-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, BQJBjbs6WokODbUt3P6953VnO5boYR4flEe7ruW8O7nr6AQKhxiajjAOUuIgp1Kj CjxDaW2BFUZ4qne+8FqKlg== 0000912057-02-032192.txt : 20020814 0000912057-02-032192.hdr.sgml : 20020814 20020814174800 ACCESSION NUMBER: 0000912057-02-032192 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 5 CONFORMED PERIOD OF REPORT: 20020630 FILED AS OF DATE: 20020814 FILER: COMPANY DATA: COMPANY CONFORMED NAME: AVAYA INC CENTRAL INDEX KEY: 0001116521 STANDARD INDUSTRIAL CLASSIFICATION: TELEPHONE & TELEGRAPH APPARATUS [3661] IRS NUMBER: 223713430 STATE OF INCORPORATION: DE FISCAL YEAR END: 0930 FILING VALUES: FORM TYPE: 10-Q SEC ACT: 1934 Act SEC FILE NUMBER: 001-15951 FILM NUMBER: 02737354 BUSINESS ADDRESS: STREET 1: 211 MOUNT AIRY RD CITY: BASKING RIDGE STATE: NJ ZIP: 07920 BUSINESS PHONE: 9089536000 MAIL ADDRESS: STREET 1: 211 MOUNT AIRY ROAD CITY: BASKING RIDGE STATE: NJ ZIP: 07920 FORMER COMPANY: FORMER CONFORMED NAME: LUCENT EN CORP DATE OF NAME CHANGE: 20000612 10-Q 1 a2086868z10-q.txt 10-Q - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 ------------------------ FORM 10-Q /X/ QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED JUNE 30, 2002 OR / / TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934
COMMISSION FILE NUMBER 001-15951 ------------------------ AVAYA INC. A DELAWARE I.R.S. EMPLOYER CORPORATION NO. 22-3713430
211 MOUNT AIRY ROAD, BASKING RIDGE, NEW JERSEY 07920 TELEPHONE NUMBER 908-953-6000 ------------------------ Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes /X/ No / / At June 30, 2002, 361,935,272 common shares were outstanding. - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- TABLE OF CONTENTS
ITEM DESCRIPTION PAGE - ---- ------------------------------------------------------------ -------- PART I--FINANCIAL INFORMATION 1. Financial Statements........................................ 2 2. Management's Discussion and Analysis of Financial Condition and Results of Operations................................... 34 3. Quantitative and Qualitative Disclosures About Market Risk........................................................ 72 PART II--OTHER INFORMATION 1. Legal Proceedings........................................... 73 2. Changes in Securities and Use of Proceeds................... 73 3. Defaults Upon Senior Securities............................. 73 4. Submission of Matters to a Vote of Security Holders......... 73 5. Other Information........................................... 73 6. Exhibits and Reports on Form 8-K............................ 73 Signatures.................................................. 74
This Quarterly Report on Form 10-Q contains trademarks, service marks and registered marks of Avaya and its subsidiaries and other companies, as indicated. Unless otherwise provided in this Quarterly Report on Form 10-Q, trademarks identified by -Registered Trademark- and -TM- are registered trademarks or trademarks, respectively, of Avaya Inc. or its subsidiaries. All other trademarks are the properties of their respective owners. Liquid Yield Option-TM- Notes is a trademark of Merrill Lynch & Co., Inc. 1 PART I ITEM 1. FINANCIAL STATEMENTS. AVAYA INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS (DOLLARS IN MILLIONS, EXCEPT PER SHARE AMOUNTS) (UNAUDITED)
THREE MONTHS ENDED NINE MONTHS ENDED JUNE 30, JUNE 30, ------------------- ------------------- 2002 2001 2002 2001 -------- -------- -------- -------- REVENUE Products.......................................... $ 708 $1,130 $2,204 $3,618 Services.......................................... 511 584 1,600 1,733 ------- ------ ------ ------ 1,219 1,714 3,804 5,351 ------- ------ ------ ------ COSTS Products.......................................... 423 583 1,348 1,866 Services.......................................... 315 400 952 1,178 ------- ------ ------ ------ 738 983 2,300 3,044 ------- ------ ------ ------ GROSS MARGIN........................................ 481 731 1,504 2,307 ------- ------ ------ ------ OPERATING EXPENSES Selling, general and administrative............... 377 482 1,202 1,606 Business restructuring charges and related expenses........................................ 9 66 103 271 Research and development.......................... 115 135 354 428 Purchased in-process research and development..... -- 1 -- 32 ------- ------ ------ ------ TOTAL OPERATING EXPENSES.......................... 501 684 1,659 2,337 ------- ------ ------ ------ OPERATING INCOME (LOSS)............................. (20) 47 (155) (30) Other income (expense), net....................... (10) 4 8 31 Interest expense.................................. (16) (10) (33) (30) ------- ------ ------ ------ INCOME (LOSS) BEFORE INCOME TAXES................... (46) 41 (180) (29) Provision (benefit) for income taxes.............. (7) 17 (58) (5) ------- ------ ------ ------ NET INCOME (LOSS)................................... $ (39) $ 24 $ (122) $ (24) ======= ====== ====== ====== Net Income (Loss) Available to Common Stockholders: Net income (loss)................................... $ (39) $ 24 $ (122) $ (24) Accretion of Series B preferred stock............... -- (7) (12) (20) Conversion charge related to Series B preferred stock............................................. -- -- (125) -- ------- ------ ------ ------ Net income (loss) available to common stockholders...................................... $ (39) $ 17 $ (259) $ (44) ======= ====== ====== ====== Earnings (Loss) Per Common Share: Basic............................................. $ (0.11) $ 0.06 $(0.81) $(0.16) ======= ====== ====== ====== Diluted........................................... $ (0.11) $ 0.06 $(0.81) $(0.16) ======= ====== ====== ======
See Notes to Consolidated Financial Statements. 2 AVAYA INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (DOLLARS IN MILLIONS, EXCEPT PER SHARE AMOUNTS) (UNAUDITED)
AS OF AS OF JUNE 30, 2002 SEPTEMBER 30, 2001 ------------- ------------------ ASSETS Current Assets: Cash and cash equivalents................................. $ 406 $ 250 Receivables, less allowances of $121 at June 30, 2002 and $105 at September 30, 2001.......................... 1,116 1,163 Inventory................................................. 527 649 Deferred income taxes, net................................ 226 246 Other current assets...................................... 244 461 ------ ------ TOTAL CURRENT ASSETS........................................ 2,519 2,769 ------ ------ Property, plant and equipment, net........................ 941 988 Deferred income taxes, net................................ 626 529 Goodwill.................................................. 187 175 Intangible assets, net.................................... 53 78 Other assets.............................................. 146 109 ------ ------ TOTAL ASSETS................................................ $4,472 $4,648 ====== ====== LIABILITIES AND STOCKHOLDERS' EQUITY Current Liabilities: Accounts payable.......................................... $ 375 $ 624 Short-term borrowings..................................... -- 145 Business restructuring reserve............................ 109 179 Payroll and benefit liabilities........................... 277 333 Deferred revenue.......................................... 148 206 Other current liabilities................................. 480 604 ------ ------ TOTAL CURRENT LIABILITIES................................... 1,389 2,091 ------ ------ Long-term debt............................................ 914 500 Benefit obligations....................................... 629 637 Other liabilities......................................... 525 544 ------ ------ TOTAL NONCURRENT LIABILITIES................................ 2,068 1,681 ------ ------ Commitments and contingencies Series B convertible participating preferred stock, par value $1.00 per share, 4 million shares authorized, issued and outstanding as of September 30, 2001.................. -- 395 ------ ------ STOCKHOLDERS' EQUITY Series A junior participating preferred stock, par value $1.00 per share, 7.5 million shares authorized; none issued and outstanding.................................. -- -- Common stock, par value $0.01 per share, 1.5 billion shares authorized, 362,234,272 and 286,851,934 issued (including 299,000 and 147,653 treasury shares) as of June 30, 2002 and September 30, 2001, respectively...... 4 3 Additional paid-in capital................................ 1,684 905 Accumulated deficit....................................... (638) (379) Accumulated other comprehensive loss...................... (32) (46) Less treasury stock at cost............................... (3) (2) ------ ------ TOTAL STOCKHOLDERS' EQUITY.................................. 1,015 481 ------ ------ TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY.................. $4,472 $4,648 ====== ======
See Notes to Consolidated Financial Statements. 3 AVAYA INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (DOLLARS IN MILLIONS) (UNAUDITED)
NINE MONTHS ENDED JUNE 30, ------------------- 2002 2001 -------- -------- OPERATING ACTIVITIES: Net loss.................................................. $(122) $ (24) Adjustments to reconcile net loss to net cash used for operating activities: Business restructuring charges........................ 87 154 Depreciation and amortization......................... 174 198 Provision for receivables............................. 110 35 Deferred income taxes................................. (78) 68 Purchased in-process research and development......... -- 32 Gain on assets sold................................... -- (6) Adjustments for other non-cash items, net............. 61 6 Changes in operating assets and liabilities, net of effects of acquired businesses: Receivables......................................... 265 193 Inventory........................................... 78 (45) Accounts payable.................................... (257) (272) Business restructuring reserve...................... (148) (268) Payroll and benefits, net........................... (66) 6 Deferred revenue.................................... 7 (93) Other assets and liabilities........................ (114) (203) ----- ----- NET CASH USED FOR OPERATING ACTIVITIES...................... (3) (219) ----- ----- INVESTING ACTIVITIES: Capital expenditures...................................... (96) (214) Proceeds from the sale of property, plant and equipment... 5 72 Acquisitions of businesses, net of cash acquired.......... (6) (120) Purchases of equity investments........................... -- (27) Other investing activities, net........................... 1 (3) ----- ----- NET CASH USED FOR INVESTING ACTIVITIES...................... (96) (292) ----- ----- FINANCING ACTIVITIES: Issuance of Series B preferred stock...................... -- 368 Issuance of warrants...................................... -- 32 Issuance of common stock.................................. 232 36 Net decrease in commercial paper.......................... (432) (140) Repayment of other short-term borrowings.................. (13) -- Issuance (repayment) of long-term debt.................... 895 (9) Payment of issuance costs related to debt and equity offerings............................................... (29) -- Net decrease in credit facility borrowings................ (200) -- Proceeds from (termination of) accounts receivable securitization.......................................... (200) 200 Other financing activities, net........................... (1) -- ----- ----- NET CASH PROVIDED BY FINANCING ACTIVITIES................... 252 487 ----- ----- Effect of exchange rate changes on cash and cash equivalents............................................... 3 (4) ----- ----- Net increase (decrease) in cash and cash equivalents........ 156 (28) Cash and cash equivalents at beginning of fiscal year....... 250 271 ----- ----- Cash and cash equivalents at end of period.................. $ 406 $ 243 ===== =====
See Notes to Consolidated Financial Statements. 4 AVAYA INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) 1. BACKGROUND AND BASIS OF PRESENTATION BACKGROUND On September 30, 2000, Avaya Inc. (the "Company" or "Avaya") was spun off from Lucent Technologies Inc. ("Lucent") pursuant to a contribution by Lucent of its enterprise networking businesses to the Company (the "Contribution") and a distribution of the outstanding shares of the Company's common stock to Lucent stockholders (the "Distribution"). The Company provides communication systems and software for enterprises, including businesses, government agencies and other organizations. The Company offers a broad range of voice, converged voice and data, customer relationship management, messaging, multi-service networking and structured cabling products and services. BASIS OF PRESENTATION The accompanying unaudited consolidated financial statements of the Company as of June 30, 2002 and for the three and nine months ended June 30, 2002 and 2001, have been prepared in accordance with accounting principles generally accepted in the United States of America for interim financial statements and the rules and regulations of the Securities and Exchange Commission for interim financial statements, and should be read in conjunction with the Company's Annual Report on Form 10-K for the fiscal year ended September 30, 2001. In the Company's opinion, the unaudited interim consolidated financial statements reflect all adjustments, consisting of normal and recurring adjustments, necessary for a fair presentation of the financial condition, results of operations and cash flows for the periods indicated. Certain prior year amounts have been reclassified to conform to the current interim period presentation. The consolidated results of operations for the interim periods reported are not necessarily indicative of the results to be experienced for the entire fiscal year. 2. RECENT ACCOUNTING PRONOUNCEMENTS AND CHANGE IN ACCOUNTING ESTIMATE SFAS 143 In August 2001, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standards ("SFAS") No. 143, "Accounting for Asset Retirement Obligations" ("SFAS 143"), which provides the accounting requirements for retirement obligations associated with tangible long-lived assets. This Statement requires entities to record the fair value of a liability for an asset retirement obligation in the period in which it is incurred. This Statement is effective for the Company's 2003 fiscal year, and early adoption is permitted. The adoption of SFAS 143 is not expected to have a material impact on the Company's consolidated results of operations, financial position or cash flows. SFAS 144 In October 2001, the FASB issued Statement No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets" ("SFAS 144"), which requires that long-lived assets to be disposed of by sale be measured at the lower of carrying amount or fair value less cost to sell, whether reported in continuing operations or in discontinued operations. SFAS 144 also expands the reporting of discontinued operations to include components of an entity that have been or will be disposed of rather than limiting such discontinuance to a segment of a business. This Statement excludes from the definition of 5 AVAYA INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (UNAUDITED) 2. RECENT ACCOUNTING PRONOUNCEMENTS AND CHANGE IN ACCOUNTING ESTIMATE (CONTINUED) long-lived assets goodwill and other intangibles that are not amortized in accordance with Statement No. 142, "Goodwill and Other Intangible Assets" ("SFAS 142") noted below. SFAS 144 is effective for the Company's 2003 fiscal year, and early adoption is permitted. The Company is currently evaluating the impact of SFAS 144 to determine the effect, if any, it may have on the Company's consolidated results of operations, financial position or cash flows. SFAS 145 In May 2001, the FASB issued Statement No. 145, which rescinds SFAS No. 4, "Reporting Gains and Losses from Extinguishment of Debt," SFAS No. 44, "Accounting for Intangible Assets of Motor Carriers," and SFAS No. 64, "Extinguishments of Debt Made to Satisfy Sinking-Fund Requirements" ("SFAS 145"). This Statement also amends SFAS No. 13, "Accounting for Leases," to eliminate an inconsistency between the required accounting for sale-leaseback transactions and the required accounting for certain lease modifications that have economic effects that are similar to sale-leaseback transactions. As a result of the rescission of SFAS 4 and SFAS 64, the criteria in Accounting Principles Board Opinion No. 30 will be used to classify gains and losses from debt extinguishment. This Statement also amends other existing authoritative pronouncements to make various technical corrections, clarify meanings, or describe their applicability under changed conditions. SFAS 145 is effective for the Company's 2003 fiscal year, and early adoption is permitted. The Company is currently evaluating the impact of SFAS 145 to determine the effect, if any, it may have on the Company's consolidated results of operations, financial position or cash flows. SFAS 146 In July 2002, the FASB issued Statement No. 146, "Accounting for Costs Associated with Exit or Disposal Activities" ("SFAS 146"), which addresses financial accounting and reporting for costs associated with exit or disposal activities, and nullifies Emerging Issues Task Force (EITF) Issue No. 94-3, "Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred in a Restructuring)" which previously governed the accounting treatment for restructuring activities. SFAS 146 applies to costs associated with an exit activity that does not involve an entity newly acquired in a business combination or with a disposal activity covered by SFAS 144. Those costs include, but are not limited to, the following: (1) termination benefits provided to current employees that are involuntarily terminated under the terms of a benefit arrangement that, in substance, is not an ongoing benefit arrangement or an individual deferred-compensation contract, (2) costs to terminate a contract that is not a capital lease, and (3) costs to consolidate facilities or relocate employees. This Statement does not apply to costs associated with the retirement of long-lived assets covered by SFAS 143. SFAS 146 is effective for exit or disposal activities initiated after December 31, 2002, and early adoption is permitted. The Company is currently evaluating the impact of SFAS 146 to determine the effect, if any, it may have on the Company's consolidated results of operations, financial position or cash flows. INTERNAL USE SOFTWARE In the second quarter of fiscal 2002, the Company changed the estimated useful life of certain internal use software to reflect actual experience as a stand-alone company on the utilization of such 6 AVAYA INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (UNAUDITED) 2. RECENT ACCOUNTING PRONOUNCEMENTS AND CHANGE IN ACCOUNTING ESTIMATE (CONTINUED) software and extended the useful life of these assets from three to seven years. This change lowered depreciation expense by approximately $5 million and $9 million, equivalent to $0.01 and $0.02 per diluted share, for the three and nine months ended June 30, 2002, respectively. 3. GOODWILL AND INTANGIBLE ASSETS Effective October 1, 2001, the Company adopted SFAS 142, which requires that goodwill and certain other intangible assets having indefinite lives no longer be amortized to earnings, but instead be subject to periodic testing for impairment. Intangible assets determined to have definitive lives will continue to be amortized over their remaining useful lives. In connection with the adoption of SFAS 142, the Company reviewed the classification of its existing goodwill and other intangible assets, reassessed the useful lives previously assigned to other intangible assets, and discontinued amortization of goodwill. The Company also tested goodwill for impairment by comparing the fair value of the Company's reporting units to their carrying value as of October 1, 2001 and determined that there was no goodwill impairment. The provisions of SFAS 142 require that goodwill of a reporting unit be tested for impairment on an annual basis or between annual tests if an event occurs or circumstances change that would more likely than not reduce the fair value of a reporting unit below its carrying amount. The Company intends to conduct the required impairment review for fiscal 2002 during the fourth quarter of fiscal 2002, at which time, if an impairment is identified, it will be recorded as an operating expense in the Statement of Operations. For the three and nine months ended June 30, 2001, goodwill amortization, net of tax, amounted to $10 million and $28 million, respectively. If the Company had adopted SFAS 142 as of the beginning of the first quarter of fiscal 2001 and discontinued goodwill amortization, net income and earnings (loss) per common share on a pro forma basis would have been as follows:
PRO FORMA ------------------------------------------------ THREE MONTHS ENDED NINE MONTHS ENDED JUNE 30, 2001 JUNE 30, 2001 -------------------- ------------------- (DOLLARS IN MILLIONS, EXCEPT PER SHARE AMOUNTS) Net income................................... $ 34 $ 4 Earnings (Loss) per common share: Basic...................................... $0.09 $(0.06) Diluted.................................... $0.09 $(0.06)
The carrying value of goodwill of $187 million as of June 30, 2002 consists of $141 million related to the Systems segment and $46 million related to the Applications segment. The $12 million increase in the carrying value of goodwill from September 30, 2001 is attributable to the Company's acquisition of Conita Technologies in May 2002, a purchase accounting adjustment related to the Quintus Corporation acquisition, and the impact of foreign currency exchange rate fluctuations. 7 AVAYA INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (UNAUDITED) 3. GOODWILL AND INTANGIBLE ASSETS (CONTINUED) The following table presents the components of the Company's intangible assets:
AS OF JUNE 30, 2002 AS OF SEPTEMBER 30, 2001 ---------------------------------- ---------------------------------- GROSS GROSS CARRYING ACCUMULATED CARRYING ACCUMULATED AMOUNT AMORTIZATION NET AMOUNT AMORTIZATION NET -------- ------------ -------- -------- ------------ -------- (DOLLARS IN MILLIONS) Existing technology..................... $160 $115 $45 $160 $92 $68 Other intangibles....................... 13 5 8 12 2 10 ---- ---- --- ---- --- --- Total intangible assets................. $173 $120 $53 $172 $94 $78 ==== ==== === ==== === ===
Intangible assets with definitive lives are amortized over a period of three to six years. Amortization expense for such intangible assets was $9 million for each of the three month periods ended June 30, 2002 and 2001, and $26 million and $23 million for the nine months ended June 30, 2002 and 2001, respectively. Estimated amortization expense for the remainder of fiscal 2002 and the five succeeding fiscal years is as follows:
FISCAL YEAR AMOUNT - ----------- --------------------- (DOLLARS IN MILLIONS) 2002 (remaining three months).............................. $ 9 2003....................................................... 21 2004....................................................... 12 2005....................................................... 8 2006....................................................... 3 --- Total...................................................... $53 ===
4. COMPREHENSIVE INCOME (LOSS) Other comprehensive income is recorded directly to a separate section of stockholders' equity in accumulated other comprehensive loss and includes unrealized gains and losses excluded from the Consolidated Statements of Operations. These unrealized gains and losses consist of primarily foreign currency translation adjustments, which are not adjusted for income taxes since they primarily relate to indefinite investments in non-U.S. subsidiaries.
