treatment of comparable capped call structures in the convertible debt market.

C. Constructive Sale Risk — Section 1259

Section 1259 of the Internal Revenue Code provides that a taxpayer is treated as having made a "constructive sale" of an "appreciated financial position" if the taxpayer enters into certain enumerated transactions that substantially eliminate risk of loss and opportunity for gain with respect to the appreciated financial position. The enumerated transactions include short sales, offsetting notional principal contracts, and futures or forward contracts to deliver the same or substantially identical property. A constructive sale triggers immediate recognition of gain as if the appreciated position had been sold at its fair market value on the date of the constructive sale.

The relevant question for OWS is whether the combination of the convertible Notes (which create a potential obligation to deliver shares or pay cash, representing a form of "short exposure" to OWS common stock) and the capped calls (which provide OWS with the right to receive shares or cash if the stock price rises above the conversion price) could be characterized as a constructive sale of OWS common stock under Section 1259.

Our analysis concludes that Section 1259 does not apply to OWS in this context for the following reasons:

First, and most fundamentally, OWS does not hold an "appreciated financial position" in its own stock within the meaning of Section 1259. Section 1259(b) defines an "appreciated financial position" as any position with respect to any stock, debt instrument, or partnership interest if there would be gain if the position were sold, assigned, or otherwise terminated at its fair market value. A corporation's interest in its own authorized but unissued shares does not constitute a "position" in stock for purposes of Section 1259. The provision is directed at holders of appreciated positions — investors, traders, and other taxpayers who own stock and seek to lock in unrealized gains without triggering a taxable disposition. It is not directed at issuers of stock, whose transactions in their own equity are governed by Section 1032. There is no published authority applying Section 1259 to a corporation acting as an issuer of its own stock, and the legislative history of Section 1259 does not suggest that Congress intended the provision to reach corporate issuers.

Second, even if Section 1259 were applied by analogy to the capped call structure, the transactions would not satisfy the statutory requirements for a constructive sale. A constructive sale requires that the taxpayer's combined positions substantially eliminate both the risk of loss and the opportunity for gain with respect to the appreciated position. In the case of the capped call transactions, the upside protection provided by the capped calls is limited by the cap price of $110.07 per share. Above the cap price, OWS retains full dilution exposure — that is, OWS will experience dilution to the extent the stock price exceeds the cap price at the time of conversion. The existence of the cap means that the capped call transactions do not fully eliminate the "opportunity for gain" (or, more precisely, the risk of dilution in the issuer context) associated with the convertible Notes. In the analogous investor context, a capped call spread with an upper strike would not constitute a constructive sale because the investor retains meaningful economic exposure to price movements above the cap.

Third, the convertible Notes themselves are not a "short sale" or "forward contract" in the traditional sense. The Notes are debt instruments with a contingent equity feature (the conversion right belongs to the noteholders, not to OWS), and OWS's obligation is to pay cash and/or deliver shares upon conversion at the election of the noteholders. The characterization of the Notes as creating a "short position" in OWS stock for purposes of Section 1259 would be a novel extension of the statute that is not supported by existing authority.

Conclusion: Section 1259 constructive sale risk is not applicable to OWS as the issuer of its own common stock. The capped call transactions do not give rise to a constructive sale of OWS common stock, and no constructive sale concern exists with respect to the proposed structure.

D. Premium Deductibility

The $28,750,000 aggregate premium paid by OWS for the capped call transactions is not deductible as an interest expense under Section 163 of the Internal Revenue Code, nor is it deductible as a current business expense under Section 162. Under the prepaid forward contract characterization discussed in Section III.A above, the premium is a capital expenditure that must be capitalized and becomes part of OWS's adjusted basis in the capped call contracts.

The premium does not constitute "interest" within the meaning of Section 163 because it is not paid for the use or forbearance of money. The capped calls are equity derivative contracts, not debt instruments, and the premium is the purchase price for the call spread options. The premium is also not deductible as an ordinary and necessary business expense under Section 162 because it represents the acquisition cost of a capital asset (the capped call contracts), which must be capitalized under the general rules of Sections 263 and 1012.

Upon settlement or expiration of the capped call transactions, OWS's tax consequences will be determined by reference to the analysis set forth in Section III.B above. If the capped calls are settled in shares of OWS common stock, Section 1032 will apply, and OWS will not recognize gain or loss. If the capped calls are settled in cash, OWS will recognize capital gain or loss equal to the difference between the cash received and OWS's basis in the capped call contracts (i.e., the allocable portion of the $28,750,000 premium). If the capped calls expire unexercised (i.e., the stock price is at or below the conversion price at expiration), OWS will realize a capital loss equal to its basis in the expired contracts.

For financial accounting purposes, as discussed in the separate April 10, 2023 memorandum, the capped call cost of $28,750,000 is recorded as a reduction to additional paid-in capital under ASC 815-40, consistent with the equity classification of the capped calls. This accounting treatment — which does not affect OWS's income statement or earnings per share — aligns with the tax analysis in that neither the accounting treatment nor the tax treatment results in a current-period expense or deduction for the capped call premium.

E. Withholding and Reporting Considerations

No U.S. federal withholding tax should be imposed on the premium payments by OWS to the dealer counterparties. The premium payments are consideration for the acquisition of financial instruments (the capped call contracts) and are not in the nature of interest, dividends, or other fixed or determinable annual or periodical income subject to withholding under Sections 1441 through 1446 of the Internal Revenue Code.

Both Ridgepoint and Northvane are U.S. entities — Ridgepoint is an SEC-registered broker-dealer organized as a Delaware limited liability company, and Northvane is a Delaware limited partnership registered as a swap dealer with the CFTC. As domestic entities, neither counterparty is subject to withholding under the Foreign Account Tax Compliance Act ("FATCA") provisions of Sections 1471 through 1474, nor is withholding required under the nonresident alien withholding provisions of Section 1441. Each counterparty will provide OWS with a completed IRS Form W-9 certifying its U.S. taxpayer identification number and exemption from backup withholding.

No Form 1099 or other information reporting obligation should arise with respect to the premium payments by OWS to the counterparties. The payments are made in connection with a securities or derivatives transaction in the ordinary course of business, and the counterparties are exempt recipients for purposes of information reporting under Treasury Regulation § 1.6049-4(c). OWS should retain copies of the counterparties' W-9 forms in its files for documentation purposes.

IV. Dodd-Frank Act and CFTC Regulatory Considerations

A. Overview of Regulatory Framework

Title VII of the Dodd-Frank Wall Street Reform and Consumer Protection Act (Pub. L. 111-203), enacted in 2010, established a comprehensive regulatory framework for over-the-counter ("OTC") derivatives. Title VII divided regulatory jurisdiction over OTC derivatives between the Securities and Exchange Commission ("SEC") and the Commodity Futures Trading Commission ("CFTC") based on the type of derivative instrument. "Security-based swaps" — generally, swaps based on a single security, a narrow-based security index, or the occurrence of an event relating to a single issuer or a narrow-based group of issuers — are subject to SEC jurisdiction under Section 3(a)(68) of the Securities Exchange Act of 1934 (the "Exchange Act"). "Swaps" — a broader category that includes interest rate swaps, commodity swaps, and swaps based on broad-based security indexes — are subject to CFTC jurisdiction under the Commodity Exchange Act (the "CEA").

The capped call transactions at issue are equity derivative transactions that reference OWS common stock, which is a single equity security listed on the Nasdaq Stock Market. Because the underlying reference asset is a single security, the capped call transactions constitute "security-based swaps" within the meaning of Section 3(a)(68) of the Exchange Act and are subject to SEC (rather than CFTC) regulatory jurisdiction. This jurisdictional determination governs the applicable registration, clearing, trade reporting, margin, and business conduct requirements.

Notwithstanding the SEC jurisdictional determination, we note that Northvane Financial Products LP is separately registered as a swap dealer with the CFTC, and its internal compliance infrastructure applies certain CFTC-derived policies and procedures to its equity derivatives activity, including security-based swap activity. This is common among large dealer entities that participate in multiple product classes across both the CFTC and SEC regulatory regimes. Ridgepoint Capital Markets LLC is an SEC-registered broker-dealer and conducts its equity derivatives business through its principal trading desk, subject to applicable SEC and FINRA rules. Both entities are expected to comply with the regulatory requirements applicable to their respective registrations in connection with the capped call transactions.

B. Swap Dealer / Security-Based Swap Dealer Status of Counterparties

Ridgepoint Capital Markets LLC. Ridgepoint is an SEC-registered broker-dealer (CRD No. 37892) with its principal office at 383 Madison Avenue, 22nd Floor, New York, New York 10179. Ridgepoint is acting in its principal capacity (not as agent) with respect to the capped call transactions. Ridgepoint's equity derivatives desk, led by Cameron Walsh (Managing Director, Head of Equity Derivatives Structuring) and Natasha Okonkwo (Director, Convertible Bond Overlay Trading), routinely executes capped call and other equity-linked hedging transactions in connection with convertible bond offerings. Ridgepoint is subject to SEC rules applicable to security-based swap dealers to the extent that it meets the applicable registration thresholds or has voluntarily registered as a security-based swap dealer. We understand that Ridgepoint's security-based swap activity exceeds the de minimis threshold under SEC Rule 3a71-2 and that Ridgepoint has registered (or is in the process of registering) as a security-based swap dealer with the SEC. Ridgepoint's compliance with applicable security-based swap dealer requirements — including capital, margin, recordkeeping, and business conduct rules — is Ridgepoint's responsibility and does not impose obligations on OWS (other than the obligation to cooperate with counterparty due diligence and comply with applicable reporting requirements, as discussed below).

Northvane Financial Products LP. Northvane is a Delaware limited partnership with its principal office at 1 Liberty Plaza, 40th Floor, New York, New York 10006. Northvane is registered as a swap dealer with the CFTC (NFA ID 0528741) and is also expected to be subject to SEC security-based swap dealer rules in connection with its equity derivatives activity. Philip Granier, Managing Partner and Head of Equity Derivatives, is the primary contact for the capped call transactions. Northvane's equity derivatives business focuses on structured hedging products for corporate issuers, including capped call and call spread overlay transactions in connection with convertible debt offerings. Northvane's regulatory status as a registered swap dealer and expected security-based swap dealer imposes on Northvane (and not on OWS) the obligation to comply with applicable capital, margin, recordkeeping, reporting, and business conduct requirements under both CFTC and SEC rules.

Both Ridgepoint and Northvane are expected to have the requisite regulatory authorizations to enter into the capped call transactions as contemplated. Calderwood & Harkness should confirm the current registration status of each counterparty prior to closing.

C. End-User Exception Analysis for OWS

OWS is not a swap dealer, major swap participant, security-based swap dealer, or major security-based swap participant. OWS is a commercial operating company — a fabless semiconductor design company — that is entering into the capped call transactions for the purpose of hedging or mitigating the dilutive impact of the convertible Notes on its existing stockholders. OWS does not engage in derivatives trading as a regular business activity and is not in the business of making a market in swaps or security-based swaps.

As a non-dealer, non-major-participant counterparty, OWS may avail itself of the end-user exception from clearing requirements. For swaps (CFTC-regulated), the end-user clearing exemption is set forth in Section 3C(g)(1) of the CEA, as implemented by CFTC Rule 50.50. For security-based swaps (SEC-regulated), the parallel clearing exemption is set forth in Section 3C(g)(1) of the Exchange Act, as implemented by SEC rules. Because the capped call transactions are security-based swaps subject to SEC jurisdiction, the relevant clearing exemption is the SEC end-user exception. However, the analytical framework is substantially similar under both regimes.

To qualify for the end-user exception, OWS must satisfy the following conditions:

(i) OWS must not be a financial entity (as defined in Section 2(h)(7)(C) of the CEA and Section 3C(g)(3) of the Exchange Act). OWS is a semiconductor company, not a financial entity, and satisfies this requirement.

(ii) OWS must be using the capped call transactions to hedge or mitigate commercial risk. The capped calls are being entered into to hedge the dilutive impact of the Notes on OWS's existing stockholders and to manage the potential cash outflows upon conversion. This purpose constitutes hedging or mitigation of commercial risk.

(iii) OWS must notify the applicable regulator (the SEC, for security-based swaps) of how it generally meets its financial obligations associated with entering into non-cleared security-based swaps. This reporting can typically be satisfied through the counterparties' trade reporting obligations.

Additionally, the end-user exception requires that the decision to claim the exception be made by an "appropriate committee" of OWS's board of directors (or equivalent governing body). Accordingly, the Board Resolutions to be adopted on May 19, 2023 should include a recital specifically authorizing OWS's entry into the capped call transactions and a determination by the Board (or an authorized committee thereof) that the capped call transactions are entered into for the purpose of hedging or mitigating commercial risk and that OWS elects to avail itself of the end-user clearing exception. Audrey Zhou should prepare the relevant board resolution language for inclusion in the form of resolutions.

With respect to reporting obligations, OWS must comply with applicable trade reporting requirements under SEC Regulation SBSR (Rule 901 et seq.). However, under the regulatory framework for security-based swaps, reporting obligations for transactions between a non-dealer counterparty and a registered security-based swap dealer generally fall on the dealer counterparty. Accordingly, Ridgepoint and Northvane, as the dealer counterparties, should bear the primary responsibility for reporting the capped call transactions to a registered security-based swap data repository. OWS should confirm with each counterparty that the counterparty will fulfill the applicable reporting obligations and should cooperate with any information requests necessary for the counterparties to complete their reports.

D. Margin and Collateral Considerations

Under SEC rules for uncleared security-based swaps (SEC Rules 18a-3 and 15Fh-3, among others), registered security-based swap dealers are generally required to collect initial margin and variation margin from their counterparties in connection with uncleared security-based swap transactions. The margin requirements are designed to mitigate counterparty credit risk and are calculated based on the notional amount, risk profile, and mark-to-market value of the security-based swap.

However, OWS, as a commercial end-user that is not a financial entity, may be eligible for the end-user margin exception, which is analogous to the CFTC's end-user margin exception under CFTC Rule 23.150(b). Under the end-user margin exception, a registered security-based swap dealer is not required to collect initial or variation margin from a counterparty that qualifies as a commercial end-user and is entering into the security-based swap to hedge or mitigate commercial risk. The same conditions that support OWS's eligibility for the end-user clearing exception (discussed in Section IV.C above) also support OWS's eligibility for the end-user margin exception.

In any event, as a practical matter, the capped call transactions are fully prepaid by OWS. OWS pays the entire premium of $28,750,000 ($17,250,000 to Ridgepoint and $11,500,000 to Northvane) on the trade date (expected to be May 30, 2023), and there are no ongoing payment obligations from OWS to the counterparties during the term of the capped calls. Because OWS has fully prepaid the capped calls, there is no ongoing margin obligation on the OWS side, and the counterparties bear the performance risk (i.e., the risk that the counterparties must deliver shares or cash to OWS upon exercise or expiration of the capped calls). The counterparties are not at risk of non-payment by OWS beyond the initial premium, which has already been paid.

The ISDA documentation should confirm that no additional margin or collateral is required from OWS beyond the upfront premium payment. The Confirmation should state explicitly that OWS has no obligation to post initial margin, variation margin, or any other form of collateral in connection with the capped call transactions. The counterparties will manage their own hedging and margin obligations — including any regulatory capital and margin requirements applicable to their positions — through their internal risk management and treasury operations.

E. Business Conduct Standards

Dealer counterparties are subject to Dodd-Frank business conduct standards when dealing with OWS as a counterparty. These "external business conduct" rules are designed to protect end-user counterparties and include a number of specific requirements that the dealer counterparties must satisfy in connection with the capped call transactions.

The principal business conduct requirements applicable to the capped call transactions include:

(i) Eligible Contract Participant ("ECP") Verification. The dealer counterparties must verify that OWS is an "eligible contract participant" as defined in Section 1a(18) of the CEA. OWS qualifies as an ECP on multiple grounds, including: (a) total assets exceeding $10,000,000, as OWS's most recent audited financial statements (for the fiscal year ended December 31, 2022) report total assets of approximately $1.47 billion; and (b) status as a corporation whose securities are listed on a national securities exchange (Nasdaq: OWS). OWS's ECP status should be confirmed in writing as part of the pre-trade documentation process.

(ii) Disclosure of Material Risks, Characteristics, and Incentives. The dealer counterparties must disclose to OWS the material risks of the capped call transactions, the material characteristics of the transactions (including settlement mechanics, early termination events, and anti-dilution adjustments), and the material incentives and conflicts of interest that the dealer counterparties may have in connection with the transactions (including, in the case of Ridgepoint, its dual role as initial purchaser and capped call counterparty).

(iii) Fair Dealing. The dealer counterparties must communicate with OWS in a fair and balanced manner, based on principles of fair dealing and good faith, and must not engage in manipulative, deceptive, or fraudulent conduct in connection with the capped call transactions.

(iv) No Advisory Duty Absent Written Agreement. The dealer counterparties are not acting as advisors to OWS in connection with the capped call transactions. No written advisory agreement exists between OWS and either counterparty, and the counterparties do not owe OWS a fiduciary or advisory duty. The ISDA documentation should include an acknowledgment by OWS that it is not relying on the counterparties for advice and that it has made its own independent determination to enter into the transactions.

Calderwood & Harkness should confirm that each counterparty provides the required pre-trade disclosures to OWS in writing and that OWS acknowledges receipt of such disclosures prior to execution of the capped call Confirmations. It is customary for the dealer counterparties to provide a pre-trade disclosure letter or package, and OWS should execute a corresponding acknowledgment.

V. ISDA Documentation Structure

A. Framework: 2002 ISDA Master Agreement

Each capped call transaction will be documented under a separate 2002 ISDA Master Agreement (published by the International Swaps and Derivatives Association, Inc.) between OWS, on the one hand, and each dealer counterparty, on the other hand. Accordingly, two ISDA Master Agreements will be executed: one between OWS and Ridgepoint Capital Markets LLC, and one between OWS and Northvane Financial Products LP. Each ISDA Master Agreement will be supplemented by a negotiated Schedule (containing the parties' elections, modifications, and additional provisions) and a Confirmation (setting forth the specific economic terms of the capped call transaction).

The 2002 ISDA Master Agreement form was selected over the 1992 form for several reasons. The 2002 form is the current industry standard for equity-linked derivative transactions, including convertible bond overlay structures such as capped calls. The 2002 form includes more developed close-out netting and early termination provisions, a more clearly articulated framework for calculating early termination amounts (using "Close-out Amount" methodology rather than the dual "Market Quotation" and "Loss" methodologies of the 1992 form), and updated provisions addressing force majeure events. Market practice among major dealers in the convertible bond capped call market has largely converged on the 2002 form, and both Ridgepoint and Northvane have indicated their preference for the 2002 form.

The governing law for each ISDA Master Agreement, Schedule, and Confirmation will be the laws of the State of New York, without regard to conflicts of law principles, consistent with standard market practice for ISDA-documented transactions. The parties will submit to the non-exclusive jurisdiction of the courts of the State of New York and the United States District Court for the Southern District of New York. Jury trial waiver provisions will be included.

B. Key Schedule Elections and Negotiation Points

The Schedule to each ISDA Master Agreement will contain the parties' elections with respect to the various optional provisions of the Master Agreement, as well as additional representations, covenants, and events of default tailored to the capped call transactions. The following are the key Schedule elections and negotiation points that we have identified:

Specified Entities. No Specified Entities will be designated for purposes of Sections 5(a)(v) (Default Under Specified Transaction), 5(a)(vi) (Cross-Default), or 5(b)(iv) (Credit Event Upon Merger). This is standard for a single-issuer corporate counterparty that does not have affiliates whose defaults or credit events should trigger termination rights under the ISDA Master Agreement.