THREE MONTHS ENDED NINE MONTHS ENDED JUNE 30, JUNE 30, ------------------- ------------------- 2002 2001 2002 2001 -------- -------- -------- -------- (DOLLARS IN MILLIONS) Net income (loss).............................. $(39) $24 $(122) $(24) Other comprehensive income..................... 39 5 14 16 ---- --- ----- ---- Total comprehensive income (loss).............. $ -- $29 $(108) $ (8) ==== === ===== ====
8 AVAYA INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (UNAUDITED) 5. SUPPLEMENTARY FINANCIAL INFORMATION AND OTHER TRANSACTIONS STATEMENT OF OPERATIONS INFORMATION
THREE MONTHS ENDED NINE MONTHS ENDED JUNE 30, JUNE 30, ------------------- ------------------- 2002 2001 2002 2001 -------- -------- -------- -------- (DOLLARS IN MILLIONS) OTHER INCOME (EXPENSE), NET Loss on foreign currency transactions.......... $(12) $-- $(3) $(1) Gain on assets sold............................ -- -- -- 6 Interest income................................ 5 7 16 22 Miscellaneous, net............................. (3) (3) (5) 4 ---- --- --- --- Total other income (expense), net.......... $(10) $ 4 $ 8 $31 ==== === === ===
BALANCE SHEET INFORMATION
AS OF AS OF JUNE 30, 2002 SEPTEMBER 30, 2001 ------------- ------------------ (DOLLARS IN MILLIONS) INVENTORY Completed goods......................................... $386 $420 Work in process and raw materials....................... 141 229 ---- ---- Total inventory..................................... $527 $649 ==== ====
RECEIVABLES, LESS ALLOWANCES The receivables allowance as of September 30, 2001, which previously represented a reserve for uncollectible accounts, has been restated to also include an estimate of $37 million for the resolution of potential issues such as disputed invoices, customer satisfaction claims and pricing discrepancies. The reclassified amount, which had previously been included as a direct reduction to receivables, was recorded to conform to the June 30, 2002 presentation. SUPPLEMENTAL CASH FLOW INFORMATION Acquisition of businesses:
NINE MONTHS ENDED JUNE 30, ----------------------- 2002 2001 ---------- ---------- (DOLLARS IN MILLIONS) Fair value of assets acquired, net of cash acquired......... $ 8 $192 Less: Fair value of liabilities assumed..................... (2) (72) --- ---- Acquisition of businesses, net of cash acquired............. $ 6 $120 === ====
In the second quarter of fiscal 2001, the Company paid off $9 million of debt assumed from its acquisition of VPNet Technologies, Inc. 9 AVAYA INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (UNAUDITED) 5. SUPPLEMENTARY FINANCIAL INFORMATION AND OTHER TRANSACTIONS (CONTINUED) Non-cash transactions:
NINE MONTHS ENDED JUNE 30, ----------------------- 2002 2001 ---------- ---------- (DOLLARS IN MILLIONS) Accretion of Series B preferred stock (Note 9).............. $ 12 $20 Book value of converted Series B preferred stock (Note 9).................................................. 395 -- Conversion charge related to Series B preferred stock (Note 9).................................................. 125 -- Issuance of common stock in connection with the Warburg transactions (Note 9)..................................... (532) -- Deferred taxes on stock options............................. 4 -- Fair market value of stock options issued in connection with acquisition............................................... -- 16 Adjustments to Contribution by Lucent: Accounts receivable....................................... -- 8 Property, plant and equipment, net........................ -- 7 ----- --- Total non-cash transactions................................. $ 4 $51 ===== ===
AIRCRAFT SALE-LEASEBACK In March 2002, the Company elected to terminate early an aircraft sale-leaseback agreement and, pursuant to the terms of the agreement, the Company agreed to purchase the aircraft from the lessor for a purchase price equal to the unamortized lease balance of approximately $33 million. The closing of the purchase was completed in April 2002. 6. SECURITIZATION OF ACCOUNTS RECEIVABLE In June 2001, the Company entered into a receivables purchase agreement and transferred a designated pool of qualified trade accounts receivable to a special purpose entity ("SPE"), which in turn sold an undivided ownership interest in the pool of receivables to an unaffiliated financial institution for cash proceeds of $200 million. The receivables purchase agreement was terminated in March 2002 as described below. The financial institution is an affiliate of Citibank, N.A., a lender and the agent for the other lenders under the Credit Facilities described in Note 8 and the counterparty to the $150 million interest rate swap described in Note 8. The designated pool of qualified receivables held by the SPE was pledged as collateral to secure the obligations to the financial institution. During the term of the receivables purchase agreement, the Company had a retained interest in the designated pool of receivables to the extent the value of the receivables exceeded the outstanding amount of the financial institution's investment. The carrying amount of the Company's retained interest, which approximated fair value because of the short-term nature of the receivables, was recorded in other current assets. Collections of receivables were used by the SPE to repay the financial institution's investment in accordance with the receivables purchase agreement, and the financial institution in turn purchased, from time to time, new interests in receivables up to an aggregate investment at any time of $200 million. Effective March 15, 2002, the Company elected to terminate the receivables purchase agreement, which was scheduled to expire in June 2002. As a result of the early termination, purchases of interests 10 AVAYA INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (UNAUDITED) 6. SECURITIZATION OF ACCOUNTS RECEIVABLE (CONTINUED) in receivables by the financial institution ceased, and collections on receivables that constituted the designated pool of trade accounts receivable were used to liquidate the financial institution's $200 million investment under the agreement. As of June 30, 2002, the entire $200 million investment had been liquidated using collections of such receivables. No portion of the retained interest was utilized to liquidate the financial institution's remaining $126 million investment that had been outstanding at the beginning of the third quarter of fiscal 2002. Upon liquidation in full of the financial institution's investment on April 5, 2002, the remaining $109 million in retained interest was reclassified to receivables. As of September 30, 2001, the Company had a retained interest of $153 million in the SPE's designated pool of qualified accounts receivable. 7. BUSINESS RESTRUCTURING CHARGES AND RELATED EXPENSES The Company recorded business restructuring charges and related expenses of $9 million and $103 million for the three and nine months ended June 30, 2002, respectively. Included in the nine month amount is an $84 million pretax charge taken in the second quarter of fiscal 2002 associated with the Company's efforts to improve its business performance in response to the continued industry-wide economic slowdown. The components of this charge include $73 million of employee separation costs, $10 million of lease termination costs, and $1 million of other exit costs. The charge for employee separation costs is comprised of $67 million for severance and other employee separation costs, and $6 million primarily related to the cost of curtailment in accordance with SFAS No. 88, "Employers' Accounting for Settlements and Curtailments of Defined Benefit Pension Plans and for Termination Benefits." The employee separation costs were incurred in connection with the elimination of approximately 2,000 employee positions. Lease termination costs are comprised primarily of information technology lease termination payments. The September 30, 2001 business restructuring reserve reflects the remaining balance associated with the Company's pretax business restructuring charges of $520 million in fiscal 2000 related to its separation from Lucent, $134 million in the second quarter of fiscal 2001 related to the outsourcing of certain manufacturing operations, and $540 million in the fourth quarter of fiscal 2001 for the acceleration of the Company's restructuring plan. 11 AVAYA INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (UNAUDITED) 7. BUSINESS RESTRUCTURING CHARGES AND RELATED EXPENSES (CONTINUED) The following table summarizes the status of the Company's business restructuring reserve and other related expenses as of and for the nine months ended June 30, 2002:
BUSINESS RESTRUCTURING RESERVE OTHER RELATED EXPENSES --------------------------------------------------- -------------------------- TOTAL TOTAL BUSINESS EMPLOYEE LEASE OTHER BUSINESS RESTRUCTURING SEPARATION TERMINATION EXIT RESTRUCTURING ASSET INCREMENTAL RESERVE AND COSTS OBLIGATIONS COSTS RESERVE IMPAIRMENTS PERIOD COSTS RELATED EXPENSES ---------- ----------- -------- ------------- ----------- ------------ ---------------- (DOLLARS IN MILLIONS) Balance as of September 30, 2001... $96 $78 $5 $179 $ -- $ -- $179 Charges................ 73 10 1 84 3 16 103 Increase in benefit obligations.......... (6) -- -- (6) -- -- (6) Cash payments.......... (99) (46) (3) (148) -- (16) (164) Asset impairments...... -- -- -- -- (3) -- (3) --- --- -- ---- --------- --------- ---- Balance as of June 30, 2002................. $64 $42 $3 $109 $ -- $ -- $109 === === == ==== ========= ========= ====
Employee separation costs included in the business restructuring reserve were made through lump sum payments, although certain union-represented employees elected to receive a series of payments extending over a period of up to two years from the date of departure. Payments to employees who elected to receive severance through a series of payments will extend through fiscal 2004. The workforce reductions related to the Company's separation from Lucent, the outsourcing of certain manufacturing operations and the acceleration of its restructuring plan were substantially complete at the end of fiscal 2001. In connection with the workforce reduction charge taken in the second quarter of fiscal 2002, approximately 1,600 of the 2,000 employees had departed the Company as of June 30, 2002. The charges for lease termination obligations, which consisted of real estate and equipment leases, included approximately 2.8 million square feet of excess space which has been entirely vacated as of June 30, 2002. Payments on lease termination obligations will be substantially completed by 2003 because, in certain circumstances, the remaining lease payments were less than the termination fees. For the three and nine months ended June 30, 2002, the Company recorded $9 million and $19 million, respectively, of other related expenses, including relocation and consolidation costs, computer transition expenditures, and an asset impairment, associated with the Company's ongoing restructuring initiatives. For the three and nine months ended June 30, 2001, the Company recorded $46 million and $117 million, respectively, of other related expenses associated with the Company's separation from Lucent related primarily to computer system transition costs such as data conversion activities, asset transfers, and training. In addition, during the third quarter of fiscal 2001, the Company recorded a $20 million asset impairment charge related to its Shreveport, Louisiana manufacturing facility, which was closed in conjunction with its initiative to outsource certain manufacturing operations. The Company also recorded $42 million in selling, general and administrative expenses for additional start-up activities during the nine months ended June 30, 2001, largely resulting from marketing costs associated with continuing to establish the Avaya brand. See Note 14--Subsequent Events "Business Restructuring Charge" for related disclosures. 12 AVAYA INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (UNAUDITED) 8. SHORT-TERM BORROWINGS AND LONG-TERM DEBT
AS OF AS OF JUNE 30, 2002 SEPTEMBER 30, 2001 ------------- ------------------ (DOLLARS IN MILLIONS) Short-term borrowings: Five-year revolving credit facility....................... $ -- $132 Other short-term borrowings............................... -- 13 ---- ---- Total short-term borrowings, including current maturities............................................ -- 145 ---- ---- Long-term debt: Commercial paper.......................................... -- 432 Five-year revolving credit facility....................... -- 68 LYONs convertible debt, net of discount................... 471 -- Senior Secured Notes, net of discount..................... 443 -- ---- ---- Total long-term debt.................................... 914 500 ---- ---- Total short-term borrowings and long-term debt.......... $914 $645 ==== ====
DEBT RATINGS The Company's ability to obtain external financing is affected by the Company's debt ratings, which are periodically reviewed by the major credit rating agencies. During the second quarter of fiscal 2002, the Company's commercial paper and long-term debt ratings were downgraded. Ratings as of June 30, 2002 are as follows (all ratings include a negative outlook): Moody's: Commercial paper.......................................... No Rating Long-term senior unsecured debt........................... Ba3 Senior secured notes...................................... Ba2 Standard & Poor's: Commercial paper.......................................... No Rating Long-term senior unsecured debt........................... BB- Senior secured notes...................................... BB- Corporate credit.......................................... BB+
On July 31, 2002, Standard & Poor's placed the Company's corporate credit rating on CreditWatch with negative implications. COMMERCIAL PAPER PROGRAM During the second quarter of fiscal 2002, Standard & Poor's and Moody's downgraded the Company's commercial paper rating several times and eventually withdrew their rating of the Company's commercial paper at the Company's request. This recent withdrawal of the Company's commercial paper rating makes it impossible for the Company to access the commercial paper market, which until recently was the Company's primary source of liquidity. 13 AVAYA INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (UNAUDITED) 8. SHORT-TERM BORROWINGS AND LONG-TERM DEBT (CONTINUED) As a result of the impact of the ratings downgrades on the Company's ability to issue commercial paper, in February 2002, the Company borrowed $300 million under its five-year Credit Facility to repay commercial paper obligations. As of June 30, 2002, all remaining commercial paper obligations and the borrowing under the five-year credit facility had been repaid using proceeds from the offering of the Senior Secured Notes discussed below. REVOLVING CREDIT FACILITIES The Company has two revolving credit facilities (the "Credit Facilities") with third party financial institutions. As of September 30, 2001, these Credit Facilities consisted of a $400 million 364-day Credit Facility that expires in August 2002 and an $850 million five-year Credit Facility that expires in September 2005. As required by the terms of the Credit Facilities, upon the closing of the offering of the Senior Secured Notes in March 2002, the Credit Facilities were reduced proportionately by an amount equal to the $425 million of proceeds, net of certain deferred financing costs, realized from the offering of the Senior Secured Notes. Accordingly, as of June 30, 2002, the Credit Facilities consisted of a $561 million five-year Credit Facility and a $264 million 364-day Credit Facility. No amounts were outstanding under either Credit Facility as of June 30, 2002. Funds are available under the Credit Facilities for general corporate purpose and for acquisitions up to $150 million. Based on the Company's current debt ratings, any borrowings under the Credit Facilities are secured, subject to certain exceptions, by security interests in the equipment, accounts receivable, inventory, and U.S. intellectual property rights of the Company and that of any of its subsidiaries guaranteeing its obligations under the Credit Facilities as described below. Borrowings are also secured by a pledge of the stock of most of the Company's domestic subsidiaries and 65% of the stock of a foreign subsidiary that, together with its subsidiaries, holds the beneficial and economic right to utilize certain of the Company's domestic intellectual property rights outside North America. The security interests would be suspended in the event the Company's corporate credit rating was at least BBB by Standard & Poor's and its long-term senior unsecured debt rating was at least Baa2 by Moody's, in each case with a stable outlook. The Company's long-term senior unsecured debt is currently rated Ba3 by Moody's, and the Company's corporate credit is currently on CreditWatch and rated BB+ by Standard & Poor's, each with a negative outlook. Any current or future domestic subsidiaries (other than certain excluded subsidiaries) whose revenues constitute 5% or greater of the Company's consolidated revenues or whose assets constitute 5% or greater of the Company's consolidated total assets will be required to guarantee its obligations under the Credit Facilities. There are no Avaya subsidiaries that currently meet these criteria. The Credit Facilities also include negative covenants, including limitations on affiliate transactions, restricted payments and investments and advances. The Credit Facilities also restrict the Company's ability and that of its subsidiaries to incur debt, subject to certain exceptions. The Company is permitted to use the Credit Facilities to fund acquisitions in an aggregate amount not to exceed $150 million and can make larger acquisitions so long as the Credit Facilities are not used to fund the purchase price. In addition, the Credit Facilities require that in connection with any acquisition, no default under the Credit Facilities shall have occurred and be continuing or would result from such acquisition, and the Company shall be in compliance with the financial ratio test described below after giving pro forma effect to such acquisition. 