Cross-Default. The Cross-Default provision (Section 5(a)(vi) of the 2002 ISDA Master Agreement) will be included and made applicable to both OWS and the dealer counterparties. The threshold amount for triggering a Cross-Default event will be negotiated. We recommend a threshold of $25,000,000, which is consistent with the materiality threshold in OWS's existing revolving credit facility with Crestline National Bank, N.A. (as amended, the "Credit Facility"). A $25,000,000 threshold is reasonable in light of OWS's financial profile (total assets of approximately $1.47 billion; annual revenues of approximately $680 million) and provides a meaningful screen against immaterial defaults while ensuring that the counterparties are protected against material credit deterioration.

Credit Event Upon Merger. The Credit Event Upon Merger provision (Section 5(b)(iv)) will be applicable to OWS. This provision gives the dealer counterparties a termination right in the event that OWS is involved in a merger, consolidation, or similar transaction and the surviving or resulting entity is "materially weaker" than OWS immediately prior to the transaction. The "materially weaker" standard is inherently subjective, and we should negotiate the standard to require a good faith, commercially reasonable determination by the Non-affected Party (the counterparty). OWS may wish to limit the scope of this provision to transactions in which the surviving entity fails to maintain a specified credit standard (e.g., investment grade rating from a nationally recognized statistical rating organization), but this limitation may be difficult to achieve given OWS's current non-investment-grade credit profile.

Automatic Early Termination. Automatic Early Termination will not be applicable to any party. This is the standard election for U.S. counterparties that are not subject to insolvency stay concerns under which a non-defaulting party's termination rights might be suspended or impaired by operation of law. In the event of OWS's insolvency, the counterparties will rely on their contractual right to designate an Early Termination Date under Section 6(a) of the Master Agreement rather than on automatic termination. Neither Ridgepoint nor Northvane is expected to request Automatic Early Termination.

Netting. Full close-out netting provisions will apply under the 2002 ISDA Master Agreement. The "single agreement" concept — pursuant to which each ISDA Master Agreement, together with all Schedules, Confirmations, and Credit Support Documents, constitutes a single agreement between the parties — will be maintained. Close-out netting enables the parties to net all amounts owing under all transactions documented under the ISDA Master Agreement upon early termination, resulting in a single net amount payable by one party to the other. This netting right is a fundamental credit risk mitigation feature of the ISDA documentation framework.

Calculation Agent. The respective dealer counterparty (Ridgepoint or Northvane, as applicable) shall serve as Calculation Agent for the capped call transaction documented under its ISDA Master Agreement and Confirmation. The Calculation Agent is responsible for making determinations, calculations, and adjustments with respect to the capped call, including the calculation of settlement amounts, anti-dilution adjustments, and early termination amounts. Dealer counterparty appointment as Calculation Agent is standard market practice for capped call transactions; however, the dealer counterparty's role as Calculation Agent creates a potential conflict of interest, as the Calculation Agent's determinations may affect the amounts payable to or by the parties. Calderwood & Harkness should negotiate a dispute resolution mechanism pursuant to which, if OWS disputes a Calculation Agent determination, the parties will refer the matter to an independent third-party dealer selected by mutual agreement (or, failing agreement, by a specified selection mechanism) for a binding or non-binding determination. This dispute resolution provision provides OWS with a meaningful check on the Calculation Agent's discretion without disrupting the standard market structure.

Transfer. Assignment or transfer of rights and obligations under the ISDA Master Agreement and the capped call Confirmation by OWS will require the prior written consent of the dealer counterparty, not to be unreasonably withheld. The dealer counterparties may transfer their rights and obligations to affiliates without OWS's consent, subject to the requirement that the transferee affiliate maintains a credit profile and regulatory status reasonably comparable to that of the transferring counterparty. Any transfer by a dealer counterparty to a non-affiliate will require OWS's prior written consent. These transfer provisions are generally consistent with market practice but should be confirmed through negotiation.

Tax Representations. Standard tax representations under Sections 3(e) and 3(f) of the 2002 ISDA Master Agreement will be included. OWS will represent its status as a United States person for U.S. federal income tax purposes and will deliver an IRS Form W-9 to each counterparty. Each counterparty will make corresponding representations regarding its tax status and deliver a Form W-9 to OWS. The parties will also make standard FATCA representations as applicable.

Additional Termination Events. The Schedule will include the following Additional Termination Events, each of which will trigger the dealer counterparty's right (but not obligation) to terminate the related capped call transaction:

(i) Delisting. OWS common stock ceases to be listed on the Nasdaq Stock Market (or any nationally recognized successor exchange) and is not relisted on another nationally recognized exchange within a specified cure period (to be negotiated, typically 10 business days).

(ii) Fundamental Change Under the Indenture. The occurrence of a "Fundamental Change" as defined in the Indenture governing the Notes. A Fundamental Change generally includes certain change-of-control transactions, tender offers, and delistings.

(iii) Early Redemption of the Notes. OWS exercises its right to redeem the Notes prior to maturity (the optional redemption right is available on or after June 6, 2026, subject to the satisfaction of the stock price condition — i.e., OWS common stock trading at or above 130% of the conversion price, or approximately $122.85 per share, for at least 20 of the last 30 consecutive trading days).

(iv) Termination of the Notes. The Notes are terminated, repurchased, or retired prior to their scheduled maturity for any other reason (including a repurchase offer upon a Fundamental Change or open market repurchases).

Each of these Additional Termination Events reflects a circumstance in which the capped call structure is no longer necessary or in which the reference asset (OWS common stock) has been fundamentally altered. The counterparties will insist on termination rights in these circumstances to manage their hedging exposure. Upon the occurrence of an Additional Termination Event, the dealer counterparty, as the "Affected Party," will have the right to designate an Early Termination Date, and the termination payment will be calculated in accordance with the Close-out Amount methodology under Section 6(e) of the 2002 ISDA Master Agreement.

Set-Off. The dealer counterparties will request broad set-off rights, permitting the counterparty to set off any amounts owed to it under the ISDA Master Agreement against any amounts owed by it to OWS under any other agreement between the parties (including, in the case of Ridgepoint, amounts owed under the Purchase Agreement for the Notes offering). OWS should negotiate reciprocal set-off rights, permitting OWS to set off amounts owed to it by the counterparty under the ISDA Master Agreement against amounts owed by OWS to the counterparty under any other agreement. Reciprocal set-off is not always achievable in negotiations with major dealers, but it is a reasonable request and should be pursued.

C. Confirmation Structure

Each Confirmation will be a separate document supplementing the relevant ISDA Master Agreement and will constitute a "Confirmation" within the meaning of Section 1(c) of the 2002 ISDA Master Agreement. The Confirmation will contain the specific economic terms of the capped call transaction, including all material parameters necessary to define the parties' rights and obligations.

The key defined terms and economic parameters to be included in each Confirmation are as follows:

The number of options under each Confirmation will be calculated based on the number of Notes outstanding (including any Notes issued upon exercise of the over-allotment option) and allocated proportionally between the two counterparties. For example, if the full $287,500,000 aggregate principal amount of Notes is outstanding, the total number of options will be 287,500 (one option per $1,000 principal amount of Notes), of which 172,500 will be allocated to Ridgepoint and 115,000 to Northvane.

The Confirmations will also contain detailed provisions addressing the following:

• Anti-Dilution Adjustments. The anti-dilution adjustments to the lower strike price, upper strike price (cap price), and number of options will mirror those set forth in the Indenture to be executed with Broadmere Trust Company, N.A. The Confirmation will specify that adjustments will be made upon the occurrence of stock splits, reverse stock splits, stock dividends, spin-offs, extraordinary dividends, tender offers, recapitalizations, and other dilutive or anti-dilutive events that trigger adjustments to the conversion rate under the Indenture. The mirroring mechanism is essential to ensure that the capped call hedge remains aligned with the conversion terms of the Notes.

• Settlement Valuation Period. The Confirmation will specify a valuation period for determining the settlement amount upon exercise or expiration of the capped calls. The valuation period should track the conversion settlement valuation period under the Indenture (expected to be a 40-day observation period) to ensure consistency between the conversion payout and the capped call payout.

• Early Termination and Unwinding Mechanics. The Confirmation will address the mechanics and timing of settlement upon early termination of the capped calls, including termination triggered by early redemption of the Notes, Fundamental Change, or other Additional Termination Events. The settlement calculation should be based on the Close-out Amount methodology, and the Confirmation should specify the timing for payment of the termination amount.

• Disruption Events and Fallback Provisions. The Confirmation will contain provisions addressing market disruption events (e.g., trading halts, exchange closures, extraordinary market conditions) that may affect the determination of settlement amounts or the exercise of the capped calls. Standard ISDA equity definitions (2002 ISDA Equity Derivatives Definitions or 2011 Equity Definitions, as applicable) will govern the fallback provisions.

D. Relationship Between Capped Calls and the Indenture

It is important to emphasize that the capped call transactions are separate and independent contracts between OWS and the dealer counterparties. The capped calls are not part of the Indenture, are not secured by any property pledged under the Indenture, and do not benefit the holders of the Notes in any respect. The noteholders have no rights under, and no recourse to, the capped call transactions, and the existence or termination of the capped calls does not affect the noteholders' rights under the Notes or the Indenture.

The Offering Memorandum (both the Preliminary Offering Memorandum, expected to be dated May 18, 2023, and the Final Offering Memorandum, expected to be dated May 24, 2023) will describe the capped call transactions, their purpose (dilution offset), and their key terms, including the identities of the counterparties, the aggregate cost of the capped calls, and the cap price. The Offering Memorandum will also include a risk factor addressing the counterparty credit risk associated with the capped calls — specifically, the risk that the dealer counterparties may fail to perform their obligations under the capped calls, in which event OWS would not receive the expected dilution offset and could suffer a loss equal to the premium paid.

The alignment of the capped call adjustments with the Indenture adjustments is a critical structural feature. If the conversion rate under the Indenture is adjusted as a result of an anti-dilution event, the corresponding adjustments to the capped call strike prices and number of options should ensure that the capped call hedge continues to offset the same economic exposure. The Confirmation will contain a specific mechanism — typically a cross-reference to the Indenture adjustment provisions and a representation by OWS to notify the counterparties of any adjustment — to effectuate this alignment. Calderwood & Harkness should review the adjustment provisions of the Indenture carefully to ensure that they are mirrored accurately in the Confirmations.

In the event that OWS exercises its optional redemption right under the Indenture (available on or after June 6, 2026, subject to the stock price condition that OWS common stock has traded at or above 130% of the then-applicable conversion price — approximately $122.85 per share based on the initial conversion price of $94.50 — for at least 20 of the last 30 consecutive trading days preceding the date on which OWS provides notice of redemption), the capped calls will be subject to early termination or unwinding. The Confirmation should address the settlement mechanics and timing for such early termination, including (i) the calculation method for the early termination payment (Close-out Amount or, alternatively, a specified formula), (ii) the timing for notice of termination by OWS to the counterparties, and (iii) the payment date for the termination amount. Because the optional redemption right is only exercisable when the stock price is significantly above the conversion price, the capped calls will likely have meaningful in-the-money value at the time of early termination, and the counterparties will be required to make a termination payment to OWS.

VI. Counterparty Hedging Activity and Market Impact

A. Initial Hedge

Upon execution of the capped call transactions on the trade date (expected to be May 30, 2023), the dealer counterparties are expected to establish initial delta hedges by purchasing shares of OWS common stock in the open market and/or by entering into other derivative transactions referencing OWS common stock. The initial delta hedge for a capped call position typically involves purchasing a number of shares of the underlying stock equal to the aggregate delta of the capped call position, which represents the sensitivity of the capped call value to changes in the stock price.

This initial hedging activity may have the effect of increasing the trading price of OWS common stock in the period immediately surrounding the pricing and closing of the Notes offering. The increase in buying pressure from the counterparties' hedging activity could, in turn, affect the pricing of the Notes, including the initial conversion price and the cap price. The initial purchasers of the Notes — including Ridgepoint, which serves as both lead initial purchaser and capped call counterparty — may coordinate the timing and sequencing of the hedging activity with the pricing of the Notes offering to optimize the overall economics for OWS and the initial purchasers.

The potential market impact of counterparty hedging activity is a standard risk factor disclosure in convertible note offerings with capped call overlays. The Offering Memorandum will include a risk factor addressing the potential effect of t