14 AVAYA INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (UNAUDITED) 8. SHORT-TERM BORROWINGS AND LONG-TERM DEBT (CONTINUED) The Credit Facilities require the Company to maintain a ratio of consolidated Earnings Before Interest, Taxes, Depreciation and Amortization ("EBITDA") to interest expense consisting of the previous four consecutive fiscal quarters of not less than three to one for each quarter beginning with the period ending March 31, 2002 until September 30, 2002 and a ratio of not less than four to one at all times thereafter. The Company is also required to maintain consolidated EBITDA in the following amounts for each of the periods noted below: - $20 million for the quarter ended March 31, 2002; - $80 million for the two-quarter period ended June 30, 2002; - $180 million for the three-quarter period ended September 30, 2002; - $300 million for the four-quarter period ended December 31, 2002; and - $400 million for each four-quarter period thereafter. For purposes of these calculations, the Company is permitted to exclude from the computation of consolidated EBITDA up to $163 million of restructuring charges, including asset impairment and other one time expenses to be taken no later than the fourth quarter of fiscal 2002 and any write down of intangibles associated with the adoption of SFAS 142. In addition, the Company may exclude certain business restructuring charges and related expenses taken in fiscal 2001. During the second and third quarters of fiscal 2002, the Company incurred $97 million of such business restructuring charges and related expenses. As of June 30, 2002, the Company was in compliance with all required covenants. See Note 14--Subsequent Events "Revolving Credit Facilities" for related disclosures. UNCOMMITTED CREDIT FACILITIES The Company, through its foreign operations, has entered into several uncommitted credit facilities totaling $82 million and $118 million, of which letters of credit of $27 million and $10 million were issued and outstanding as of June 30, 2002 and September 30, 2001, respectively. Letters of credit are purchased guarantees that ensure the Company's performance or payment to third parties in accordance with specified terms and conditions. LYONS CONVERTIBLE DEBT In the first quarter of fiscal 2002, the Company sold through an underwritten public offering under a shelf registration statement an aggregate principal amount at maturity of approximately $944 million of Liquid Yield Option-TM- Notes due 2021 ("LYONs"). The proceeds of approximately $448 million, net of a $484 million discount and $12 million of underwriting fees, were used to refinance a portion of the Company's outstanding commercial paper. The underwriting fees of $12 million were recorded as deferred financing costs and are being amortized to interest expense over a three-year period through October 31, 2004, which represents the first date holders may require the Company to purchase all or a portion of their LYONs. For the three and nine months ended June 30, 2002, $1 million and $3 million, respectively, of deferred financing costs were recorded as interest expense. The original issue discount of $484 million accretes daily at a rate of 3.625% per year calculated on a semiannual bond equivalent basis. The Company will not make periodic cash payments of interest 15 AVAYA INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (UNAUDITED) 8. SHORT-TERM BORROWINGS AND LONG-TERM DEBT (CONTINUED) on the LYONs. Instead, the amortization of the discount is recorded as interest expense and represents the accretion of the LYONs issue price to their maturity value. For the three and nine months ended June 30, 2002, $4 million and $11 million, respectively, of interest expense on the LYONs was recorded resulting in an accreted value of $471 million as of June 30, 2002. The discount will cease to accrete on the LYONs upon maturity, conversion, purchase by the Company at the option of the holder, or redemption by Avaya. The LYONs are unsecured obligations that rank equally in right of payment with all existing and future unsecured and unsubordinated indebtedness of Avaya. The LYONs are convertible into 35,333,073 shares of Avaya common stock at any time on or before the maturity date. The conversion rate may be adjusted for certain reasons, but will not be adjusted for accrued original issue discount. Upon conversion, the holder will not receive any cash payment representing accrued original issue discount. Accrued original issue discount will be considered paid by the shares of common stock received by the holder of the LYONs upon conversion. Avaya may redeem all or a portion of the LYONs for cash at any time on or after October 31, 2004 at a price equal to the sum of the issue price and accrued original issue discount on the LYONs as of the applicable redemption date. Conversely, holders may require the Company to purchase all or a portion of their LYONs on October 31, 2004, 2006 and 2011 at a price equal to the sum of the issue price and accrued original issue discount on the LYONs as of the applicable purchase date. The Company may, at its option, elect to pay the purchase price in cash or shares of common stock, or any combination thereof. The indenture governing the LYONs includes certain covenants, including a limitation on the Company's ability to grant liens on significant domestic real estate properties or the stock of its subsidiaries holding such properties. SENIOR SECURED NOTES In March 2002, the Company issued through an underwritten public offering under a shelf registration statement $440 million aggregate principal amount of 11 1/8% Senior Secured Notes due April 2009 (the "Senior Secured Notes") and received net proceeds of approximately $425 million, net of a $5 million discount and $10 million of issuance costs. Interest on the Senior Secured Notes is payable on April 1 and October 1 of each year beginning on October 1, 2002. The Company recorded interest expense related to the Senior Secured Notes of $12 million and $13 million for the three and nine months ended June 30, 2002, respectively. The $5 million discount is being amortized to interest expense over the seven-year term to maturity. The $10 million of issuance costs were recorded as deferred financing costs and are also being amortized to interest expense over the term of the Notes. The proceeds from the issuance were used to repay amounts outstanding under the five-year Credit Facility and for general corporate purposes. The Company may redeem the Senior Secured Notes, in whole or from time to time in part, at the redemption prices expressed as a percentage of principal amount noted below plus accrued and unpaid 16 AVAYA INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (UNAUDITED) 8. SHORT-TERM BORROWINGS AND LONG-TERM DEBT (CONTINUED) interest to the applicable redemption date, if redeemed during the twelve-month period beginning on April 1 of the following years:
YEARS PERCENTAGES - ----- ----------- 2006........................................................ 105.563% 2007........................................................ 102.781% 2008........................................................ 100.000%
The Senior Secured Notes are secured by a second priority security interest in the collateral securing the Company's obligations under the Credit Facilities and its obligations under the interest rate swap agreements described below. In the event that (i) the Company's corporate credit is rated at least BBB by Standard & Poor's and its long-term senior unsecured debt is rated at least Baa2 by Moody's, each without a negative outlook or its equivalent, or (ii) subject to certain conditions, at least $400 million of unsecured indebtedness is outstanding or available under the Credit Facilities or a bona fide successor credit facility, the security interest in the collateral securing the Senior Secured Notes will terminate. The indenture governing the Senior Secured Notes includes negative covenants that limit the Company's ability to incur secured debt and enter into sale/leaseback transactions. In addition, the indenture also includes conditional covenants that limit the Company's ability to incur debt, enter into affiliate transactions, or make restricted payments or investments and advances. These conditional covenants will apply to the Company until such time that the Senior Secured Notes are rated at least BBB- by Standard & Poor's and Baa3 by Moody's, in each case without a negative outlook or its equivalent. INTEREST RATE SWAP AGREEMENTS In April 2002, the Company entered into two interest rate swap agreements with a total notional amount of $200 million that qualify and are designated as fair value hedges in accordance with SFAS 133, "Accounting for Derivative Instruments and Hedging Activities." The swap agreements mature in April 2009 and were executed in order to: - convert a portion of the Senior Secured Notes fixed-rate debt into floating-rate debt; - maintain a capital structure containing appropriate amounts of fixed and floating-rate debt; and - reduce net interest payments and expense in the near-term. 17 AVAYA INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (UNAUDITED) 8. SHORT-TERM BORROWINGS AND LONG-TERM DEBT (CONTINUED) Under these agreements, the Company receives a fixed interest rate of 11.125% and pays a floating interest rate based on LIBOR plus an agreed-upon spread, which was equal to a weighted average interest rate of 7.25% as of June 30, 2002. The amount paid and the amount received are calculated based on the total notional amount of $200 million. Since the relevant terms of the swap agreements match the corresponding terms of the Senior Secured Notes, there is no hedge ineffectiveness. Accordingly, gains and losses on the swap agreements will fully offset the losses and gains on the hedged portion of the Senior Secured Notes, which are marked to market at each reporting date. As of June 30, 2002, the Company recorded the fair market value of the swaps of $8 million as other assets along with a corresponding increase to the hedged debt, both of which were recorded through other income (expense), net. Interest payments are recognized through interest expense and are made and received on the first day of each April and October, commencing on October 1, 2002 and ending on the maturity date. On the last day of each semi-annual interest payment period, the interest payment for the previous six months will be made based upon the six month LIBOR rate (in arrears) on that day, plus the applicable margin, as shown in the table below. Since the interest rate is not known until the end of each semi-annual interest period, estimates are used during such period based upon published forward-looking LIBOR rates. Any differences between the estimated interest expense and the actual interest payment are recorded to interest expense at the end of each semi-annual interest period. These interest rate swaps resulted in actual interest expense for the three and nine months ended June 30, 2002 of $4 million as compared with interest expense of $6 million had the Company not entered into these agreements. The following table outlines the terms of the swap agreements:
RECEIVE FIXED MATURITY DATE NOTIONAL AMOUNT INTEREST RATE PAY VARIABLE INTEREST RATE - ------------- --------------------- ------------- --------------------------------------------------- (DOLLARS IN MILLIONS) April 2009 $150 11.125% Six month LIBOR (in arrears) plus 5.055% spread April 2009 50 11.125% Six month LIBOR (in arrears) plus 5.098% spread ---- Total $200 ====
Each counterparty to the swap agreements is a lender under the Credit Facilities. The Company's obligations under these swap agreements are secured on the same basis as its obligations under the Credit Facilities. 9. CONVERTIBLE PARTICIPATING PREFERRED STOCK AND OTHER RELATED EQUITY TRANSACTIONS WARBURG TRANSACTIONS In October 2000, the Company sold to Warburg Pincus Equity Partners, L.P. and certain of its investment funds (the "Warburg Entities") four million shares of the Company's Series B convertible participating preferred stock and warrants to purchase the Company's common stock for an aggregate purchase price of $400 million. On March 21, 2002, the Company completed a series of transactions pursuant to which the Warburg Entities (i) converted all four million shares of the Series B preferred stock into 38,329,365 shares of Avaya's common stock based on a conversion price of $11.31 per share, 18 AVAYA INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (UNAUDITED) 9. CONVERTIBLE PARTICIPATING PREFERRED STOCK AND OTHER RELATED EQUITY TRANSACTIONS (CONTINUED) which was reduced from the original conversion price of $26.71 per share, (ii) purchased an additional 286,682 shares of common stock by exercising a portion of the warrants at an exercise price of $34.73 per share resulting in gross proceeds of approximately $10 million, and (iii) purchased 14,383,953 shares of the Company's common stock for $6.26 per share (the reported closing price of Avaya's common stock on the New York Stock Exchange on March 8, 2002), resulting in gross proceeds of approximately $90 million. In connection with these transactions, the Company incurred approximately $4 million of financing costs which were recorded as a reduction to additional paid-in capital. As of June 30, 2002, there were no shares of Series B preferred stock outstanding and, accordingly, the Series B preferred stock has ceased accruing dividends. As a result of these transactions, the Warburg entities hold approximately 53 million shares of the Company's common stock, which represents approximately 15% of the Company's outstanding common stock, and warrants to purchase approximately 12 million additional shares of common stock. These warrants have an exercise price of $34.73 of which warrants exercisable for 6,724,665 shares of common stock expire on October 2, 2004, and warrants exercisable for 5,379,732 shares of common stock expire on October 2, 2005. The conversion of the Series B preferred stock and the exercise of the warrants resulted in a charge to accumulated deficit of approximately $125 million, in addition to the $5 million accretion of the Series B preferred stock from January 1, 2002 through the date of conversion. This charge primarily represents the impact of reducing the preferred stock conversion price from $26.71 per share as originally calculated under the certificate of designations for the Series B preferred stock to $11.31 per share, as permitted under the certificate of designations. The Company recorded a total of $12 million of accretion for the period from October 1, 2001 through the date of conversion. PUBLIC OFFERING OF COMMON STOCK On March 15, 2002, the Company sold 19.55 million shares of common stock for $5.90 per share in a public offering. The Company received proceeds of approximately $112 million, which is net of approximately $3 million of underwriting fees reflected as a reduction to additional paid-in capital. 10. EARNINGS (LOSS) PER SHARE OF COMMON STOCK Basic earnings (loss) per common share was calculated by dividing net income (loss) available to common stockholders by the weighted average number of common shares outstanding during the period. Diluted earnings (loss) per common share was calculated by adjusting net income (loss) available to common stockholders and weighted average outstanding shares, assuming conversion of all potentially dilutive securities including stock options, warrants, convertible participating preferred stock and convertible debt. 19 AVAYA INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (UNAUDITED) 10. EARNINGS (LOSS) PER SHARE OF COMMON STOCK (CONTINUED) Net loss available to common stockholders for both the basic and diluted loss per common share calculations for the nine months ended June 30, 2002 includes the $125 million conversion charge related to the Series B preferred stock (see Note 9).