MEMORANDUM
PRIVILEGED AND CONFIDENTIAL ATTORNEY-CLIENT PRIVILEGE / ATTORNEY WORK PRODUCT
CALDERWOOD & HARKNESS LLP 600 Lexington Avenue, 30th Floor New York, New York 10022
This memorandum is prepared in connection with Calderwood & Harkness LLP's representation of Optiwave Semiconductor Corp. in the proposed offering of $250,000,000 aggregate principal amount of 2.75% Convertible Senior Notes due 2028 and related capped call transactions. Privileged and confidential.
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I. Executive Summary and Purpose
The purpose of this memorandum is to analyze the principal tax, regulatory, and structural considerations arising from the capped call transactions that Optiwave Semiconductor Corp. ("OWS" or the "Company") proposes to enter into concurrently with the issuance of its 2.75% Convertible Senior Notes due 2028 (the "Notes"). This memorandum is intended to serve as a comprehensive internal working document for the deal team and to identify key negotiation points, open issues, and action items in connection with the capped call overlay structure.
The capped call transactions are designed to offset potential dilution to OWS common stock, par value $0.001 per share (Nasdaq: OWS), upon conversion of the Notes, or, alternatively, to offset cash payments that OWS would otherwise be required to make in excess of the aggregate principal amount of the Notes upon conversion. By entering into the capped call transactions, OWS effectively raises the economic dilution point from the initial conversion price of approximately $94.50 per share to the cap price of $110.07 per share. In practical terms, the capped call transactions provide OWS with a hedging mechanism that substantially reduces the dilutive impact of the Notes on OWS's existing stockholders within the range between the initial conversion price and the cap price.
Two dealer counterparties have been identified for the capped call transactions: Ridgepoint Capital Markets LLC ("Ridgepoint") and Northvane Financial Products LP ("Northvane"). The notional amount of the capped call transactions will be allocated between the two counterparties on a 60/40 basis, with Ridgepoint receiving 60% of the notional and Northvane receiving 40% of the notional. The aggregate premium cost for the capped call transactions is $28,750,000, of which Ridgepoint's share is $17,250,000 and Northvane's share is $11,500,000. This cost will be funded from the gross proceeds of the Notes offering.
This memorandum covers five principal areas of analysis:
1. U.S. Federal Income Tax Treatment. The characterization of the capped call transactions from OWS's perspective, including the proper treatment of the premium paid and the consequences of settlement.
2. Section 1032 Analysis. The application of Section 1032 of the Internal Revenue Code to OWS upon settlement of the capped calls in shares of its own common stock.
3. Constructive Sale Risk Under Section 1259. Whether the combination of the convertible Notes and the capped call transactions gives rise to constructive sale treatment under Section 1259 of the Internal Revenue Code with respect to OWS's common stock.
4. Dodd-Frank and Regulatory Implications. The application of the Dodd-Frank Wall Street Reform and Consumer Protection Act, including security-based swap regulation by the SEC and related CFTC considerations, to OWS and the dealer counterparties.
5. ISDA Documentation Structure and Key Negotiation Points. The framework for documenting the capped call transactions under the 2002 ISDA Master Agreement and the principal elections, terms, and negotiation points in the Schedule and Confirmation.
This memorandum should be read in conjunction with the separate Calderwood & Harkness LLP memorandum dated April 10, 2023 (prepared by Claire Dempsey and Leonard Cross), which analyzes the accounting treatment of the Notes and the capped call transactions under ASC 470-20 / ASU 2020-06, as well as the general U.S. federal income tax treatment of the Notes themselves. The April 10, 2023 memorandum addresses the accounting classification of the Notes as a single liability instrument following the adoption of ASU 2020-06 and the equity classification of the capped call transactions under ASC 815-40. This memorandum does not duplicate that analysis but cross-references it where relevant.
II. Transaction Overview and Key Economic Terms
A. Structure of the Capped Call
The capped call transactions are privately negotiated call spread transactions on OWS common stock, to be entered into between OWS, on the one hand, and each of Ridgepoint and Northvane, on the other hand. Each capped call transaction is structured as a combination of two economically linked option positions: a purchased call option at a lower strike price and a written (sold) call option at an upper strike price (the "cap price"). Together, these two positions are economically equivalent to a call spread, sometimes referred to as a "bull call spread" or "capped call overlay."
The lower strike price of the purchased call option component is set equal to the initial conversion price of the Notes, which is approximately $94.50 per share. This initial conversion price is derived from the initial conversion rate of 10.5820 shares of OWS common stock per $1,000 principal amount of Notes (i.e., $1,000 ÷ 10.5820 ≈ $94.50). The upper strike price, or cap price, of the written call option component is $110.07 per share. The cap price represents a premium of approximately 50.0% over the reference price of $73.38 per share, which is expected to be set as the closing sale price of OWS common stock on the Nasdaq Stock Market on the pricing date for the Notes offering, anticipated to be May 23, 2023.
The economic effect of the capped call transactions is as follows: if the market price of OWS common stock exceeds the initial conversion price of approximately $94.50 per share but remains at or below the cap price of $110.07 per share at the time of conversion of the Notes or expiration of the capped calls, the capped calls will deliver value to OWS equal to the difference between the stock price and the initial conversion price (on a per-share basis), thereby fully offsetting the dilutive effect of conversion within that range. If the stock price exceeds the cap price, the capped calls will deliver value equal to the difference between the cap price and the initial conversion price ($110.07 − $94.50 = $15.57 per share, subject to adjustment), and OWS will experience dilution only with respect to the portion of the stock price that exceeds the cap price. In effect, the capped call transactions raise the effective conversion price of the Notes from approximately $94.50 per share to $110.07 per share for dilution purposes.
The expiration date of the capped call transactions is June 1, 2028, which matches the maturity date of the Notes. The capped calls are subject to earlier exercise or termination in connection with conversion of the Notes, early redemption by OWS, or the occurrence of certain termination events specified in the ISDA documentation, as discussed in greater detail in Section V below.
B. Notional Allocation and Cost
The total aggregate principal amount of the Notes offering is $250,000,000, with an additional 15% over-allotment option granted to the initial purchasers in the amount of $37,500,000, resulting in a total potential principal amount of $287,500,000 if the over-allotment option is exercised in full. The capped call transactions are being sized to cover the full principal amount of the Notes, including the over-allotment portion, such that if the over-allotment option is exercised in full, the capped call notional will equal $287,500,000.
The allocation of the capped call notional between the two dealer counterparties is as follows:
The aggregate capped call cost of $28,750,000 will be funded from the gross proceeds of the Notes offering. The use of proceeds section of the Offering Memorandum will identify the capped call premium as a specified use of proceeds, and the funds flow memorandum for the closing (currently anticipated for May 30, 2023) will include wire transfer instructions for the premium payments to each of Ridgepoint and Northvane.
It should be noted that the notional allocation reflects the relative roles of the counterparties in the overall transaction. Ridgepoint, as the lead initial purchaser and sole bookrunning manager for the Notes offering, is allocated a larger share of the capped call notional, which is consistent with market practice and reflects its central role in structuring and pricing the offering. The implications of Ridgepoint's dual role are discussed in Section VI.C below.
C. Settlement Mechanics
The capped call transactions are designed to mirror the conversion settlement mechanics of the Notes. Under the terms of the Indenture (to be entered into between OWS and Broadmere Trust Company, N.A., as Trustee), OWS will have the right to elect the settlement method for conversions of the Notes. It is anticipated that OWS will elect "net share settlement," pursuant to which OWS will pay cash in an amount equal to the principal amount of the converting Notes and deliver shares of OWS common stock (or cash, or a combination thereof) for the conversion value in excess of the principal amount.
The capped call Confirmations will contain settlement provisions that correspond to the conversion settlement method elected by OWS under the Indenture. Specifically, upon conversion of the Notes (or upon expiration of the capped calls if no conversion has occurred), the capped calls will deliver to OWS shares of OWS common stock (or, at OWS's election, cash) in an amount equal to the value by which the per-share stock price exceeds the lower strike price, capped at the upper strike price. The number of shares deliverable will be calculated based on the applicable number of options and the relevant stock price during a valuation period that tracks the conversion settlement valuation period under the Indenture.
This mirroring of settlement mechanics is critical to the effectiveness of the capped call structure as a dilution-offset mechanism. If OWS elects net share settlement under the Indenture and receives shares from the counterparties under the capped calls, OWS can use the shares received from the counterparties to satisfy, in whole or in part, its obligation to deliver shares to converting noteholders, thereby avoiding the issuance of additional shares from its authorized but unissued share pool and mitigating net dilution.
The anti-dilution adjustments applicable to the capped call strike prices and the number of options will track the anti-dilution adjustments set forth in the Indenture. This is essential to ensure that the capped call hedge remains aligned with the conversion terms of the Notes throughout the life of the instruments. The Confirmation will specify that adjustments to the lower strike price, the upper strike price (cap price), and the number of options will be made in accordance with the same formulas and upon the occurrence of the same triggering events (e.g., stock dividends, stock splits, spin-offs, tender offers, and make-whole fundamental changes) as the adjustments to the conversion rate and conversion price under the Indenture.
III. U.S. Federal Income Tax Analysis — OWS Perspective
A. Characterization of the Capped Call Transactions
A threshold question for the U.S. federal income tax analysis is the proper characterization of the capped call transactions. Two principal characterizations are available: (i) integration with the Notes as a single financial instrument, or (ii) treatment as separate prepaid forward contracts on OWS common stock. The characterization has significant consequences for the tax treatment of both the Notes and the capped calls.
Integration Approach. Under the integration approach, the capped call transactions would be treated as part of the debt instrument for purposes of Section 163 of the Internal Revenue Code and the original issue discount ("OID") rules set forth in Sections 1271 through 1275. If the capped calls were integrated with the Notes, the combined instrument could be viewed as a contingent payment debt instrument or as a debt instrument with modified conversion terms, which would affect the calculation of the yield to maturity and the OID accruals on the Notes. Integration treatment could also affect the characterization of the premium paid by OWS as a component of the borrowing cost of the Notes, potentially enabling some portion of the premium to be treated as deductible interest expense over the life of the Notes.
However, integration treatment is uncertain and, in our view, unlikely to be sustained given the structure of the transactions. The capped calls are entered into with counterparties (Ridgepoint and Northvane) that are separate from the noteholders. The capped calls are not embedded options within the Notes; they are independent, freestanding contracts documented under separate ISDA Master Agreements and Confirmations. The noteholders have no rights under, or recourse to, the capped call transactions, and the capped calls do not modify the conversion terms of the Notes as between OWS and the noteholders. The separate counterparty structure, separate documentation, and separate settlement mechanics all weigh against integration. Moreover, we are not aware of any published IRS guidance, revenue ruling, or judicial decision that mandates integration of separately documented capped call transactions with concurrently issued convertible notes for U.S. federal income tax purposes.
Prepaid Forward Contract Characterization. The more likely and customary characterization — consistent with prevailing market practice and the approach taken by issuers and their counsel in comparable convertible note offerings — is to treat the capped calls as separate prepaid forward contracts on OWS common stock. Under this characterization, OWS pays a fixed premium ($28,750,000 in aggregate, allocated between the two counterparties) in exchange for a contractual right to receive a future delivery of shares of OWS common stock (or, at OWS's election, cash) contingent on the price of OWS common stock at the time of exercise or expiration. The prepaid forward contract characterization is supported by the economic substance of the transactions: OWS makes a single upfront payment and receives a contingent future delivery, which is the hallmark of a prepaid forward or prepaid variable forward contract.
As separate contracts, the capped calls should not affect the tax treatment of the Notes as variable rate debt instruments (as analyzed in the separate April 10, 2023 memorandum). The OID calculations, the determination of stated interest, and the convertible debt treatment under Sections 163(l) and 1272 should be unaffected by the existence of the capped calls, provided the IRS does not seek to integrate the two instruments.