THREE MONTHS ENDED NINE MONTHS ENDED JUNE 30, JUNE 30, ----------------------- ----------------------- 2002 2001 2002 2001 ---------- ---------- ---------- ---------- (DOLLARS AND SHARES IN MILLIONS, EXCEPT PER SHARE AMOUNTS) Net income (loss) available to common stockholders................................ $ (39) $ 17 $ (259) $ (44) ====== ====== ====== ====== SHARES USED IN COMPUTING EARNINGS (LOSS) PER COMMON SHARE: Basic....................................... 362 285 318 283 ====== ====== ====== ====== Diluted..................................... 362 286 318 283 ====== ====== ====== ====== EARNINGS (LOSS) PER COMMON SHARE: Basic....................................... $(0.11) $ 0.06 $(0.81) $(0.16) ====== ====== ====== ====== Diluted..................................... $(0.11) $ 0.06 $(0.81) $(0.16) ====== ====== ====== ====== SECURITIES EXCLUDED FROM THE COMPUTATION OF DILUTED EARNINGS (LOSS) PER COMMON SHARE: Options(1).................................. 52 66 46 66 Series B preferred stock(2)................. -- 16 38 16 Warrants(1)................................. 12 12 12 12 Convertible debt(1)......................... 82 -- 54 -- ------ ------ ------ ------ Total....................................... 146 94 150 94 ====== ====== ====== ======
- ------------------------ (1) These securities have been excluded from the diluted earnings (loss) per common share calculation since the effect of their inclusion would have been antidilutive. (2) When applying the "if-converted" method, the Series B convertible participating preferred stock is assumed to have been converted as of October 1, 2001. However, in applying the "if-converted" method, the Series B convertible participating preferred stock was excluded from the diluted earnings (loss) per common share calculation since the effect of its inclusion would have been antidilutive. 11. OPERATING SEGMENTS Effective January 1, 2002, the Company implemented an internal reorganization and as a result, the Company currently assesses its performance and allocates its resources among four rather than three operating segments. The Company divided its Communications Solutions segment into two reportable segments: Systems and Applications. The objective of the reorganization was to enable the 20 AVAYA INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (UNAUDITED) 11. OPERATING SEGMENTS (CONTINUED) Company to manage its product groups with greater precision. The Systems segment includes sales to small to midsized enterprises, which includes data switches and small to midsized telephony products, and sales to large customers, referred to as Enterprise Systems, which include sales of all enterprise telephony products, virtual private networks, and data Local Area Network and Wide Area Network equipment. The Applications segment consists of customer relationship management, voice and unified messaging, and unified communication products and related professional services. In addition, the Company shifted installation and the network consulting portion of professional services previously reported in Communications Solutions to the Services segment. The Services segment continues to include maintenance, value-added and data services. The Connectivity Solutions segment represents structured cabling systems and electronic cabinets. As part of the changes made in the second quarter of fiscal 2002, the Company also redirected a larger portion of corporate operating expenses, consisting mostly of marketing and selling expenses, to each of the operating segments. The costs of shared services and other corporate center operations that (i) are managed on a common basis, (ii) are not identified with the operating segments, and (iii) represent business activities that do not qualify for separate operating segment reporting are aggregated in the Corporate and other category. Such costs include primarily business restructuring charges and related expenses, research and development, information technology, corporate finance and real estate costs. As a result of the changes discussed above, fiscal 2001 amounts set forth in the table below have been restated to conform to the Company's current operating segment presentation. In addition, Avaya's consolidated financial statements for the three and nine months ended June 30, 2001 have been restated to reflect these changes. Intersegment sales approximate fair market value and are not significant. See Note 14--Subsequent Events "Segment Business Model Evolution" for subsequent changes to our operating segments. 21 AVAYA INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (UNAUDITED) 11. OPERATING SEGMENTS (CONTINUED) OPERATING SEGMENTS
THREE MONTHS ENDED NINE MONTHS ENDED JUNE 30, JUNE 30, ------------------- ------------------- 2002 2001 2002 2001 -------- -------- -------- -------- (DOLLARS IN MILLIONS) SYSTEMS: Total revenue...................... $ 384 $ 541 $1,240 $1,799 Operating income................... 3 47 39 240 APPLICATIONS: Total revenue...................... $ 160 $ 217 $ 521 $ 702 Operating income (loss)............ (2) (10) (11) 32 SERVICES: Total revenue...................... $ 511 $ 584 $1,600 $1,733 Operating income................... 133 96 433 290 CONNECTIVITY SOLUTIONS: Total revenue...................... $ 164 $ 372 $ 443 $1,117 Operating income (loss)............ 9 134 (41) 360
RECONCILING ITEMS A reconciliation of the totals reported for the operating segments to the corresponding line items in the consolidated financial statements is presented below:
THREE MONTHS ENDED NINE MONTHS ENDED JUNE 30, JUNE 30, ------------------- ------------------- 2002 2001 2002 2001 -------- -------- -------- -------- (DOLLARS IN MILLIONS) REVENUE Total operating segments................... $1,219 $1,714 $3,804 $5,351 OPERATING INCOME (LOSS) Total operating segments................... 143 267 420 922 Corporate and other: Business restructuring charges, related expenses and start-up expenses......... (9) (66) (103) (313) Purchased in-process research and development............................ -- (1) -- (32) Corporate and unallocated shared expenses............................... (154) (153) (472) (607) ------ ------ ------ ------ Total operating income (loss).......... $ (20) $ 47 $ (155) $ (30) ====== ====== ====== ======
22 AVAYA INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (UNAUDITED) 11. OPERATING SEGMENTS (CONTINUED) GEOGRAPHIC INFORMATION
THREE MONTHS ENDED NINE MONTHS ENDED JUNE 30, JUNE 30, ------------------- ------------------- 2002 2001 2002 2001 -------- -------- -------- -------- (DOLLARS IN MILLIONS) REVENUE(1) U.S................................................ $ 908 $1,280 $2,780 $4,021 International...................................... 311 434 1,024 1,330 ------ ------ ------ ------ Total............................................ $1,219 $1,714 $3,804 $5,351 ====== ====== ====== ======
- ------------------------ (1) Revenue is attributed to geographic areas based on the location of customers. CONCENTRATIONS No single customer accounted for more than 10% of the Company's revenue for the nine months ended June 30, 2002. In March 2000, as part of its strategy to strengthen its distribution network, Avaya sold its primary distribution function for voice communications systems for small and mid-sized enterprises to Expanets, Inc., currently the Company's largest dealer. The terms of the sale provided that the Company would provide billing, collection and maintenance services for Expanets for a transitional period. In May 2001, the dealer agreement was restructured to more precisely define the customer base to be serviced by each party, including small or branch offices of larger enterprises. At the time the dealer agreement was restructured, Expanets' efforts to obtain a commercial credit facility were hampered by the fact that its billing and collection function had not yet been migrated to its information systems. Because of the importance to Avaya of the Expanets relationship and the customer base served by Expanets, the Company agreed to provide a $125 million short-term line of credit (as amended as described below, the "Dealer Credit Agreement"). The Dealer Credit Agreement applies to certain unpaid and outstanding receivables for amounts due to Avaya by Expanets. A delay in the migration of the billing and collection function until December 2001 affected Expanets' ability to obtain a collateralized commercial credit facility by the original March 31, 2002 expiration date of the Dealer Credit Agreement. Accordingly, in March 2002, the Company entered into an amendment to the Dealer Credit Agreement with Expanets and its parent company, NorthWestern Corporation. The Dealer Credit Agreement provides for installment payments under the credit line in the amounts of $25 million in March 2002, $20 million in April 2002, and $25 million in August 2002 with the remaining balance due on December 31, 2002. As of June 30, 2002, the Company had received the first two installment payments. The Dealer Credit Agreement provides that the borrowing limit shall be reduced by the amount of each installment payment upon the receipt of such payment and may also be offset by certain obligations of the Company to Expanets related to the March 2000 sale of the distribution function to Expanets. As of June 30, 2002 and September 30, 2001, the borrowing limit was $69 million 23 AVAYA INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (UNAUDITED) 11. OPERATING SEGMENTS (CONTINUED) and $121 million, respectively. The interest rate on the line of credit will accrue at an annual rate of 12% through August 31, 2002, and increase to 15% on September 1, 2002. The following table summarizes the amounts receivable from Expanets, including amounts outstanding under the line of credit, as of June 30, 2002 and September 30, 2001:
AS OF AS OF JUNE 30, 2002 SEPTEMBER 30, 2001 ------------- ------------------ (DOLLARS IN MILLIONS) Receivables........................................... $ 50 $117 Other current assets.................................. 47 81 ---- ---- Total amounts receivable from Expanets.............. $ 97 $198 ==== ==== Secured and unsecured components of the amounts receivable are as follows: Secured line of credit (included in receivables).... $ 47 $ 71 Secured line of credit (included in other current assets)........................................... 22 50 ---- ---- Total secured line of credit...................... 69 121 Unsecured (included in receivables)............... 28 77 ---- ---- Total amounts receivable from Expanets.............. $ 97 $198 ==== ====
Amounts recorded in receivables represent trade receivables due from Expanets on sales of products and maintenance services. Amounts recorded in other current assets represent receivables due from Expanets for transitional services provided under a transition services agreement. Outstanding amounts under the line of credit are secured by Expanets' accounts receivable and inventory. In addition, NorthWestern has guaranteed up to $50 million of Expanets' obligations under the Dealer Credit Agreement. A default by NorthWestern of its guarantee obligations under the Dealer Credit Agreement would constitute a default under the Expanets' dealer agreement with the Company, resulting in a termination of the non-competition provisions contained in such agreement and permitting the Company to sell products to Expanets' customers. There can be no assurance that Expanets will be able to comply with the remaining terms of the Dealer Credit Agreement. In the event Expanets is unable to comply with the terms of the Dealer Credit Agreement and a default occurs, the remedies available to Avaya under such agreement may be insufficient to satisfy in full all of Expanets' obligations to the Company. For the nine months ended June 30, 2001, sales to Expanets, which are included in the Systems and Applications segments, were approximately 10% of the Company's revenue. CONNECTIVITY SOLUTIONS In February 2002, the Company engaged Salomon Smith Barney Inc. to explore alternatives for the Company's Connectivity Solutions segment, including the possible sale of the business. The Connectivity Solutions segment consists of the Company's structured cabling systems and electronic cabinets and markets products including (i) the SYSTIMAX-Registered Trademark- product line of structured cabling systems primarily to 24 AVAYA INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (UNAUDITED) 11. OPERATING SEGMENTS (CONTINUED) enterprises of various sizes for wiring phones, workstations, personal computers, local area networks and other communications devices through their buildings or across their campuses, (ii) the ExchangeMAX-Registered Trademark- product line of structured cabling systems primarily to central offices of service providers, such as telephone companies or Internet service providers, and (iii) electronic cabinets to enclose electronic devices and equipment primarily to service providers. The Company's goal in exploring alternatives for the Connectivity Solutions segment is to strengthen its focus on higher growth opportunities by emphasizing the Systems, Applications and Services offerings, such as converged voice and data network products and unified communication and customer relationship management solutions. These offerings, unlike the Connectivity Solutions offerings, are targeted exclusively at enterprises and the Company believes that they offer increased growth potential. In addition, management believes that the proceeds from any sale of the Connectivity Solutions segment would help enhance the Company's liquidity. Connectivity Solutions revenue comprised $164 million, or 13.5%, and $443 million, or 11.6%, for the three and nine months ended June 30, 2002, respectively, and $1,322 million, or 19.5%, of the Company's total revenue in the fiscal year ended September 30, 2001. 12. TRANSACTIONS WITH LUCENT AND OTHER RELATED PARTY TRANSACTIONS CONTRIBUTION AND DISTRIBUTION AGREEMENT In connection with the Contribution and Distribution, the Company and Lucent executed and delivered the Contribution and Distribution Agreement and certain related agreements. Pursuant to the Contribution and Distribution Agreement, Lucent contributed to the Company substantially all of the assets, liabilities and operations associated with its enterprise networking businesses (the "Company's Businesses"). The Contribution and Distribution Agreement, among other things, provides that, in general, the Company will indemnify Lucent for all liabilities including certain pre-Distribution tax obligations of Lucent relating to the Company's Businesses and all contingent liabilities primarily relating to the Company's Businesses or otherwise assigned to the Company. In addition, the Contribution and Distribution Agreement provides that certain contingent liabilities not directly identifiable with one of the parties will be shared in the proportion of 90% by Lucent and 10% by the Company. The Contribution and Distribution Agreement also provides that contingent liabilities in excess of $50 million that are primarily related to Lucent's businesses shall be borne 90% by Lucent and 10% by the Company and contingent liabilities in excess of $50 million that are primarily related to the Company's Businesses shall be borne equally by the parties. In addition, if the Distribution fails to qualify as a tax-free distribution under Section 355 of the Internal Revenue Code because of an acquisition of the Company's stock or assets, or some other actions of the Company, then the Company will be solely liable for any resulting corporate taxes. OTHER RELATED PARTY TRANSACTIONS Jeffrey A. Harris, a senior managing director of Warburg Pincus LLC and a general partner of Warburg, Pincus & Co. each of which is an affiliate of Warburg Pincus Equity Partners L.P., resigned from the Company's board of directors prior to the approval by the board of the transactions disclosed 25 AVAYA INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (UNAUDITED) 12. TRANSACTIONS WITH LUCENT AND OTHER RELATED PARTY TRANSACTIONS (CONTINUED) under "Warburg Transactions" in Note 9. Mr. Harris had served as the chairman of Avaya's audit and finance committee. The board has appointed Mark Leslie, a member of the audit and finance committee, to succeed Mr. Harris as chairman of that committee. In April 2002, the Warburg Entities exercised their contractual right to designate for election to the board a director unaffiliated with the Warburg Entities reasonably acceptable to the Company's board of directors. Accordingly, Anthony P. Terraciano was appointed to the Company's board as the Warburg Entities' nominee. Henry B. Schacht has been a director of Avaya since September 2000. Mr. Schacht is currently on a leave of absence as a managing director and senior advisor of Warburg Pincus LLC. Each of Mr. Schacht and Mr. Terracciano may be entitled to indemnification by affiliates of Warburg Pincus LLC and Warburg, Pincus & Co. against certain liabilities that each may incur as a result of serving as a director of the Company. 13. COMMITMENTS AND CONTINGENCIES LEGAL PROCEEDINGS From time to time the Company is involved in legal proceedings arising in the ordinary course of business. Other than as described below, the Company believes there is no litigation pending against it that could have, individually or in the aggregate, a material adverse effect on its financial position, results of operations or cash flows. YEAR 2000 ACTIONS Three separate purported class action lawsuits are pending against Lucent, one in state court in West Virginia, one in federal court in the Southern District of New York and another in federal court in the Southern District of California. The case in New York was filed in January 1999 and, after being dismissed, was refiled in September 2000. The case in West Virginia was filed in April 1999 and the case in California was filed in June 1999, and amended in 2000 to include Avaya as a defendant. The Company may also be named a party to the other actions and, in any event, has assumed the obligations of Lucent for all of these cases under the Contribution and Distribution Agreement. All three actions are based upon claims that Lucent sold products that were not Year 2000 compliant, meaning that the products were designed and developed without considering the possible impact of the change in the calendar from December 31, 1999 to January 1, 2000. The complaints allege that the sale of these products violated statutory consumer protection laws and constituted breaches of implied warranties. A class has recently been certified in the West Virginia state court matter, but the other matters have not been so certified. The certified class includes those persons or entities that purchased, leased or financed the products in question. In addition, the court also certified as a subclass all class members who had service protection plans or other service or extended warranty contracts with Lucent in effect as of April 1, 1998, as to which Lucent failed to offer a free Year 2000-compliant solution. The complaints seek, among other remedies, compensatory damages, punitive damages and counsel fees in amounts that have not yet been specified. At this time, the Company cannot determine whether the outcome of these actions will have a material adverse effect on its financial position, results of operations or cash flows. In addition, if these cases are not resolved in a timely manner, they will require expenditure of significant legal costs related to their defense. 26 AVAYA INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (UNAUDITED) 13. COMMITMENTS AND CONTINGENCIES (CONTINUED) COUPON PROGRAM CLASS ACTION In April 1998, a class action was filed against Lucent in state court in New Jersey, alleging that Lucent improperly administered a coupon program resulting from the settlement of a prior class action. The plaintiffs allege that Lucent improperly limited the redemption of the coupons from dealers by not allowing them to be combined with other volume discount offers, thus limiting the market for the coupons. The Company has assumed the obligations of Lucent for these cases under the Contribution and Distribution Agreement. The complaint alleges breach of contract, fraud and other claims and the plaintiffs seek compensatory and consequential damages, interest and attorneys' fees. The parties have entered into a settlement agreement that has been approved by the court pursuant to a written order. The period for submitting a claim notification expired July 15, 2002. The Company is in the process of winding up the administration of the resolution of this matter. See Note 14--Subsequent Events "Developments in Legal Proceedings" for related disclosure. LUCENT SECURITIES LITIGATION In November 2000, three purported class actions were filed against Lucent in the Federal District Court for the District of New Jersey alleging violations of the federal securities laws as a result of the facts disclosed in Lucent's announcement on November 21, 2000 that it had identified a revenue recognition issue affecting its financial results for the fourth quarter of fiscal 2000. The actions purport to be filed on behalf of purchasers of Lucent common stock during the period from October 10, 2000 (the date Lucent originally reported these financial results) through November 21, 2000. The above actions have been consolidated with other purported class actions filed against Lucent on behalf of its stockholders in January 2000 and are pending in the Federal District Court for the District of New Jersey. The Company understands that Lucent's motion to dismiss the Fifth Consolidated Amended and Supplemental Class Action Complaint in the consolidated action was denied by the court in June 2002. As a result of the denial of its motion to dismiss, the Company understands that Lucent has filed a motion for partial summary judgment, seeking a dismissal of a portion of the Fifth Consolidated Amended and Supplemental Class Action Complaint. The plaintiffs allege that they were injured by reason of certain alleged false and misleading statements made by Lucent in violation of the federal securities laws. The consolidated cases were initially filed on behalf of stockholders of Lucent who bought Lucent common stock between October 26, 1999 and January 6, 2000, but the consolidated complaint was amended to include purported class members who purchased Lucent common stock up to November 21, 2000. A class has not yet been certified in the consolidated actions. The plaintiffs in all these stockholder class actions seek compensatory damages plus interest and attorneys' fees. Any liability incurred by Lucent in connection with these stockholder class action lawsuits may be deemed a shared contingent liability under the Contribution and Distribution Agreement and, as a result, the Company would be responsible for 10% of any such liability. All of these actions are in the early stages of litigation and an outcome cannot be predicted and, as a result, there can be no assurance that these cases will not have a material adverse effect on the Company's financial position, results of operations or cash flows. 