We note that the forthcoming tax memorandum from Leonard Cross to OWS, which is expected to be finalized by the closing date and ultimately dated May 29, 2023, will set forth the firm's conclusions on the tax characterization of the capped calls and the Notes for purposes of the Offering Memorandum tax disclosure. The Offering Memorandum will contain a summary of the material U.S. federal income tax considerations for holders of the Notes and will note the treatment of the capped calls as separate transactions that do not affect the tax treatment of the Notes.
B. Section 1032 Analysis
Section 1032 of the Internal Revenue Code provides that a corporation does not recognize gain or loss on the receipt of money or other property in exchange for its own stock, including treasury stock. This provision is fundamental to the tax treatment of corporate equity issuances and repurchases and has been interpreted broadly by the IRS and the courts to cover range transactions in which a corporation issues or receives its own stock.
The capped call transactions involve OWS paying a premium to the dealer counterparties and receiving, upon exercise or expiration, shares of its own common stock (which OWS then uses to satisfy its conversion obligations to the noteholders) or, at OWS's election, cash in lieu thereof. To the extent OWS receives shares of its own common stock upon settlement of the capped calls, Section 1032 should apply to the settlement and OWS should not recognize gain or loss on such receipt. This is true regardless of whether the fair market value of the shares received at settlement exceeds or is less than the premium paid by OWS for the capped calls. The Section 1032 nonrecognition rule applies to the receipt of the shares, and OWS's basis in the shares received should be their fair market value at the time of receipt (although this point has limited significance, as OWS will typically use the shares immediately to satisfy its conversion obligations).
The application of Section 1032 to capped call settlements in stock is well supported by the language of the statute and by longstanding IRS authority. The transaction is economically analogous to a corporation entering into a forward purchase contract for its own shares: the corporation pays a price (the premium) and receives its own shares at a future date. Section 1032 has been applied to forward contracts on a corporation's own stock in a number of published and private rulings, and the IRS has consistently concluded that the corporation does not recognize gain or loss on such transactions.
If OWS elects cash settlement from the counterparties rather than share settlement, the analysis changes. Section 1032 would not directly apply to a cash settlement, because OWS would not be receiving its own stock. In that case, the cash received by OWS from the counterparties would be treated as proceeds from the settlement of a financial contract, and OWS's gain or loss would be determined by comparing the cash received to its basis in the capped call contract (i.e., the premium paid, allocated to the settled portion). However, as a practical matter, if OWS elects cash settlement of the capped calls, the cash received would offset the cash that OWS is required to pay to converting noteholders in excess of the principal amount of the Notes, and OWS's overall tax position would be governed by the debt repayment rules under Sections 1271 through 1275, including the rules applicable to retirement of debt instruments.
Key conclusion: The Section 1032 analysis strongly supports the proposed capped call structure. To the extent OWS settles the capped calls in shares of its own common stock — which is the expected default settlement method — OWS should not recognize taxable income on settlement. This result is central to the economic rationale for the capped call overlay and is consistent with the treatment of comparable capped call structures in the convertible debt market.
C. Constructive Sale Risk — Section 1259
Section 1259 of the Internal Revenue Code provides that a taxpayer is treated as having made a "constructive sale" of an "appreciated financial position" if the taxpayer enters into certain enumerated transactions that substantially eliminate risk of loss and opportunity for gain with respect to the appreciated financial position. The enumerated transactions include short sales, offsetting notional principal contracts, and futures or forward contracts to deliver the same or substantially identical property. A constructive sale triggers immediate recognition of gain as if the appreciated position had been sold at its fair market value on the date of the constructive sale.
The relevant question for OWS is whether the combination of the convertible Notes (which create a potential obligation to deliver shares or pay cash, representing a form of "short exposure" to OWS common stock) and the capped calls (which provide OWS with the right to receive shares or cash if the stock price rises above the conversion price) could be characterized as a constructive sale of OWS common stock under Section 1259.
Our analysis concludes that Section 1259 does not apply to OWS in this context for the following reasons:
First, and most fundamentally, OWS does not hold an "appreciated financial position" in its own stock within the meaning of Section 1259. Section 1259(b) defines an "appreciated financial position" as any position with respect to any stock, debt instrument, or partnership interest if there would be gain if the position were sold, assigned, or otherwise terminated at its fair market value. A corporation's interest in its own authorized but unissued shares does not constitute a "position" in stock for purposes of Section 1259. The provision is directed at holders of appreciated positions — investors, traders, and other taxpayers who own stock and seek to lock in unrealized gains without triggering a taxable disposition. It is not directed at issuers of stock, whose transactions in their own equity are governed by Section 1032. There is no published authority applying Section 1259 to a corporation acting as an issuer of its own stock, and the legislative history of Section 1259 does not suggest that Congress intended the provision to reach corporate issuers.
Second, even if Section 1259 were applied by analogy to the capped call structure, the transactions would not satisfy the statutory requirements for a constructive sale. A constructive sale requires that the taxpayer's combined positions substantially eliminate both the risk of loss and the opportunity for gain with respect to the appreciated position. In the case of the capped call transactions, the upside protection provided by the capped calls is limited by the cap price of $110.07 per share. Above the cap price, OWS retains full dilution exposure — that is, OWS will experience dilution to the extent the stock price exceeds the cap price at the time of conversion. The existence of the cap means that the capped call transactions do not fully eliminate the "opportunity for gain" (or, more precisely, the risk of dilution in the issuer context) associated with the convertible Notes. In the analogous investor context, a capped call spread with an upper strike would not constitute a constructive sale because the investor retains meaningful economic exposure to price movements above the cap.
Third, the convertible Notes themselves are not a "short sale" or "forward contract" in the traditional sense. The Notes are debt instruments with a contingent equity feature (the conversion right belongs to the noteholders, not to OWS), and OWS's obligation is to pay cash and/or deliver shares upon conversion at the election of the noteholders. The characterization of the Notes as creating a "short position" in OWS stock for purposes of Section 1259 would be a novel extension of the statute that is not supported by existing authority.
Conclusion: Section 1259 constructive sale risk is not applicable to OWS as the issuer of its own common stock. The capped call transactions do not give rise to a constructive sale of OWS common stock, and no constructive sale concern exists with respect to the proposed structure.
D. Premium Deductibility
The $28,750,000 aggregate premium paid by OWS for the capped call transactions is not deductible as an interest expense under Section 163 of the Internal Revenue Code, nor is it deductible as a current business expense under Section 162. Under the prepaid forward contract characterization discussed in Section III.A above, the premium is a capital expenditure that must be capitalized and becomes part of OWS's adjusted basis in the capped call contracts.
The premium does not constitute "interest" within the meaning of Section 163 because it is not paid for the use or forbearance of money. The capped calls are equity derivative contracts, not debt instruments, and the premium is the purchase price for the call spread options. The premium is also not deductible as an ordinary and necessary business expense under Section 162 because it represents the acquisition cost of a capital asset (the capped call contracts), which must be capitalized under the general rules of Sections 263 and 1012.
Upon settlement or expiration of the capped call transactions, OWS's tax consequences will be determined by reference to the analysis set forth in Section III.B above. If the capped calls are settled in shares of OWS common stock, Section 1032 will apply, and OWS will not recognize gain or loss. If the capped calls are settled in cash, OWS will recognize capital gain or loss equal to the difference between the cash received and OWS's basis in the capped call contracts (i.e., the allocable portion of the $28,750,000 premium). If the capped calls expire unexercised (i.e., the stock price is at or below the conversion price at expiration), OWS will realize a capital loss equal to its basis in the expired contracts.
For financial accounting purposes, as discussed in the separate April 10, 2023 memorandum, the capped call cost of $28,750,000 is recorded as a reduction to additional paid-in capital under ASC 815-40, consistent with the equity classification of the capped calls. This accounting treatment — which does not affect OWS's income statement or earnings per share — aligns with the tax analysis in that neither the accounting treatment nor the tax treatment results in a current-period expense or deduction for the capped call premium.
E. Withholding and Reporting Considerations
No U.S. federal withholding tax should be imposed on the premium payments by OWS to the dealer counterparties. The premium payments are consideration for the acquisition of financial instruments (the capped call contracts) and are not in the nature of interest, dividends, or other fixed or determinable annual or periodical income subject to withholding under Sections 1441 through 1446 of the Internal Revenue Code.
Both Ridgepoint and Northvane are U.S. entities — Ridgepoint is an SEC-registered broker-dealer organized as a Delaware limited liability company, and Northvane is a Delaware limited partnership registered as a swap dealer with the CFTC. As domestic entities, neither counterparty is subject to withholding under the Foreign Account Tax Compliance Act ("FATCA") provisions of Sections 1471 through 1474, nor is withholding required under the nonresident alien withholding provisions of Section 1441. Each counterparty will provide OWS with a completed IRS Form W-9 certifying its U.S. taxpayer identification number and exemption from backup withholding.
No Form 1099 or other information reporting obligation should arise with respect to the premium payments by OWS to the counterparties. The payments are made in connection with a securities or derivatives transaction in the ordinary course of business, and the counterparties are exempt recipients for purposes of information reporting under Treasury Regulation § 1.6049-4(c). OWS should retain copies of the counterparties' W-9 forms in its files for documentation purposes.
IV. Dodd-Frank Act and CFTC Regulatory Considerations
A. Overview of Regulatory Framework
Title VII of the Dodd-Frank Wall Street Reform and Consumer Protection Act (Pub. L. 111-203), enacted in 2010, established a comprehensive regulatory framework for over-the-counter ("OTC") derivatives. Title VII divided regulatory jurisdiction over OTC derivatives between the Securities and Exchange Commission ("SEC") and the Commodity Futures Trading Commission ("CFTC") based on the type of derivative instrument. "Security-based swaps" — generally, swaps based on a single security, a narrow-based security index, or the occurrence of an event relating to a single issuer or a narrow-based group of issuers — are subject to SEC jurisdiction under Section 3(a)(68) of the Securities Exchange Act of 1934 (the "Exchange Act"). "Swaps" — a broader category that includes interest rate swaps, commodity swaps, and swaps based on broad-based security indexes — are subject to CFTC jurisdiction under the Commodity Exchange Act (the "CEA").
The capped call transactions at issue are equity derivative transactions that reference OWS common stock, which is a single equity security listed on the Nasdaq Stock Market. Because the underlying reference asset is a single security, the capped call transactions constitute "security-based swaps" within the meaning of Section 3(a)(68) of the Exchange Act and are subject to SEC (rather than CFTC) regulatory jurisdiction. This jurisdictional determination governs the applicable registration, clearing, trade reporting, margin, and business conduct requirements.
Notwithstanding the SEC jurisdictional determination, we note that Northvane Financial Products LP is separately registered as a swap dealer with the CFTC, and its internal compliance infrastructure applies certain CFTC-derived policies and procedures to its equity derivatives activity, including security-based swap activity. This is common among large dealer entities that participate in multiple product classes across both the CFTC and SEC regulatory regimes. Ridgepoint Capital Markets LLC is an SEC-registered broker-dealer and conducts its equity derivatives business through its principal trading desk, subject to applicable SEC and FINRA rules. Both entities are expected to comply with the regulatory requirements applicable to their respective registrations in connection with the capped call transactions.
B. Swap Dealer / Security-Based Swap Dealer Status of Counterparties
Ridgepoint Capital Markets LLC. Ridgepoint is an SEC-registered broker-dealer (CRD No. 37892) with its principal office at 383 Madison Avenue, 22nd Floor, New York, New York 10179. Ridgepoint is acting in its principal capacity (not as agent) with respect to the capped call transactions. Ridgepoint's equity derivatives desk, led by Cameron Walsh (Managing Director, Head of Equity Derivatives Structuring) and Natasha Okonkwo (Director, Convertible Bond Overlay Trading), routinely executes capped call and other equity-linked hedging transactions in connection with convertible bond offerings. Ridgepoint is subject to SEC rules applicable to security-based swap dealers to the extent that it meets the applicable registration thresholds or has voluntarily registered as a security-based swap dealer. We understand that Ridgepoint's security-based swap activity exceeds the de minimis threshold under SEC Rule 3a71-2 and that Ridgepoint has registered (or is in the process of registering) as a security-based swap dealer with the SEC. Ridgepoint's compliance with applicable security-based swap dealer requirements — including capital, margin, recordkeeping, and business conduct rules — is Ridgepoint's responsibility and does not impose obligations on OWS (other than the obligation to cooperate with counterparty due diligence and comply with applicable reporting requirements, as discussed below).
Northvane Financial Products LP. Northvane is a Delaware limited partnership with its principal office at 1 Liberty Plaza, 40th Floor, New York, New York 10006. Northvane is registered as a swap dealer with the CFTC (NFA ID 0528741) and is also expected to be subject to SEC security-based swap dealer rules in connection with its equity derivatives activity. Philip Granier, Managing Partner and Head of Equity Derivatives, is the primary contact for the capped call transactions. Northvane's equity derivatives business focuses on structured hedging products for corporate issuers, including capped call and call spread overlay transactions in connection with convertible debt offerings. Northvane's regulatory status as a registered swap dealer and expected security-based swap dealer imposes on Northvane (and not on OWS) the obligation to comply with applicable capital, margin, recordkeeping, reporting, and business conduct requirements under both CFTC and SEC rules.
Both Ridgepoint and Northvane are expected to have the requisite regulatory authorizations to enter into the capped call transactions as contemplated. Calderwood & Harkness should confirm the current registration status of each counterparty prior to closing.
C. End-User Exception Analysis for OWS
OWS is not a swap dealer, major swap participant, security-based swap dealer, or major security-based swap participant. OWS is a commercial operating company — a fabless semiconductor design company — that is entering into the capped call transactions for the purpose of hedging or mitigating the dilutive impact of the convertible Notes on its existing stockholders. OWS does not engage in derivatives trading as a regular business activity and is not in the business of making a market in swaps or security-based swaps.
As a non-dealer, non-major-participant counterparty, OWS may avail itself of the end-user exception from clearing requirements. For swaps (CFTC-regulated), the end-user clearing exemption is set forth in Section 3C(g)(1) of the CEA, as implemented by CFTC Rule 50.50. For security-based swaps (SEC-regulated), the parallel clearing exemption is set forth in Section 3C(g)(1) of the Exchange Act, as implemented by SEC rules. Because the capped call transactions are security-based swaps subject to SEC jurisdiction, the relevant clearing exemption is the SEC end-user exception. However, the analytical framework is substantially similar under both regimes.
To qualify for the end-user exception, OWS must satisfy the following conditions:
(i) OWS must not be a financial entity (as defined in Section 2(h)(7)(C) of the CEA and Section 3C(g)(3) of the Exchange Act). OWS is a semiconductor company, not a financial entity, and satisfies this requirement.
(ii) OWS must be using the capped call transactions to hedge or mitigate commercial risk. The capped calls are being entered into to hedge the dilutive impact of the Notes on OWS's existing stockholders and to manage the potential cash outflows upon conversion. This purpose constitutes hedging or mitigation of commercial risk.
(iii) OWS must notify the applicable regulator (the SEC, for security-based swaps) of how it generally meets its financial obligations associated with entering into non-cleared security-based swaps. This reporting can typically be satisfied through the counterparties' trade reporting obligations.
Additionally, the end-user exception requires that the decision to claim the exception be made by an "appropriate committee" of OWS's board of directors (or equivalent governing body). Accordingly, the Board Resolutions to be adopted on May 19, 2023 should include a recital specifically authorizing OWS's entry into the capped call transactions and a determination by the Board (or an authorized committee thereof) that the capped call transactions are entered into for the purpose of hedging or mitigating commercial risk and that OWS elects to avail itself of the end-user clearing exception. Audrey Zhou should prepare the relevant board resolution language for inclusion in the form of resolutions.
With respect to reporting obligations, OWS must comply with applicable trade reporting requirements under SEC Regulation SBSR (Rule 901 et seq.). However, under the regulatory framework for security-based swaps, reporting obligations for transactions between a non-dealer counterparty and a registered security-based swap dealer generally fall on the dealer counterparty. Accordingly, Ridgepoint and Northvane, as the dealer counterparties, should bear the primary responsibility for reporting the capped call transactions to a registered security-based swap data repository. OWS should confirm with each counterparty that the counterparty will fulfill the applicable reporting obligations and should cooperate with any information requests necessary for the counterparties to complete their reports.
D. Margin and Collateral Considerations
Under SEC rules for uncleared security-based swaps (SEC Rules 18a-3 and 15Fh-3, among others), registered security-based swap dealers are generally required to collect initial margin and variation margin from their counterparties in connection with uncleared security-based swap transactions. The margin requirements are designed to mitigate counterparty credit risk and are calculated based on the notional amount, risk profile, and mark-to-market value of the security-based swap.
However, OWS, as a commercial end-user that is not a financial entity, may be eligible for the end-user margin exception, which is analogous to the CFTC's end-user margin exception under CFTC Rule 23.150(b). Under the end-user margin exception, a registered security-based swap dealer is not required to collect initial or variation margin from a counterparty that qualifies as a commercial end-user and is entering into the security-based swap to hedge or mitigate commercial risk. The same conditions that support OWS's eligibility for the end-user clearing exception (discussed in Section IV.C above) also support OWS's eligibility for the end-user margin exception.
In any event, as a practical matter, the capped call transactions are fully prepaid by OWS. OWS pays the entire premium of $28,750,000 ($17,250,000 to Ridgepoint and $11,500,000 to Northvane) on the trade date (expected to be May 30, 2023), and there are no ongoing payment obligations from OWS to the counterparties during the term of the capped calls. Because OWS has fully prepaid the capped calls, there is no ongoing margin obligation on the OWS side, and the counterparties bear the performance risk (i.e., the risk that the counterparties must deliver shares or cash to OWS upon exercise or expiration of the capped calls). The counterparties are not at risk of non-payment by OWS beyond the initial premium, which has already been paid.
The ISDA documentation should confirm that no additional margin or collateral is required from OWS beyond the upfront premium payment. The Confirmation should state explicitly that OWS has no obligation to post initial margin, variation margin, or any other form of collateral in connection with the capped call transactions. The counterparties will manage their own hedging and margin obligations — including any regulatory capital and margin requirements applicable to their positions — through their internal risk management and treasury operations.
E. Business Conduct Standards
Dealer counterparties are subject to Dodd-Frank business conduct standards when dealing with OWS as a counterparty. These "external business conduct" rules are designed to protect end-user counterparties and include a number of specific requirements that the dealer counterparties must satisfy in connection with the capped call transactions.
The principal business conduct requirements applicable to the capped call transactions include:
(i) Eligible Contract Participant ("ECP") Verification. The dealer counterparties must verify that OWS is an "eligible contract participant" as defined in Section 1a(18) of the CEA. OWS qualifies as an ECP on multiple grounds, including: (a) total assets exceeding $10,000,000, as OWS's most recent audited financial statements (for the fiscal year ended December 31, 2022) report total assets of approximately $1.47 billion; and (b) status as a corporation whose securities are listed on a national securities exchange (Nasdaq: OWS). OWS's ECP status should be confirmed in writing as part of the pre-trade documentation process.
(ii) Disclosure of Material Risks, Characteristics, and Incentives. The dealer counterparties must disclose to OWS the material risks of the capped call transactions, the material characteristics of the transactions (including settlement mechanics, early termination events, and anti-dilution adjustments), and the material incentives and conflicts of interest that the dealer counterparties may have in connection with the transactions (including, in the case of Ridgepoint, its dual role as initial purchaser and capped call counterparty).
(iii) Fair Dealing. The dealer counterparties must communicate with OWS in a fair and balanced manner, based on principles of fair dealing and good faith, and must not engage in manipulative, deceptive, or fraudulent conduct in connection with the capped call transactions.
(iv) No Advisory Duty Absent Written Agreement. The dealer counterparties are not acting as advisors to OWS in connection with the capped call transactions. No written advisory agreement exists between OWS and either counterparty, and the counterparties do not owe OWS a fiduciary or advisory duty. The ISDA documentation should include an acknowledgment by OWS that it is not relying on the counterparties for advice and that it has made its own independent determination to enter into the transactions.
Calderwood & Harkness should confirm that each counterparty provides the required pre-trade disclosures to OWS in writing and that OWS acknowledges receipt of such disclosures prior to execution of the capped call Confirmations. It is customary for the dealer counterparties to provide a pre-trade disclosure letter or package, and OWS should execute a corresponding acknowledgment.
V. ISDA Documentation Structure
A. Framework: 2002 ISDA Master Agreement
Each capped call transaction will be documented under a separate 2002 ISDA Master Agreement (published by the International Swaps and Derivatives Association, Inc.) between OWS, on the one hand, and each dealer counterparty, on the other hand. Accordingly, two ISDA Master Agreements will be executed: one between OWS and Ridgepoint Capital Markets LLC, and one between OWS and Northvane Financial Products LP. Each ISDA Master Agreement will be supplemented by a negotiated Schedule (containing the parties' elections, modifications, and additional provisions) and a Confirmation (setting forth the specific economic terms of the capped call transaction).
The 2002 ISDA Master Agreement form was selected over the 1992 form for several reasons. The 2002 form is the current industry standard for equity-linked derivative transactions, including convertible bond overlay structures such as capped calls. The 2002 form includes more developed close-out netting and early termination provisions, a more clearly articulated framework for calculating early termination amounts (using "Close-out Amount" methodology rather than the dual "Market Quotation" and "Loss" methodologies of the 1992 form), and updated provisions addressing force majeure events. Market practice among major dealers in the convertible bond capped call market has largely converged on the 2002 form, and both Ridgepoint and Northvane have indicated their preference for the 2002 form.
The governing law for each ISDA Master Agreement, Schedule, and Confirmation will be the laws of the State of New York, without regard to conflicts of law principles, consistent with standard market practice for ISDA-documented transactions. The parties will submit to the non-exclusive jurisdiction of the courts of the State of New York and the United States District Court for the Southern District of New York. Jury trial waiver provisions will be included.
B. Key Schedule Elections and Negotiation Points
The Schedule to each ISDA Master Agreement will contain the parties' elections with respect to the various optional provisions of the Master Agreement, as well as additional representations, covenants, and events of default tailored to the capped call transactions. The following are the key Schedule elections and negotiation points that we have identified:
Specified Entities. No Specified Entities will be designated for purposes of Sections 5(a)(v) (Default Under Specified Transaction), 5(a)(vi) (Cross-Default), or 5(b)(iv) (Credit Event Upon Merger). This is standard for a single-issuer corporate counterparty that does not have affiliates whose defaults or credit events should trigger termination rights under the ISDA Master Agreement.
Cross-Default. The Cross-Default provision (Section 5(a)(vi) of the 2002 ISDA Master Agreement) will be included and made applicable to both OWS and the dealer counterparties. The threshold amount for triggering a Cross-Default event will be negotiated. We recommend a threshold of $25,000,000, which is consistent with the materiality threshold in OWS's existing revolving credit facility with Crestline National Bank, N.A. (as amended, the "Credit Facility"). A $25,000,000 threshold is reasonable in light of OWS's financial profile (total assets of approximately $1.47 billion; annual revenues of approximately $680 million) and provides a meaningful screen against immaterial defaults while ensuring that the counterparties are protected against material credit deterioration.