27 AVAYA INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (UNAUDITED) 13. COMMITMENTS AND CONTINGENCIES (CONTINUED) LICENSING ARBITRATION In March 2001, a third party licensor made formal demand for alleged royalty payments which it claims the Company owes as a result of a contract between the licensor and the Company's predecessors, initially entered into in 1995, and renewed in 1997. The contract provides for mediation of disputes followed by binding arbitration if the mediation does not resolve the dispute. The licensor claims that the Company owes royalty payments for software integrated into certain of the Company's products. The licensor also alleges that the Company has breached the governing contract by not honoring a right of first refusal related to development of fax software for next generation products. This matter is currently in arbitration. At this point, an outcome in the arbitration proceeding cannot be predicted and, as a result, there can be no assurance that this case will not have a material adverse effect on the Company's financial position, results of operations or cash flows. REVERSE/FORWARD STOCK SPLIT COMPLAINTS In January 2002, a complaint was filed in the Court of Chancery of the State of Delaware against the Company seeking to enjoin it from effectuating a reverse stock split followed by a forward stock split described in its proxy statement for its 2002 Annual Meeting of Shareholders held on February 26, 2002. At the annual meeting, the Company obtained the approval of its shareholders of each of three alternative transactions: - a reverse 1-for-30 stock split followed immediately by a forward 30-for-1 stock split of the Company's common stock; - a reverse 1-for-40 stock split followed immediately by a forward 40-for-1 stock split of the Company's common stock; - a reverse 1-for-50 stock split followed immediately by a forward 50-for-1 stock split of the Company's common stock. The complaint alleges, among other things, that the manner in which the Company plans to implement the transactions, as described in its proxy statement, violates certain aspects of Delaware law with regard to the treatment of fractional shares and that the description of the proposed transactions in the proxy statement is misleading to the extent it reflects such violations. The action purports to be a class action on behalf of all holders of less than 50 shares of the Company's common stock. The plaintiff is seeking, among other things, damages as well as injunctive relief enjoining the Company from effecting the transactions and requiring the Company to make corrective, supplemental disclosure. In June 2002, the court denied the plaintiff's motion for summary judgment and granted the Company's cross-motion for summary judgment. The plaintiff has since appealed the court's decision to the Delaware Supreme Court. Briefs are expected to be filed with the Delaware Supreme Court by the end of September 2002. The Company cannot provide assurance that this lawsuit will not impair its ability to implement any of the transactions. In April 2002, a complaint was filed against the Company in the Superior Court of New Jersey, Somerset County, in connection with the reverse/forward stock splits described above. The action purports to be a class action on behalf of all holders of less than 50 shares of the Company's common 28 AVAYA INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (UNAUDITED) 13. COMMITMENTS AND CONTINGENCIES (CONTINUED) stock. The plaintiff is seeking, among other things, injunctive relief enjoining the Company from effecting the transactions. In recognition of the then pending action in the Delaware Court of Chancery, the plaintiff voluntarily dismissed his complaint without prejudice. COMMISSION ARBITRATION DEMAND In July 2002, a third party representative made formal demand for arbitration for alleged unpaid commissions in an amount in excess of $10 million, stemming from the sale of products from the Company's businesses that were formerly owned by Lucent involving the Ministry of Russian Railways. As the sales of products continue, the third party representative may likely increase its commission demand. The viability of this asserted claim is based on the applicability and interpretation of a representation agreement and an amendment thereto, which provides for binding arbitration. This matter is currently proceeding to arbitration. The matter is in the early stages and an outcome in the arbitration proceeding cannot be predicted. As a result, there can be no assurance that this case will not have a material adverse effect on our financial position, results of operations or cash flows. LUCENT CONSUMER PRODUCTS CLASS ACTIONS In several class action cases (the first of which was filed on June 24, 1996), plaintiffs claim that AT&T and Lucent engaged in fraud and deceit in continuing to lease residential telephones to consumers without adequate notice that the consumers would pay well in excess of the purchase price of a telephone by continuing to lease. The cases were removed and consolidated in federal court in Alabama, and were subsequently remanded to their respective state courts (Illinois, Alabama, New Jersey, New York and California). In July 2001, the Illinois state court certified a nationwide class of plaintiffs. The case in Illinois was scheduled for trial on August 5, 2002. Prior to commencement of trial, however, the Company has been advised that the parties agreed to a settlement of the claims on a class-wide basis. The proposed settlement has been preliminarily approved by the court. A notice and hearing will occur (within two to three months) to obtain a final approval of the settlement. Any liability incurred by Lucent in connection with these class action cases will be considered an exclusive Lucent liability under the Contribution and Distribution Agreement between Lucent and Avaya and, as a result, Avaya would be responsible for 10% of any such liability in excess of $50 million. The amount for which Avaya may be responsible will not be finally determined until the class claims period expires. See Note 14--Subsequent Events "Developments in Legal Proceedings" for related disclosure. PATENT INFRINGEMENT INDEMNIFICATION CLAIMS A patent owner has sued three customers of the Company's managed services business for alleged infringement of a single patent based on the customers' voicemail service. These customers' voicemail service offerings are partially or wholly provided by the Company's managed services business. As a consequence, these customers are requesting defense and indemnification from the Company in the lawsuits under their managed services contracts. This matter is in the early stages and the Company 29 AVAYA INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (UNAUDITED) 13. COMMITMENTS AND CONTINGENCIES (CONTINUED) cannot yet determine whether the outcome of this matter will have a material adverse effect on its financial position, results of operations or cash flows. ENVIRONMENTAL MATTERS The Company is subject to a wide range of governmental requirements relating to employee safety and health and to the handling and emission into the environment of various substances used in its operations. The Company is subject to certain provisions of environmental laws, particularly in the U.S., governing the cleanup of soil and groundwater contamination. Such provisions impose liability for the costs of investigating and remediating releases of hazardous materials at currently or formerly owned or operated sites. In certain circumstances, this liability may also include the cost of cleaning up historical contamination, whether or not caused by the Company. The Company is currently conducting investigation and/or cleanup of known contamination at seven of its facilities either voluntarily or pursuant to government directives. It is often difficult to estimate the future impact of environmental matters, including potential liabilities. The Company has established financial reserves to cover environmental liabilities where they are probable and reasonably estimable. Reserves for estimated losses from environmental matters are, depending on the site, based primarily upon internal or third party environmental studies and the extent of contamination and the type of required cleanup. Although the Company believes that its reserves are adequate to cover known environmental liabilities, there can be no assurance that the actual amount of environmental liabilities will not exceed the amount of reserves for such matters or will not have a material adverse effect on the Company's financial position, results of operations or cash flows. CONDITIONAL REPURCHASE OBLIGATIONS Avaya sells products to various distributors that may obtain financing from unaffiliated third party lending institutions. In the event the lending institution repossesses the distributor's inventory of Avaya products, Avaya is obligated under certain circumstances to repurchase such inventory from the lending institution. The Company's obligation to repurchase inventory from the lending institution terminates 180 days from the date of invoicing by Avaya to the distributor. The repurchase amount is equal to the price originally paid to Avaya by the lending institution for the inventory. The amount reported to the Company from the two distributors who participate in these arrangements as their inventory on-hand was approximately $74 million as of June 30, 2002. The Company is unable to determine how much of this inventory was financed and, if so, whether any amounts have been paid to the lending institutions. Therefore, the Company's repurchase obligation could be less than the amount of inventory on-hand. While there have not been any repurchases made by Avaya under such agreements, there can be no assurance that the Company will not be obligated to repurchase inventory under these arrangements in the future. 30 AVAYA INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (UNAUDITED) 14. SUBSEQUENT EVENTS BUSINESS RESTRUCTURING CHARGE The Company has been experiencing a decline in its revenue as a result of the continued deferment by customers of information technology investments, specifically for enterprise communications products and services. Despite the unpredictability of the current business environment, the Company remains focused on its strategy to return to profitability by focusing on sustainable cost and expense reduction, among other things. To achieve that goal, the Company announced in July 2002 that it has begun to implement a company-wide restructuring to enable it to reduce costs and expenses further in order to lower the amount of revenue needed to reach the Company's profitability break-even point. In the fourth quarter of fiscal 2002, the Company expects to record a business restructuring charge and related expenses in connection with this plan of approximately $150 million. Based on the Company's initial assessment, the components of this charge are estimated to include $70 million related to a reduction of about 2,500 employee positions, up to $65 million for real estate consolidations and lease terminations, and $15 million for certain asset impairments. Because the Company is currently finalizing its restructuring plan, the actual components of this charge may vary. REVOLVING CREDIT FACILITIES In August 2002, the Company received consents from the requisite lenders under the five-year Credit Facility to amend the terms of the facility. The Company does not intend to renew the 364-day Credit Facility expiring in August 2002. The amended five-year Credit Facility will require the Company to maintain a ratio of EBITDA to interest expense of: - 1.70 to 1 for each of the four quarter periods ending September 30, 2002, December 31, 2002 and March 31, 2003; - 2.25 to 1 for the four quarter period ending June 30, 2003; - 3.50 to 1 for the four quarter period ending September 30, 2003; and - 4.00 to 1 for the four quarter period ending December 31, 2003 and each four quarter period thereafter. In addition, the amended five-year Credit Facility will require the Company to maintain minimum EBITDA of: - $70 million for the three quarter period ending September 30, 2002; - $100 million for the four quarter period ending December 31, 2002; - $115 million for the four quarter period ending March 31, 2003; - $150 million for the four quarter period ending June 30, 2003; - $250 million for the four quarter period ending September 30, 2003; 31 AVAYA INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (UNAUDITED) 14. SUBSEQUENT EVENTS (CONTINUED) - $350 million for the four quarter period ending December 31, 2003; and - $400 million for each of the four quarter periods thereafter. The definition of EBITDA in the amended five-year Credit Facility will exclude an additional $100 million of business restructuring charges and related expenses to be taken no later than the third quarter of fiscal 2003. The total business restructuring related excludable amount of $166 million, which is made up of the additional $100 million under the amended credit facility plus $66 million remaining under the existing Credit Facilities, will enable us to exclude from the definition of EBITDA the $150 million business restructuring charge announced in July 2002 plus $15 million of period costs related to our prior restructuring initiatives. A substantial portion of these costs are expected to be incurred in the fourth quarter of fiscal 2002 and the first quarter of fiscal 2003. The initial aggregate commitments under the amended five-year Credit Facility will equal $561 million, but will be subject to mandatory reduction as follows: - reduced to $500 million on December 1, 2003; - reduced to $425 million on March 1, 2004; - reduced to $350 million on June 1, 2004; and - reduced to $250 million on September 1, 2004. The Company will also be required to reduce the commitments by an amount equal to 100% of the net cash proceeds realized from the sale of any assets (other than the sale of our Connectivity Solutions business or the sale of the Company's aircraft) and by an amount equal to 50% of the net cash proceeds realized from the issuance of debt, other than refinancing debt; provided, however, that in each case, the Company shall not be required to reduce the commitments below an amount equal to $250 million less the amount of any cash used to redeem or repurchase the LYONs as described below. The amended five-year Credit Facility will provide that the Company may use up to $100 million of cash to redeem or repurchase the LYONs at any time as long as no default or event of default exists under the facility, no amounts are outstanding under the facility, the commitments are reduced in an amount equal to the cash amount used to redeem or repurchase the LYONs, and the Company's cash balance is not less than $300 million after giving pro forma effect to the redemption or repurchase of the LYONs. The amendment will provide that the existing $150 million limitation on use of the facility for acquisitions or other investments will be reduced to $75 million. The terms of the amended five-year Credit Facility are subject to the execution of definitive amendments. The Company expects to complete execution of the required amendments shortly. SEGMENT BUSINESS MODEL EVOLUTION In the fourth quarter of fiscal 2002, the Company reevaluated its business model in light of the continued deferment by customers of enterprise communications technology investments. This reevaluation has resulted in moving forward in the design of the existing operating segments to focus 32 AVAYA INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (UNAUDITED) 14. SUBSEQUENT EVENTS (CONTINUED) more firmly on aligning them with discrete customer sets and market segment opportunities in order to optimize revenue growth and profitability. Accordingly, effective for the fourth quarter of fiscal 2002, the Company will reorganize the Systems and Applications segments to form the Converged Systems & Applications segment and the Small & Medium Business Solutions segment. The Converged Systems & Applications segment will focus on large enterprise customers and the Small & Medium Business Solutions segment will reflect sales of product designed specifically for small to mid-sized enterprises. The products and services offered by the Connectivity Solutions and Services segments will remain relatively unchanged. The segments will be operated as four fully functional businesses and, as a result, this structure may cause the operating segments' results to contain certain additional costs and expenses including amounts that have been historically reported in the corporate and other category. DEVELOPMENTS IN LEGAL PROCEEDINGS Subsequent to the issuance of the Company's earnings press release for the third quarter of fiscal 2002 on July 22, 2002, the Company recorded adjustments to its financial statements as of and for the three and nine months ended June 30, 2002 in connection with certain developments in two litigation matters that occurred after the issuance of its earnings press release. In connection with the matter described under the caption "--Legal Proceedings--Coupon Program Class Action" in Note 13 Commitments and Contingencies, the period for submitting a claim in that action expired on July 15, 2002. In late July, the Company made a final determination of its obligations in this matter by aggregating all claim notifications received with a postmark dated on or before the July 15, 2002 deadline. Based on this review, the Company determined that the estimated reserve for this matter recorded in the other liabilities section of the Balance Sheet as of June 30, 2002 exceeded the amount of actual aggregate claims received by approximately $4 million and, accordingly, the Company reversed this amount to other income (expense), net in the Statements of Operations for the three and nine months ended June 30, 2002. In addition, in August 2002, the Company was advised that a settlement had been reached in the matters involving Lucent and AT&T described under the caption "--Legal Proceedings--Lucent Consumer Products Class Actions" in Note 13 Commitments and Contingencies. The proposed settlement has been preliminarily approved by the Illinois state court. Any liability borne by Lucent in connection with these class action cases will be considered an exclusive Lucent liability under the Contribution and Distribution Agreement between Lucent and the Company and, as a result, the Company is responsible for 10% of any such liability in excess of $50 million. The Company recorded an estimated liability in the other liabilities section of the Balance Sheet as of June 30, 2002 of approximately $6 million in connection with this settlement. The expense for such liability was recorded to other income (expense), net in the Statement of Operations for the three and nine months ended June 30, 2002. The $6 million represents the Company's current estimate of its liability in this matter, although the amount for which Avaya may ultimately be responsible will not be finally determined until the claims period expires. 