Credit Event Upon Merger. The Credit Event Upon Merger provision (Section 5(b)(iv)) will be applicable to OWS. This provision gives the dealer counterparties a termination right in the event that OWS is involved in a merger, consolidation, or similar transaction and the surviving or resulting entity is "materially weaker" than OWS immediately prior to the transaction. The "materially weaker" standard is inherently subjective, and we should negotiate the standard to require a good faith, commercially reasonable determination by the Non-affected Party (the counterparty). OWS may wish to limit the scope of this provision to transactions in which the surviving entity fails to maintain a specified credit standard (e.g., investment grade rating from a nationally recognized statistical rating organization), but this limitation may be difficult to achieve given OWS's current non-investment-grade credit profile.
Automatic Early Termination. Automatic Early Termination will not be applicable to any party. This is the standard election for U.S. counterparties that are not subject to insolvency stay concerns under which a non-defaulting party's termination rights might be suspended or impaired by operation of law. In the event of OWS's insolvency, the counterparties will rely on their contractual right to designate an Early Termination Date under Section 6(a) of the Master Agreement rather than on automatic termination. Neither Ridgepoint nor Northvane is expected to request Automatic Early Termination.
Netting. Full close-out netting provisions will apply under the 2002 ISDA Master Agreement. The "single agreement" concept — pursuant to which each ISDA Master Agreement, together with all Schedules, Confirmations, and Credit Support Documents, constitutes a single agreement between the parties — will be maintained. Close-out netting enables the parties to net all amounts owing under all transactions documented under the ISDA Master Agreement upon early termination, resulting in a single net amount payable by one party to the other. This netting right is a fundamental credit risk mitigation feature of the ISDA documentation framework.
Calculation Agent. The respective dealer counterparty (Ridgepoint or Northvane, as applicable) shall serve as Calculation Agent for the capped call transaction documented under its ISDA Master Agreement and Confirmation. The Calculation Agent is responsible for making determinations, calculations, and adjustments with respect to the capped call, including the calculation of settlement amounts, anti-dilution adjustments, and early termination amounts. Dealer counterparty appointment as Calculation Agent is standard market practice for capped call transactions; however, the dealer counterparty's role as Calculation Agent creates a potential conflict of interest, as the Calculation Agent's determinations may affect the amounts payable to or by the parties. Calderwood & Harkness should negotiate a dispute resolution mechanism pursuant to which, if OWS disputes a Calculation Agent determination, the parties will refer the matter to an independent third-party dealer selected by mutual agreement (or, failing agreement, by a specified selection mechanism) for a binding or non-binding determination. This dispute resolution provision provides OWS with a meaningful check on the Calculation Agent's discretion without disrupting the standard market structure.
Transfer. Assignment or transfer of rights and obligations under the ISDA Master Agreement and the capped call Confirmation by OWS will require the prior written consent of the dealer counterparty, not to be unreasonably withheld. The dealer counterparties may transfer their rights and obligations to affiliates without OWS's consent, subject to the requirement that the transferee affiliate maintains a credit profile and regulatory status reasonably comparable to that of the transferring counterparty. Any transfer by a dealer counterparty to a non-affiliate will require OWS's prior written consent. These transfer provisions are generally consistent with market practice but should be confirmed through negotiation.
Tax Representations. Standard tax representations under Sections 3(e) and 3(f) of the 2002 ISDA Master Agreement will be included. OWS will represent its status as a United States person for U.S. federal income tax purposes and will deliver an IRS Form W-9 to each counterparty. Each counterparty will make corresponding representations regarding its tax status and deliver a Form W-9 to OWS. The parties will also make standard FATCA representations as applicable.
Additional Termination Events. The Schedule will include the following Additional Termination Events, each of which will trigger the dealer counterparty's right (but not obligation) to terminate the related capped call transaction:
(i) Delisting. OWS common stock ceases to be listed on the Nasdaq Stock Market (or any nationally recognized successor exchange) and is not relisted on another nationally recognized exchange within a specified cure period (to be negotiated, typically 10 business days).
(ii) Fundamental Change Under the Indenture. The occurrence of a "Fundamental Change" as defined in the Indenture governing the Notes. A Fundamental Change generally includes certain change-of-control transactions, tender offers, and delistings.
(iii) Early Redemption of the Notes. OWS exercises its right to redeem the Notes prior to maturity (the optional redemption right is available on or after June 6, 2026, subject to the satisfaction of the stock price condition — i.e., OWS common stock trading at or above 130% of the conversion price, or approximately $122.85 per share, for at least 20 of the last 30 consecutive trading days).
(iv) Termination of the Notes. The Notes are terminated, repurchased, or retired prior to their scheduled maturity for any other reason (including a repurchase offer upon a Fundamental Change or open market repurchases).
Each of these Additional Termination Events reflects a circumstance in which the capped call structure is no longer necessary or in which the reference asset (OWS common stock) has been fundamentally altered. The counterparties will insist on termination rights in these circumstances to manage their hedging exposure. Upon the occurrence of an Additional Termination Event, the dealer counterparty, as the "Affected Party," will have the right to designate an Early Termination Date, and the termination payment will be calculated in accordance with the Close-out Amount methodology under Section 6(e) of the 2002 ISDA Master Agreement.
Set-Off. The dealer counterparties will request broad set-off rights, permitting the counterparty to set off any amounts owed to it under the ISDA Master Agreement against any amounts owed by it to OWS under any other agreement between the parties (including, in the case of Ridgepoint, amounts owed under the Purchase Agreement for the Notes offering). OWS should negotiate reciprocal set-off rights, permitting OWS to set off amounts owed to it by the counterparty under the ISDA Master Agreement against amounts owed by OWS to the counterparty under any other agreement. Reciprocal set-off is not always achievable in negotiations with major dealers, but it is a reasonable request and should be pursued.
C. Confirmation Structure
Each Confirmation will be a separate document supplementing the relevant ISDA Master Agreement and will constitute a "Confirmation" within the meaning of Section 1(c) of the 2002 ISDA Master Agreement. The Confirmation will contain the specific economic terms of the capped call transaction, including all material parameters necessary to define the parties' rights and obligations.
The key defined terms and economic parameters to be included in each Confirmation are as follows:
The number of options under each Confirmation will be calculated based on the number of Notes outstanding (including any Notes issued upon exercise of the over-allotment option) and allocated proportionally between the two counterparties. For example, if the full $287,500,000 aggregate principal amount of Notes is outstanding, the total number of options will be 287,500 (one option per $1,000 principal amount of Notes), of which 172,500 will be allocated to Ridgepoint and 115,000 to Northvane.
The Confirmations will also contain detailed provisions addressing the following:
• Anti-Dilution Adjustments. The anti-dilution adjustments to the lower strike price, upper strike price (cap price), and number of options will mirror those set forth in the Indenture to be executed with Broadmere Trust Company, N.A. The Confirmation will specify that adjustments will be made upon the occurrence of stock splits, reverse stock splits, stock dividends, spin-offs, extraordinary dividends, tender offers, recapitalizations, and other dilutive or anti-dilutive events that trigger adjustments to the conversion rate under the Indenture. The mirroring mechanism is essential to ensure that the capped call hedge remains aligned with the conversion terms of the Notes.
• Settlement Valuation Period. The Confirmation will specify a valuation period for determining the settlement amount upon exercise or expiration of the capped calls. The valuation period should track the conversion settlement valuation period under the Indenture (expected to be a 40-day observation period) to ensure consistency between the conversion payout and the capped call payout.
• Early Termination and Unwinding Mechanics. The Confirmation will address the mechanics and timing of settlement upon early termination of the capped calls, including termination triggered by early redemption of the Notes, Fundamental Change, or other Additional Termination Events. The settlement calculation should be based on the Close-out Amount methodology, and the Confirmation should specify the timing for payment of the termination amount.
• Disruption Events and Fallback Provisions. The Confirmation will contain provisions addressing market disruption events (e.g., trading halts, exchange closures, extraordinary market conditions) that may affect the determination of settlement amounts or the exercise of the capped calls. Standard ISDA equity definitions (2002 ISDA Equity Derivatives Definitions or 2011 Equity Definitions, as applicable) will govern the fallback provisions.
D. Relationship Between Capped Calls and the Indenture
It is important to emphasize that the capped call transactions are separate and independent contracts between OWS and the dealer counterparties. The capped calls are not part of the Indenture, are not secured by any property pledged under the Indenture, and do not benefit the holders of the Notes in any respect. The noteholders have no rights under, and no recourse to, the capped call transactions, and the existence or termination of the capped calls does not affect the noteholders' rights under the Notes or the Indenture.
The Offering Memorandum (both the Preliminary Offering Memorandum, expected to be dated May 18, 2023, and the Final Offering Memorandum, expected to be dated May 24, 2023) will describe the capped call transactions, their purpose (dilution offset), and their key terms, including the identities of the counterparties, the aggregate cost of the capped calls, and the cap price. The Offering Memorandum will also include a risk factor addressing the counterparty credit risk associated with the capped calls — specifically, the risk that the dealer counterparties may fail to perform their obligations under the capped calls, in which event OWS would not receive the expected dilution offset and could suffer a loss equal to the premium paid.
The alignment of the capped call adjustments with the Indenture adjustments is a critical structural feature. If the conversion rate under the Indenture is adjusted as a result of an anti-dilution event, the corresponding adjustments to the capped call strike prices and number of options should ensure that the capped call hedge continues to offset the same economic exposure. The Confirmation will contain a specific mechanism — typically a cross-reference to the Indenture adjustment provisions and a representation by OWS to notify the counterparties of any adjustment — to effectuate this alignment. Calderwood & Harkness should review the adjustment provisions of the Indenture carefully to ensure that they are mirrored accurately in the Confirmations.
In the event that OWS exercises its optional redemption right under the Indenture (available on or after June 6, 2026, subject to the stock price condition that OWS common stock has traded at or above 130% of the then-applicable conversion price — approximately $122.85 per share based on the initial conversion price of $94.50 — for at least 20 of the last 30 consecutive trading days preceding the date on which OWS provides notice of redemption), the capped calls will be subject to early termination or unwinding. The Confirmation should address the settlement mechanics and timing for such early termination, including (i) the calculation method for the early termination payment (Close-out Amount or, alternatively, a specified formula), (ii) the timing for notice of termination by OWS to the counterparties, and (iii) the payment date for the termination amount. Because the optional redemption right is only exercisable when the stock price is significantly above the conversion price, the capped calls will likely have meaningful in-the-money value at the time of early termination, and the counterparties will be required to make a termination payment to OWS.
VI. Counterparty Hedging Activity and Market Impact
A. Initial Hedge
Upon execution of the capped call transactions on the trade date (expected to be May 30, 2023), the dealer counterparties are expected to establish initial delta hedges by purchasing shares of OWS common stock in the open market and/or by entering into other derivative transactions referencing OWS common stock. The initial delta hedge for a capped call position typically involves purchasing a number of shares of the underlying stock equal to the aggregate delta of the capped call position, which represents the sensitivity of the capped call value to changes in the stock price.
This initial hedging activity may have the effect of increasing the trading price of OWS common stock in the period immediately surrounding the pricing and closing of the Notes offering. The increase in buying pressure from the counterparties' hedging activity could, in turn, affect the pricing of the Notes, including the initial conversion price and the cap price. The initial purchasers of the Notes — including Ridgepoint, which serves as both lead initial purchaser and capped call counterparty — may coordinate the timing and sequencing of the hedging activity with the pricing of the Notes offering to optimize the overall economics for OWS and the initial purchasers.
The potential market impact of counterparty hedging activity is a standard risk factor disclosure in convertible note offerings with capped call overlays. The Offering Memorandum will include a risk factor addressing the potential effect of t

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