33 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The following section should be read in conjunction with the consolidated financial statements and the notes thereto included elsewhere in this Quarterly Report on Form 10-Q. Our accompanying unaudited consolidated financial statements as of June 30, 2002 and for the three and nine months ended June 30, 2002 and 2001, have been prepared in accordance with accounting principles generally accepted in the United States of America for interim financial statements and the rules and regulations of the Securities and Exchange Commission for interim financial statements, and should be read in conjunction with our Annual Report on Form 10-K for the fiscal year ended September 30, 2001. In our opinion, the unaudited interim consolidated financial statements reflect all adjustments, consisting of normal and recurring adjustments, necessary for a fair presentation of the financial condition, results of operations and cash flows for the periods indicated. Certain prior year amounts have been reclassified to conform to the current interim period presentation. The consolidated results of operations for the interim periods reported are not necessarily indicative of the results to be experienced for the entire fiscal year. RISKS AND UNCERTAINTIES The matters discussed in Management's Discussion and Analysis of Financial Condition and Results of Operations contain forward looking statements that are based on current expectations, estimates, forecasts and projections about the industries in which we operate, management's beliefs and assumptions made by management. Such statements include, in particular, statements about our plans, strategies and prospects. Words such as "expects," "anticipates," "intends," "plans," "believes," "seeks," "estimates," variations of such words and similar expressions are intended to identify such forward looking statements. These statements are not guarantees of future performance and involve certain risks, uncertainties and assumptions, which are difficult to predict. Therefore, actual outcomes and results may differ materially from what is expressed or forecasted in such forward looking statements. Except as required under the federal securities laws and the rules and regulations of the Securities and Exchange Commission, we do not have any intention or obligation to update publicly any forward looking statements after they are made, whether as a result of new information, future events or otherwise. Important factors that could cause actual outcomes and results to differ materially from the forward looking statements we make in Management's Discussion and Analysis of Financial Condition and Results of Operations include the factors described in our most recent Annual Report on Form 10-K and those described below: OUR REVENUE HAS DECLINED SIGNIFICANTLY DURING THE PAST SEVERAL QUARTERS AND IF BUSINESS CAPITAL SPENDING, PARTICULARLY FOR ENTERPRISE COMMUNICATIONS PRODUCTS AND SERVICES, DOES NOT IMPROVE OR DETERIORATES, OUR REVENUE MAY CONTINUE TO DECLINE AND OUR OPERATING RESULTS MAY BE ADVERSELY AFFECTED. Our revenue for the quarter ended June 30, 2002 was $1,219 million, a decrease of 28.9%, or $495 million, from $1,714 million for the quarter ended June 30, 2001, a sequential decrease of 4.7%, or $60 million, from $1,279 million for the quarter ended March 31, 2002, and a sequential decrease of 6.7%, or $87 million, from $1,306 for the quarter ended December 31, 2001. Our operating results are significantly affected by the impact of economic conditions on the willingness of enterprises to make capital investments, particularly in enterprise communications technology. Although general economic conditions have shown some signs of improvement recently, we have seen a continued deferment by our customers of enterprise communications technology investments. We believe that enterprises continue to be concerned about their ability to increase revenues and thereby increase their profitability. Accordingly, they have tried to maintain or improve profitability through cost reduction and delayed capital spending. Because we do not believe that enterprise communications spending will improve significantly until some time in calendar 2003, we expect there to be continued pressure on our ability to generate revenue. 34 To the extent that enterprise communications spending does not improve or deteriorates, our revenue and operating results will continue to be adversely affected and we may not be able to comply with the financial covenants included in our credit facilities, as described in "--Liquidity and Capital Resources." THE MARKET FOR OUR TRADITIONAL BUSINESS, ENTERPRISE VOICE COMMUNICATIONS PRODUCTS, HAS BEEN SHRINKING FOR THE LAST SEVERAL YEARS AND IF WE DO NOT SUCCESSFULLY IMPLEMENT OUR STRATEGY TO EXPAND OUR SALES IN MARKET SEGMENTS WITH HIGHER GROWTH RATES, OUR REVENUE AND OPERATING RESULTS MAY CONTINUE TO BE ADVERSELY AFFECTED. We have been experiencing declines in revenue from our traditional business, enterprise voice communications products. We expect, based on various industry reports, a low growth rate or no growth in the market segments for these traditional products. We are implementing a strategy to capitalize on the higher growth opportunities in our market, including advanced communications solutions such as converged voice and data network products, customer relationship management solutions, unified communication applications and multi-service networking products. This strategy requires us to make a significant change in the direction and strategy of our company to focus on the development and sales of these advanced products. The success of this strategy, however, is subject to many risks, including the risks that: - we do not develop new products or enhancements to our current products on a timely basis to meet the changing needs of our customers; - customers do not accept our products or new technology, or industry standards develop that make our products obsolete; or - our competitors introduce new products before we do and achieve a competitive advantage by being among the first to market. Our traditional enterprise voice communications products and the advanced communications solutions described above are a part of our Systems and Applications segments. If we are unsuccessful in implementing our strategy, the contribution to our results from our Systems and Applications segments may decline, reducing our overall operating results and thereby requiring a greater need for external capital resources. WE ARE SIGNIFICANTLY CHANGING THE FOCUS OF OUR COMPANY IN ORDER TO CONCENTRATE ON THE DEVELOPMENT AND MARKETING OF ADVANCED COMMUNICATIONS SOLUTIONS, INCLUDING CONVERGED VOICE AND DATA NETWORK PRODUCTS, AND THIS CHANGE IN FOCUS MAY NOT BE SUCCESSFUL OR MAY ADVERSELY AFFECT OUR BUSINESS. We are making a significant change in the direction and strategy of our company to focus on the development and sales of products to be incorporated in advanced communications solutions, including products that facilitate the convergence of voice and data networks. In order to implement this change, we must: - retrain our sales staff to sell new types of products and improve our marketing of such products; - develop relationships with new types of distribution partners; - research and develop more converged voice and data products and products using communications media other than voice traffic, which has historically been our core area of expertise; and - build credibility among customers that we are capable of delivering advanced communications solutions beyond our historic product lines. Most of these challenges have required, and will continue to require, that we increase costs substantially without any certainty of success. If we are not successful, our operating results may be adversely affected. However, even if we successfully address these challenges, our operating results may still be adversely affected if the market opportunity for advanced communications solutions, including 35 converged voice and data network products, does not develop in the ways that we anticipate. Because this market opportunity is in its early stages, we cannot predict whether: - the demand for advanced communications solutions and converged voice and data products will grow as fast as we anticipate; - new technologies will cause the market to evolve in a manner different than we expect; or - we will be able to obtain a leadership or profitable position as this opportunity develops. The recent introduction of new Internet Protocol, or "IP", telephony products demonstrates some of the risks associated with entering new markets or introducing new technologies. IP telephony products enable enterprises to utilize internet protocol standards to digitize and compress voice signals and transmit them over their data networks. According to a recent industry study, shipments of IP telephony products dropped sequentially for the first time in the first calendar quarter of 2002. Some industry analysts have indicated that the recent introduction of the next generation of our ECLIPS portfolio of IP hardware and software may have caused many enterprises who were considering implementing IP telephony systems to reconsider their deployment plans while they evaluate our ECLIPS announcement as well a subsequent product announcement from Nortel Networks Corporation. WE MAY NOT HAVE ADEQUATE OR COST-EFFECTIVE LIQUIDITY OR CAPITAL RESOURCES. Our cash needs include making payments on and refinancing our indebtedness and funding working capital, capital expenditures, strategic acquisitions, business restructuring and related expenses, any future pension funding obligation and for general corporate purposes. Our ability to satisfy our cash needs depends on our ability to generate cash from operations and access the financial markets, both of which are subject to general economic, financial, competitive, legislative, regulatory and other factors that are beyond our control. Our ability to generate cash from operations and obtain external financing is affected by the terms of our credit agreements, the indenture governing our LYONs, and the indenture governing our Senior Secured Notes. These instruments impose, and any future indebtedness may impose, various restrictions and covenants that limit our ability to, among other things, incur additional indebtedness. In particular, the terms of our credit agreements do not allow us to issue more than $500 million of debt in the capital markets, including the $440 million of Senior Secured Notes we issued in March 2002. As a result of those restrictions, it may be difficult for us to respond to market conditions, provide for unanticipated capital investments or take advantage of business opportunities. In addition, holders may require us to purchase all or a portion of their LYONs on October 31, 2004, 2006 and 2011 at a price equal to the sum of the issue price and accrued original issue discount on the LYONs as of the applicable purchase date. We may, at our option, elect to pay the purchase price in cash or shares of common stock, or any combination thereof. If we are unable to repurchase the LYONs with common stock and do not have sufficient cash to make such purchase, we could be in default on our obligation on the LYONs. In addition, the terms of the amendment to our five-year Credit Facility described under "--Liquidity and Capital Resources" places certain restrictions on our ability to repurchase or redeem the LYONs with cash. In addition, upon the occurrence of specific kinds of change in control events, we may have substantial repayment obligations under our existing debt agreements. If we do not generate sufficient cash from operations, we will need to access the financial markets. External financing may not be available to us on acceptable terms or at all. Under the terms of any external financing, we may incur higher than expected financing expenses, and become subject to additional restrictions and covenants. Our existing Credit Facilities require us to comply with certain financial covenants. Although we were in compliance with these covenants as of June 30, 2002, our continued revenue decline and the expected recording of the $150 million restructuring charge and related expenses described under "--Business Restructuring Charges and Related Expenses" would likely have prevented us from complying with these covenants as of September 30, 2002. Accordingly, 36 as more fully described under "--Liquidity and Capital Resources," we recently received consents from the requisite lenders under our Credit Facilities to amend, among other things, the financial covenants included in our five-year credit facility. If we are unable to comply with our financial covenants and cannot amend or waive those covenants, an event of default under the Credit Facilities would occur. If a default occurs, the lenders under our Credit Facilities could accelerate the maturity of our debt obligations and terminate their commitments to lend to us. If such a default occurs when our debt obligations under the Credit Facilities exceed $100 million, our debt obligations in respect of the $50 million interest rate swap, the LYONs and the Senior Secured Notes could be accelerated. In addition, although we currently have a $264 million 364-day credit facility and a $561 million five-year credit facility, we do not intend to renew the 364-day facility expiring in August 2002 and the amendments to the five-year credit facility require mandatory commitment reductions over the remaining term of the facility and additional commitment reductions upon the issuance of debt, sales of assets or repurchase or redemption of the LYONs, thereby reducing our available liquidity. The recent slump in the U.S. equities market and, in particular, in technology stocks has adversely affected our stock price. As of August 12, 2002, the closing price of our common stock on the New York Stock Exchange was $1.34 per share. The current trading price of our common stock may hinder our ability in the near term to obtain equity financing on cost-effective terms or at all. Our ability to obtain external financing is affected by our debt ratings, which are periodically reviewed by the major credit rating agencies. Our commercial paper is no longer rated by Moody's or Standard & Poor's. These recent ratings withdrawals mean that we can no longer access the commercial paper market, which until recently has been our primary source of liquidity. Our corporate credit is on CreditWatch and rated BB+ and our long-term senior unsecured debt is rated BB- by Standard & Poor's, each with a negative outlook, and our long-term senior unsecured debt is rated Ba3 by Moody's with a negative outlook. Any increase in our level of indebtedness or deterioration of our operating results may cause a further reduction in our current debt ratings. These downgrades, among other factors, could impair our ability to secure additional financing on acceptable terms, and we cannot assure you that we will be successful in raising any of the new financing on acceptable terms. WE MAY NOT BE ABLE TO DISPOSE OF OUR CONNECTIVITY SOLUTIONS BUSINESS ON TERMS SATISFACTORY TO US OR AT ALL. In February 2002, we engaged Salomon Smith Barney Inc. to explore alternatives for our Connectivity Solutions segment, including the possible sale of the business. Our goal in exploring alternatives for our Connectivity Solutions segment is to strengthen our focus on higher growth opportunities by emphasizing our Systems, Applications and Services offerings, such as converged voice and data network products and unified communication and customer relationship management solutions. These offerings, unlike our Connectivity Solutions offerings, are targeted exclusively at enterprises and we believe offer increased growth potential. In addition, we believe that the proceeds from any sale of our Connectivity Solutions segment would help enhance our liquidity. However, we may not be able to dispose of our Connectivity Solutions segment on terms satisfactory to us or at all. If we are unable to dispose of our Connectivity Solutions segment on terms satisfactory to us or at all, our operating results and liquidity may suffer and we may not be able to focus our business on our Systems, Applications and Services offerings, which also may adversely affect our business. IF WE DISPOSE OF OUR CONNECTIVITY SOLUTIONS BUSINESS, OUR OPERATING RESULTS MAY BE ADVERSELY AFFECTED. Historically, our Connectivity Solutions segment has provided a significant contribution to our operating results. Any disposition of our Connectivity Solutions segment could result in the loss of a historically significant contributor to our operating results, which could adversely affect our consolidated operating results. See the segment information included in Note 11--Operating Segments included in our accompanying Notes to our Consolidated Financial Statements included elsewhere in 37 this report for further information regarding the contribution of Connectivity Solutions to our consolidated operating results. OUR LARGEST DEALER MAY NOT BE ABLE TO SATISFY IN FULL ITS OBLIGATIONS TO US UNDER A SHORT-TERM LINE OF CREDIT. In March 2000, as part of our strategy to strengthen our distribution network, we sold our primary distribution function for voice communications systems for small and mid-sized enterprises to Expanets, Inc., currently our largest dealer. The terms of the sale provided that we would provide billing, collection and maintenance services to Expanets for a transitional period. In May 2001, the dealer agreement was restructured to more precisely define the customer base to be serviced by each party, including small or branch offices of larger enterprises. At the time the dealer agreement was restructured, Expanets' efforts to obtain a commercial credit facility were hampered by the fact that its billing and collection function had not yet been migrated to its information systems. Because of the importance to Avaya of the Expanets relationship and the customer base served by Expanets, we agreed to provide a $125 million short-term line of credit (as amended as described below, the "Dealer Credit Agreement"). The Dealer Credit Agreement applies to certain unpaid and outstanding receivables for amounts due us by Expanets. A delay in the migration of the billing and collection function until December 2001 affected Expanets' ability to obtain a collateralized commercial credit facility by the original March 31, 2002 expiration date of the Dealer Credit Agreement. Accordingly, in March 2002, we entered into an amendment to the Dealer Credit Agreement with Expanets and its parent company, NorthWestern Corporation. The Dealer Credit Agreement provides for installment payments under the credit line in the amounts of $25 million in March 2002, $20 million in April 2002, and $25 million in August 2002 with the remaining balance due on December 31, 2002. As of June 30, 2002, we have received the first two installment payments. The Dealer Credit Agreement provides that the borrowing limit shall be reduced by the amount of each installment payment upon the receipt of such payment and may also be offset by certain obligations we have to Expanets related to the March 2000 sale of the distribution function to Expanets. As of June 30, 2002 and September 30, 2001, the borrowing limit was $69 million and $121 million, respectively. The interest rate on the line of credit will accrue at an annual rate of 12% through August 31, 2002, and increase to 15% on September 1, 2002. Outstanding amounts under the line of credit are secured by Expanets' accounts receivable and inventory. In addition, NorthWestern has guaranteed up to $50 million of Expanets' obligations under the Dealer Credit Agreement. A default by NorthWestern of its guarantee obligations under the Dealer Credit Agreement would constitute a default under the Expanets' dealer agreement with Avaya, resulting in a termination of the non-competition provisions contained in such agreement and permitting us to sell products to Expanets' customers. There can be no assurance that Expanets will be able to comply with the remaining terms of the Dealer Credit Agreement. In the event Expanets is unable to comply with the terms of the Dealer Credit Agreement and a default occurs, the remedies available to Avaya under such agreement may be insufficient to satisfy in full all of Expanets' obligations to us. WE PLAN TO EXPAND OUR INTERNATIONAL SALES, WHICH WILL SUBJECT US TO ADDITIONAL BUSINESS RISKS THAT MAY ADVERSELY AFFECT OUR OPERATING RESULTS DUE TO INCREASED COSTS. We intend to continue to pursue growth opportunities internationally. In many countries outside the United States, long-standing relationships between our potential customers and their local providers and protective regulations, including local content requirements and type approvals, create barriers to entry. In addition, pursuit of such international growth opportunities may require us to make significant investments for an extended period before returns on such investments, if any, are realized. For example, to execute our strategy to expand internationally we are incurring additional costs to enter 38 into strategic alliances focused on international sales and expanding our presence in key markets. International operations are subject to a number of other risks and potential costs, including: - expenditure of significant amounts of time and money to build a brand identity in locations where our new brand is not recognized currently without certainty that we will be successful; - unexpected changes in regulatory requirements; - inadequate protection of intellectual property in foreign countries; - adverse tax consequences; - dependence on developing relationships with qualified local distributors, dealers, value-added resellers and systems integrators; and - political and economic instability. Any of these factors could prevent us from increasing our revenue and otherwise adversely affect our operating results in international markets. We may not be able to overcome some of these barriers and may incur significant costs in addressing others. Sales to our international customers are denominated in either local currency or U.S. dollars, depending on the country or channel used to fulfill the customers' order. We manage our net currency exposure through currency forward contracts and currency options which requires us to incur additional cost for this protection, although we did recognize a loss on foreign currency transactions of $12 million for the quarter ended June 30, 2002 due to the decline in the U.S. dollar as compared to several other currencies. In addition to the foreign currency risk for our receivables, there is additional risk associated with the fact that most of our products or components are manufactured or sourced from the United States. Should the U.S. dollar strengthen against a local currency, the impact may hamper our ability to compete with other competitors, preventing us from increasing our revenue and otherwise adversely affect our operating results in international markets. IF WE DO NOT SUCCESSFULLY IMPLEMENT OUR RESTRUCTURING PLAN, WE MAY EXPERIENCE DISRUPTIONS IN OUR OPERATIONS AND INCUR HIGHER ONGOING COSTS OR THE IMPLEMENTATION OF OUR RESTRUCTURING PLAN MAY NOT RESULT IN THE COST SAVINGS WE EXPECT, IN WHICH CASE OUR OPERATING RESULTS MAY BE ADVERSELY AFFECTED. We are in the process of implementing a company-wide restructuring designed to enable our company to reduce costs and expenses in order to reduce the amount of revenue needed to reach our profitability break-even point. The primary components of the plan are workforce reductions, real estate consolidations and lease terminations. As a result of these actions, we expect to record a business restructuring charge in the fourth quarter of fiscal 2002 of approximately $150 million. If we are unsuccessful in implementing this restructuring plan, we may experience disruptions in our operations and incur higher ongoing costs, which may adversely affect our operating results. In addition, we cannot assure you that we will realize the cost savings we expect from this restructuring plan or any of our prior restructuring initiatives. WE MAY INCUR LIABILITIES AS A RESULT OF OUR OBLIGATION TO INDEMNIFY LUCENT TECHNOLOGIES INC. IN CONNECTION WITH OUR SPIN-OFF FROM LUCENT IN SEPTEMBER 2000. Pursuant to the contribution and distribution agreement we entered into with Lucent in connection with our spin-off from Lucent on September 30, 2000, Lucent contributed to us substantially all of the assets, liabilities and operations associated with its enterprise networking businesses and distributed all of the outstanding shares of our common stock to its stockholders. The contribution and distribution agreement, among other things, provides that, in general, we will indemnify Lucent for all liabilities including certain pre-distribution tax obligations of Lucent relating to our businesses and all contingent liabilities primarily relating to our businesses or otherwise assigned to us. In addition, the contribution and distribution agreement provides that certain contingent liabilities not directly identifiable with one of the parties will be shared in the proportion of 90% by Lucent and 10% by us. The contribution and distribution agreement also provides that contingent liabilities in excess of $50 million that are 39 primarily related to Lucent's businesses shall be borne 90% by Lucent and 10% by us and contingent liabilities in excess of $50 million that are primarily related to our businesses shall be borne equally by the parties. Please see "--Legal Proceedings" for a description of certain matters involving Lucent for which we have assumed responsibility under the contribution and distribution agreement and a description of other matters for which we may be obligated to indemnify Lucent. We cannot assure you we will not have to make indemnification payments to Lucent in connection with these matters or that Lucent will not submit a claim for indemnification to us in connection with any future matter. In addition, our ability to assess the impact of matters for which we may have to indemnify Lucent is made more difficult by the fact that we do not control the defense of these matters. WE DEPEND ON CONTRACT MANUFACTURERS TO PRODUCE MOST OF OUR PRODUCTS AND IF THESE MANUFACTURERS ARE UNABLE TO FILL OUR ORDERS ON A TIMELY AND RELIABLE BASIS, WE WILL LIKELY BE UNABLE TO DELIVER OUR PRODUCTS TO MEET CUSTOMER ORDERS OR SATISFY THEIR REQUIREMENTS. We have outsourced a significant portion of our manufacturing operations related to our Systems and Applications segments. Our ability to realize the intended benefits of our manufacturing outsourcing initiative will depend on the willingness and ability of contract manufacturers to produce our products. We may experience significant disruption to our operations by outsourcing so much of our manufacturing. If our contract manufacturers terminate their relationships with us or are unable to fill our orders on a timely basis, we may be unable to deliver our products to meet our customers' orders, which could delay or decrease our revenue or otherwise have an adverse effect on our operations. THE TERMINATION OF STRATEGIC ALLIANCES OR THE FAILURE TO FORM ADDITIONAL STRATEGIC ALLIANCES COULD LIMIT OUR ACCESS TO CUSTOMERS AND HARM OUR REPUTATION WITH CUSTOMERS. Our strategic alliances are important to our success because they provide us the ability to offer comprehensive advanced communications solutions, reach a broader customer base and strengthen brand awareness. We may not be successful in creating new strategic alliances on acceptable terms or at all. In addition, most of our current strategic alliances can be terminated under various circumstances, some of which may be beyond our control. Further, our alliances are generally non-exclusive, which means our partners may develop alliances with some of our competitors. We may become more reliant on strategic alliances in the future, which would increase the risk to our business of losing these alliances. Because we have announced publicly our strategy to form alliances, as well as announced the alliances we have entered into, early termination of our alliances may harm our reputation with our customers and cause our revenue to decline to the extent we are unable to deliver new products or our customer base is reduced. IF THE DOWNWARD TREND IN PENSION ASSET VALUES AND HIGHER RETIREE HEALTH CARE COSTS CONTINUES, WE MAY INCUR ADDITIONAL EXPENSE AND FUNDING OBLIGATIONS THAT WILL HAVE AN ADVERSE EFFECT ON OUR FINANCIAL POSITION, RESULTS OF OPERATIONS AND CASH FLOWS. The recent decline in the global equity markets has resulted in a decrease in the value of the assets in our pension plan. This decline will likely adversely affect our related accounting results in future periods through higher pension expense, additional minimum liabilities with corresponding reductions in stockholders' equity, and increased cash funding requirements. In addition, we may incur higher expense related to our postretirement health plans as a result of higher health care cost trends. We currently estimate that we will be required to record a minimum pension liability of approximately $160 million with corresponding reductions in stockholders' equity on September 30, 2002. In addition, based on the value of the assets in our pension plan as of January 1, 2002, we will be required to fund approximately $30 million to the plan in September 2003 for the 2002 plan year and will likely be required to make quarterly funding payments in an aggregate amount not to exceed $30 million during calendar 2003 for the 2003 plan year. 40 IF THE VALUE OF OUR LONG-LIVED ASSETS DECREASES, WE MAY INCUR IMPAIRMENT LOSSES. The provisions of SFAS 142 require us to test goodwill for impairment at least annually. We intend to conduct the required impairment review for fiscal 2002 during the fourth quarter of fiscal 2002, at which time, if an impairment is identified, it will be recognized as a non-cash charge to the Statement of Operations. Further non-cash charges to other long-lived assets may result if triggered by a goodwill impairment loss. Please see "--The Application of Critical Accounting Policies" for further discussion of this requirement. IF WE ARE UNABLE TO PROTECT OUR PROPRIETARY RIGHTS, OUR BUSINESS AND FUTURE PROSPECTS MAY BE HARMED. Although we attempt to protect our intellectual property through patents, trademarks, trade secrets, copyrights, confidentiality and nondisclosure agreements and other measures, intellectual property is difficult to protect and these measures may not provide adequate protection for our proprietary rights. Patent filings by third parties, whether made before or after the date of our filings, could render our intellectual property less valuable. Competitors may misappropriate our intellectual property, disputes as to ownership of intellectual property may arise and our intellectual property may otherwise become known or independently developed by competitors. The failure to protect our intellectual property could seriously harm our business and future prospects because we believe that developing new products and technology that are unique to us is critical to our success. If we do not obtain sufficient international protection for our intellectual property, our competitiveness in international markets could be significantly impaired, which would limit our growth and future revenue. WE MAY BE SUBJECT TO LITIGATION AND INFRINGEMENT CLAIMS, WHICH COULD CAUSE US TO INCUR SIGNIFICANT EXPENSES OR PREVENT US FROM SELLING OUR PRODUCTS OR SERVICES. We cannot assure you that others will not claim that our proprietary or licensed products, systems and software are infringing their intellectual property rights or that we do not in fact infringe those intellectual property rights. We may be unaware of intellectual property rights of others that may cover some of our technology. If someone claimed that our proprietary or licensed systems and software infringed their intellectual property rights, any resulting litigation could be costly and time consuming and would divert the attention of management and key personnel from other business issues. The complexity of the technology involved and the uncertainty of intellectual property litigation increase these risks. Claims of intellectual property infringement also might require us to enter into costly royalty or license agreements. However, we may be unable to obtain royalty or license agreements on terms acceptable to us or at all. We also may be subject to significant damages or an injunction against use of our proprietary or licensed systems. A successful claim of patent or other intellectual property infringement against us could materially adversely affect our operating results. Although we generally exclude coverage where infringement arises out of the combination of our products with products of others, we may be required to indemnify our customers for some of the costs and damages of patent infringement in circumstances where our product is the factor creating the customer's infringement exposure. Any indemnification requirement could have a material adverse effect on our business and our operating results. Please see "--Legal Proceedings" for a description of patent infringement indemnification claims made by three customers of our managed services business. WE MAY ACQUIRE OTHER BUSINESSES OR FORM JOINT VENTURES THAT COULD NEGATIVELY AFFECT OUR OPERATING RESULTS. The pursuit of additional technology, services or distribution channels through acquisitions or joint ventures is a component of our business strategy. We may not identify or complete these transactions in a timely manner, on a cost effective basis or at all. Even if we do identify and complete these transactions, we may not be able to successfully integrate such technology, services or distribution channels into our existing operations and we may not realize the benefits of any such acquisition or 41 joint venture. We have limited experience with acquisition activities and may have to devote substantial time and resources in order to complete acquisitions. There may also be risks of entering markets in which we have no or limited experience. In addition, by making acquisitions, we could assume unknown or contingent liabilities. WE MAY NOT BE ABLE TO HIRE AND RETAIN HIGHLY SKILLED EMPLOYEES, WHICH COULD AFFECT OUR ABILITY TO COMPETE EFFECTIVELY AND MAY ADVERSELY AFFECT OUR OPERATING RESULTS. We depend on highly skilled technical personnel to research and develop, market and service new products. To succeed, we must hire and retain employees who are highly skilled in the rapidly changing communications and Internet technologies. In particular, as we implement our strategy of focusing on advanced communications solutions and the convergence of voice and data networks, we will need to: - retain our researchers in order to maintain a group sufficiently large to support our strategy to continue to introduce innovative products and to offer comprehensive advanced communications solutions; - hire more employees with experience developing and providing advanced communications products and services; - hire and train a customer service organization to service our multi-service networking products; and - retrain our existing sales force to sell converged and advanced communications products and services. Individuals who have these skills and can perform the services we need to provide our products and services are scarce. Because the competition for qualified employees in our industry is intense, hiring and retaining employees with the skills we need is both time-consuming and expensive. We might not be able to hire enough of them or to retain the employees we do hire. Our inability to hire and retain the individuals we seek could hinder our ability to sell our existing products, systems, software or services or to develop and sell new products, systems, software or services. If we are not able to attract and retain qualified individuals, we will not be able to successfully implement many of our strategies and our business will be harmed. OUR INDUSTRY IS HIGHLY COMPETITIVE AND IF WE CANNOT EFFECTIVELY COMPETE, OUR REVENUE MAY DECLINE. The market for our products and services is very competitive and subject to rapid technological advances. We expect the intensity of competition to continue to increase in the future as existing competitors enhance and expand their product and service offerings and as new participants enter the market. Increased competition also may result in price reductions, reduced gross margins and loss of market share. Our failure to maintain and enhance our competitive position would adversely affect our business and prospects. We compete with a number of equipment manufacturers and software companies in selling our communications systems and software. Further, our customer relationship management professional services consultants compete against a number of professional services firms. Some of our customers and strategic partners are also competitors of ours. We expect to face increasing competitive pressures from both existing and future competitors in the markets we serve and we may not be able to compete successfully against these competitors. The sizes of our competitors vary across our market segments, as do the resources we have allocated to the segments we target. Therefore, many of our competitors have greater financial, personnel, capacity and other resources than we have in each of our market segments or overall. As a result, our competitors may be in a stronger position to respond quickly to potential acquisitions and other market opportunities, new or emerging technologies and changes in client requirements. Competitors with greater financial resources also may be able to offer lower prices, additional products or services or other incentives that we cannot match or do not offer. These competitors may be in a stronger position to respond quickly to new or emerging technologies and may be able to undertake 42 more extensive marketing campaigns, adopt more aggressive pricing policies and make more attractive offers to potential customers, employees and strategic partners. IF THE DISTRIBUTION DOES NOT QUALIFY FOR TAX-FREE TREATMENT, WE COULD BE REQUIRED TO PAY LUCENT OR THE INTERNAL REVENUE SERVICE A SUBSTANTIAL AMOUNT OF MONEY. Lucent has received a private letter ruling from the Internal Revenue Service stating, based on certain assumptions and representations, that the distribution would not be taxable to Lucent. Nevertheless, Lucent could incur significant tax liability if the distribution did not qualify for tax-free treatment because any of those assumptions or representations were not correct. Although any U.S. federal income taxes imposed in connection with the distribution generally would be imposed on Lucent, we could be liable for all or a portion of any taxes owed for the reasons described below. First, as part of the distribution, we and Lucent entered into a tax sharing agreement. This agreement generally allocates between Lucent and us the taxes and liabilities relating to the failure of the distribution to be tax-free. Under the tax sharing agreement, if the distribution fails to qualify as a tax-free distribution to Lucent under Section 355 of the Internal Revenue Code because of an issuance or an acquisition of our stock or an acquisition of our assets, or some other actions of ours, then we will be solely liable for any resulting taxes to Lucent. Second, aside from the tax sharing agreement, under U.S. federal income tax laws, we and Lucent are jointly and severally liable for Lucent's U.S. federal income taxes resulting from the distribution being taxable. This means that even if we do not have to indemnify Lucent under the tax sharing agreement, we may still be liable to the Internal Revenue Service for all or part of these taxes if Lucent fails to pay them. These liabilities of Lucent could arise from actions taken by Lucent over which we have no control, including an issuance or acquisition of stock (or acquisition of assets) of Lucent. OVERVIEW We are a leading provider of communications systems and software for enterprises, including businesses, government agencies and other organizations. We offer voice, converged voice and data, customer relationship management, messaging, multi-service networking and structured cabling products and services. Multi-service networking products are those products that support network infrastructures which carry voice, video and data traffic over any of the protocols, or set of procedures, supported by the Internet on local area and wide area data networks. A structured cabling system is a flexible cabling system designed to connect phones, workstations, personal computers, local area networks and other communications devices through a building or across one or more campuses. We are a worldwide leader in sales of messaging and structured cabling systems and a U.S. leader in sales of enterprise voice communications and call center systems. We are not a leader in multi-service networking products, and our product portfolio in this area is less complete than the portfolios of some of our competitors. In addition, we are not a leader in sales of certain converged voice and data products, including server-based Internet Protocol telephony systems. We are implementing a strategy focused on these and other advanced communications solutions. OPERATING SEGMENTS Effective January 1, 2002, we implemented an internal reorganization and as a result, we currently assess our performance and allocate our resources among four rather than three operating segments. We divided our Communications Solutions segment into two reportable segments: Systems and Applications. Our objective of the reorganization was to enable us to understand and manage our product groups with greater precision. The Systems segment includes sales to small to midsized enterprises, which includes data switches and small to midsized telephony products, and sales to our large customers, referred to as Enterprise Systems, which include sales of all enterprise telephony products, virtual private networks, and data Local Area Network and Wide Area Network equipment. The Applications segment consists of customer relationship management, voice and unified messaging, 43 and unified communication products and related professional services. In addition, we shifted installation and the network consulting portion of professional services previously reported in Communications Solutions to the Services segment. The Services segment continues to include maintenance, value-added and data services. The Connectivity Solutions segment represents structured cabling systems and electronic cabinets. As part of the changes made in the second quarter of fiscal 2002, we also redirected a larger portion of corporate operating expenses, consisting mostly of marketing and selling expenses, to each of the operating segments. The costs of shared services and other corporate center operations that (i) are managed on a common basis, (ii) are not identified with the operating segments, and (iii) represent business activities that do not qualify for separate operating segment reporting are aggregated in the Corporate and other category. Such costs include primarily business restructuring charges and related expenses, research and development, information technology, corporate finance and real estate costs. As a result of the changes discussed above, fiscal 2001 amounts have been restated to conform to the current operating segment presentation. Intersegment sales approximate fair market value and are not significant. SEGMENT BUSINESS MODEL EVOLUTION In the fourth quarter of fiscal 2002, we reevaluated our business model in light of the continued deferment by customers of enterprise communications technology investments. This reevaluation has resulted in moving forward in the design of the existing operating segments to focus more firmly on aligning them with discrete customer sets and market segment opportunities in order to optimize revenue growth and profitability. Accordingly, effective for the fourth quarter of fiscal 2002, we will reorganize the Systems and Applications segments to form the Converged Systems & Applications segment and the Small & Medium Business Solutions segment. The Converged Systems & Applications segment will focus on large enterprise customers and the Small & Medium Business Solutions segment will reflect sales of product designed specifically for small to mid-sized enterprises. The products and services offered by the Connectivity Solutions and Services segments will remain relatively unchanged. The segments will be operated as four fully functional businesses and, as a result, this structure may cause the operating segments' results to contain certain additional costs and expenses including amounts that have been historically reported in the existing corporate and other category. REVENUE BY OPERATING SEGMENT The following table sets forth the allocation of our revenue among our operating segments, expressed as a percentage of total revenue:
THREE MONTHS ENDED NINE MONTHS ENDED JUNE 30, JUNE 30, ------------------- ------------------- 2002 2001 2002 2001 -------- -------- -------- -------- OPERATING SEGMENTS: Systems.................................... 31.5% 31.5% 32.6% 33.6% Applications............................... 13.1 12.7 13.7 13.1 Services................................... 41.9 34.1 42.1 32.4 Connectivity Solutions..................... 13.5 21.7 11.6 20.9 ----- ----- ----- ----- Total...................................... 100.0% 100.0% 100.0% 100.0% ===== ===== ===== =====
44 SFAS 142 Effective October 1, 2001, we adopted Statement of Financial Accounting Standards No. 142, "Goodwill and Other Intangible Assets" ("SFAS 142"), which requires that goodwill and certain other intangible assets having indefinite lives no longer be amortized to earnings, but instead be subject to periodic testing for impairment. Intangible assets determined to have definitive lives will continue to be amortized over their remaining useful lives. In connection with the adoption of SFAS 142, we reviewed the classification of our existing goodwill and other intangible assets, reassessed the useful lives previously assigned to other intangible assets, and discontinued amortization of goodwill. We also tested goodwill for impairment by comparing the fair value of our reporting units to their carrying value as of October 1, 2001 and determined that there was no goodwill impairment. See our "Results of Operations" discussion noted below for the impact of the adoption of SFAS 142 on selling, general and administrative expense. The provisions of SFAS 142 require that goodwill of a reporting unit be tested for impairment on an annual basis or between annual tests if an event occurs or circumstances change that would more likely than not reduce the fair value of a reporting unit below its carrying amount. We intend to conduct the required impairment review for fiscal 2002 during the fourth quarter of fiscal 2002, at which time, if an impairment is identified, it will be recorded as an operating expense in the Statement of Operations. For the three and nine months ended June 30, 2001, goodwill amortization, net of tax, amounted to $10 million and $28 million, respectively. If we had adopted SFAS 142 as of the beginning of the first quarter of fiscal 2001 and discontinued goodwill amortization, net income and earnings (loss) per common share on a pro forma basis would have been as follows:
PRO FORMA ------------------------------------------------ THREE MONTHS ENDED NINE MONTHS ENDED JUNE 30, 2001 JUNE 30, 2001 ----------------------- ---------------------- (DOLLARS IN MILLIONS, EXCEPT PER SHARE AMOUNTS) Net income.................................... $ 34 $ 4 Earnings (Loss) Per Common Share: Basic....................................... $0.09 $(0.06) Diluted..................................... $0.09 $(0.06)
INTERNAL USE SOFTWARE In the second quarter of fiscal 2002, we changed the estimated useful life of certain internal use software to reflect actual experience as a stand-alone company on the utilization of such software and extended the useful life of these assets from three to seven years. This change lowered depreciation expense by approximately $5 million and $9 million, equivalent to $0.01 and $0.02 per diluted share, for the three and nine months ended June 30, 2002, respectively. BUSINESS RESTRUCTURING CHARGES AND RELATED EXPENSES We recorded business restructuring charges and related expenses of $9 million and $103 million for the three and nine months ended June 30, 2002, respectively. Included in the nine month amount is an $84 million pretax charge taken in the second quarter of fiscal 2002, of which $78 million will result in the usage of cash, associated with our efforts to improve our business performance in response to the continued industry-wide economic slowdown. The components of this charge include $73 million of employee separation costs, $10 million of lease termination costs, and $1 million of other exit costs. The charge for employee separation costs is comprised of $67 million for severance and other 45 employee separation costs, and $6 million primarily related to the cost of curtailment in accordance with SFAS No. 88, "Employers' Accounting for Settlements and Curtailments of Defined Benefit Pension Plans and for Termination Benefits." The employee separation costs were incurred in connection with the elimination of approximately 2,000 employee positions. Lease termination costs are comprised primarily of information technology lease termination payments. We expect to fund the remaining obligations associated with the charges taken during the second quarter of fiscal 2002 with available cash or cash from operations. The September 30, 2001 business restructuring reserve reflects the remaining balance associated with our pretax business restructuring charges of $520 million in fiscal 2000 related to our separation from Lucent, $134 million in the second quarter of fiscal 2001 related to our outsourcing of certain manufacturing operations, and $540 million in the fourth quarter of fiscal 2001 for the acceleration of our restructuring plan. The following table summarizes the status of our business restructuring reserve and other related expenses as of and for the nine months ended June 30, 2002:
BUSINESS RESTRUCTURING RESERVE OTHER RELATED EXPENSES --------------------------------------------------- -------------------------- TOTAL TOTAL BUSINESS EMPLOYEE LEASE OTHER BUSINESS RESTRUCTURING SEPARATION TERMINATION EXIT RESTRUCTURING ASSET INCREMENTAL RESERVE AND COSTS OBLIGATIONS COSTS RESERVE IMPAIRMENTS PERIOD COSTS RELATED EXPENSES ---------- ----------- -------- ------------- ----------- ------------ ---------------- (DOLLARS IN MILLIONS) Balance as of September 30, 2001............. $ 96 $78 $5 $ 179 $ -- $ -- $ 179 Charges................ 73 10 1 84 3 16 103 Increase in benefit obligations.......... (6) -- -- (6) -- -- (6) Cash payments.......... (99) (46) (3) (148) -- (16) (164) Asset impairments...... -- -- -- -- (3) -- (3) ---- --- -- ----- --------- --------- ----- Balance as of June 30, 2002................. $ 64 $42 $3 $ 109 $ -- $ -- $ 109 ==== === == ===== ========= ========= =====
Employee separation costs included in the business restructuring reserve were made through lump sum payments, although certain union-represented employees elected to receive a series of payments extending over a period of up to two years from the date of departure. Payments to employees who elected to receive severance through a series of payments will extend through 2004. The workforce reductions related to our separation from Lucent, the outsourcing of certain manufacturing operations and the acceleration of our restructuring plan were substantially complete at the end of fiscal 2001. In connection with the workforce reduction charge taken in the second quarter of fiscal 2002, approximately 1,600 of the 2,000 employees had departed as of June 30, 2002. The charges for lease termination obligations, which consisted of real estate and equipment leases, included approximately 2.8 million square feet of excess space which has been entirely vacated as of June 30, 2002. Payments on lease termination obligations will be substantially completed by 2003 because, in certain circumstances, the remaining lease payments were less than the termination fees. For the three and nine months ended June 30, 2002, we recorded $9 million and $19 million, respectively, of other related expenses, including relocation and consolidation costs, computer transition expenditures, and an asset impairment, associated with our ongoing restructuring initiatives. For the three and nine months ended June 30, 2001, we recorded $46 million and $117 million, respectively, of other related expenses associated with our separation from Lucent related primarily to computer system transition costs such as data conversion activities, asset transfers, and training. In addition, 46 during the third quarter of fiscal 2001, we recorded a $20 million asset impairment charge related to the Shreveport, Louisiana manufacturing facility, which was closed in conjunction with our initiative to outsource certain manufacturing operations. We also recorded $42 million in selling, general and administrative expenses for additional start-up activities during the nine months ended June 30, 2001, largely resulting from marketing costs associated with continuing to establish the Avaya brand. During the fourth quarter of fiscal 2002, we expect to incur additional period costs of approximately $15 million related to our prior restructuring initiatives. We have been experiencing a decline in our revenue as a result of the continued deferment by customers of information technology investments, specifically for enterprise communications products and services. Despite the unpredictability of the current business environment, we remain focused on our strategy to return to profitability by focusing on sustainable cost and expense reduction, among other things. To achieve that goal, we announced in July 2002 that we have begun to implement a company-wide restructuring to enable us to reduce costs and expenses further in order to lower the amount of revenue needed to reach our profitability break-even point. In the fourth quarter of fiscal 2002, we expect to record a business restructuring charge and related expenses in connection with this plan of approximately $150 million. Based on our initial assessment, the components of this charge are estimated to include $70 million related to a reduction of about 2,500 employee positions, up to $65 million for real estate consolidations and lease terminations, and $15 million for certain asset impairments. Because we are currently finalizing our restructuring plan, the actual components of this charge may vary. OUTSOURCING OF CERTAIN MANUFACTURING OPERATIONS As a result of our contract manufacturing initiative, Celestica exclusively manufactures a significant portion of our Systems and Applications products at various facilities in the U.S. and Mexico. We believe that outsourcing our manufacturing operations will allow us to improve our cash flow over the next few years through a reduction of inventory and reduced capital expenditures. We are not obligated to purchase products from Celestica in any specific quantity, except as we outline in forecasts or orders for products required to be manufactured by Celestica. In addition, we may be obligated to purchase certain excess inventory levels from Celestica that could result from our actual sales of product varying from forecast. Our outsourcing agreement with Celestica results in a concentration that, if suddenly eliminated, could have an adverse effect on our operations. While we believe that alternative sources of supply would be available, disruption of our primary source of supply could create a temporary, adverse effect on product shipments. There is no other significant concentration of business transacted with a particular supplier that could, if suddenly eliminated, have a material adverse affect on our financial position, results of operations or cash flows. 47 RESULTS OF OPERATIONS The following table sets forth line items from our Consolidated Statements of Operations as a percentage of revenue for the periods indicated:
THREE MONTHS ENDED NINE MONTHS ENDED JUNE 30, JUNE 30, ---------------------- ---------------------- 2002 2001 2002 2001 -------- -------- -------- -------- Revenue......................... 100.0% 100.0% 100.0% 100.0% Costs........................... 60.5 57.4 60.5 56.9 ----- ----- ----- ----- Gross margin.................... 39.5 42.6 39.5 43.1 ----- ----- ----- ----- Operating expenses: Selling, general and administrative.............. 31.0 28.1 31.6 30.0 Business restructuring charges and related expenses........ 0.7 3.8 2.7 5.1 Research and development...... 9.4 7.9 9.3 8.0 Purchased in-process research and development............. -- 0.1 -- 0.6 ----- ----- ----- ----- Total operating expenses........ 41.1 39.9 43.6 43.7 ----- ----- ----- ----- Operating income (loss)......... (1.6) 2.7 (4.1) (0.6) Other income (expense), net..... (0.9) 0.2 0.3 0.6 Interest expense................ (1.3) (0.5) (0.9) (0.6) Provision (benefit) for income taxes......................... (0.6) 1.0 (1.5) (0.1) ----- ----- ----- ----- Net income (loss)............... (3.2)% 1.4% (3.2)% (0.5)% ===== ===== ===== =====
THREE MONTHS ENDED JUNE 30, 2002 COMPARED TO THREE MONTHS ENDED JUNE 30, 2001 The following table shows the change in revenue, both in dollars and in percentage terms:
THREE MONTHS ENDED JUNE 30, CHANGE ---------------------- ---------------------- 2002 2001 $ % -------- -------- -------- -------- (DOLLARS IN MILLIONS) Systems.............................. $ 384 $ 541 $(157) (29.0)% Applications......................... 160 217 (57) (26.3) Services............................. 511 584 (73) (12.5) Connectivity Solutions............... 164 372 (208) (55.9) ------ ------ ----- Total operating segments......... $1,219 $1,714 $(495) (28.9)% ====== ====== =====
REVENUE. Revenue decreased 28.9%, or $495 million, from $1,714 million for the third quarter of fiscal 2001, to $1,219 million for the same period in fiscal 2002 due to decreases across each of our operating segments. Revenues in our core business, which is made up of Systems, Applications and Services, were affected largely due to customers' continued deferment of investments in enterprise communications technology and partially due to customers' hesitation to commit to spending on IP telephony solutions in the near term in light of several recent product announcements. The continued economic and business uncertainty has led to reluctance by our customers to resume capital spending for telephony equipment and related products. Widespread layoffs, high vacancy rates in commercial real estate and minimal business start-ups have each had a detrimental impact on our revenues. Sales 48 through our indirect channel, which represent sales to distributors that are typically less profitable for us as compared with sales made in the direct channel to end-user customers, decreased to 42% of total revenue in the third quarter of fiscal 2002 from 45% in the prior year quarter. Systems revenue includes sales to small and midsized enterprises, which includes data switches and small to midsized telephony products, and sales to our large customers, referred to as Enterprise Systems, which include sales of all enterprise telephony products, virtual private networks, and data Local Area Network and Wide Area Network equipment. Systems revenue declined by $157 million due to a decline of $139 million attributed to Enterprise Systems customers and $18 million attributed to sales to small to midsized enterprises, with both declines experienced primarily within the U.S. Within Enterprise Systems, the decline was attributable mainly to sales of our traditional voice communications systems, which declined by $102 million, while declines in our data equipment sales accounted for the remainder of the revenue reduction in this customer group. Sales volumes continue to be adversely affected by the lack of information technology spending by our customers. Sales through our indirect channel increased to 58% of total Systems revenue in the third quarter of fiscal 2002 from 55% in the prior year quarter. Applications revenue, which closely follows the trend of our Systems revenue because it has the same economic drivers and serves many of the same customers, declined by $57 million due to a decrease in sales volumes. This decline was the result of reductions of $28 million in customer relationship management solutions, $18 million in professional services and $11 million in messaging revenues. Sales through our indirect channel increased to 47% of total Applications revenue in the third quarter of fiscal 2002 from 35% in the prior year quarter. Services revenue decreased by $73 million due to a decline of $55 million mainly as a result of the renegotiation of a maintenance contract in March of 2002 with a major distributor which extended the term of the agreement, but lowered the monthly revenues, a depressed demand for maintenance billed on a time and materials basis due to the economic constraint on discretionary spending, and the loss of a major services contract in our Europe/Middle East/Africa region. In addition, lower product sales resulted in less training and consulting services delivered to our customers. The remainder of the decline of $18 million was due to lower demand for equipment adds, moves and changes. Sales through our indirect channel decreased to 16% of total Services revenue in the third quarter of fiscal 2002 from 19% in the prior year quarter. Connectivity Solutions revenue decreased by $208 million driven mainly by a decline of $104 million in sales of SYSTIMAX(-Registered Trademark-) structured cabling systems for enterprises. In addition, revenues from our ExchangeMAX(-Registered Trademark-) cabling for service providers declined by $57 million and electronic cabinets revenues declined by $47 million. Sales of our SYSTIMAX structured cabling systems dropped significantly as our customers continue to delay planned capital projects. In response to excess manufacturing capacity particularly in the cable industry, we implemented price reductions in the first half of the current fiscal year that contributed to a decline in revenues. In addition, distributors have scaled back purchases in an effort to reduce their inventory levels by filling sales orders with inventory from their existing stock balances. ExchangeMAX sales dropped significantly due to a lack of sales volumes caused by reductions in capital spending by service providers combined with heavy discounting in the third quarter of fiscal 2002. In response to a decline in DSL (Digital Subscriber Line) and wireless site installations, which are the two main drivers behind sales of electronic cabinets, service providers have pulled back on spending related to electronic cabinets. Sales through our indirect channel increased to 82% of total Connectivity revenue in the third quarter of fiscal 2002 from 75% in the prior year quarter. Revenue within the U.S. decreased 29.1%, or $372 million, from $1,280 million for the third quarter of fiscal 2001 to $908 million for the same period in fiscal 2002. This decrease resulted from 49 declines of $165 million in Connectivity Solutions, $102 million in Systems, $62 million in Services and $43 million in Applications. Outside the U.S., revenue decreased 28.3%, or $123 million, from $434 million for the third quarter of fiscal 2001 to $311 million for the same period in fiscal 2002. This decrease is due to declines of $55 million in Systems, $43 million in Connectivity Solutions, $14 million in Applications and $11 million in Services. Revenue outside the U.S. in the third quarter of fiscal 2002 represented 25.5% of revenue compared with 25.3% in the same period of fiscal 2001. COSTS AND GROSS MARGIN. Total costs decreased 24.9%, or $245 million, from $983 million for the third quarter of fiscal 2001 to $738 million for the same period in fiscal 2002. Gross margin percentage decreased from 42.6% in the third quarter of fiscal 2001 as compared with 39.5% in the same period of fiscal 2002. The decrease in gross margin percentage was attributed mainly to the Connectivity Solutions segment, which experienced a sharp decline in sales volumes while factory costs remained relatively fixed with the exception of several cost cutting initiatives including headcount reductions. The decrease in gross margin percentage was also somewhat impacted by a decline in the Systems segment. These decreases were partially offset by increases in the Applications and Services segments due mostly to headcount reductions. The Services segment benefited from improved efficiencies gained from relying more heavily upon a variable workforce during periods of peak demand and reducing headcount to levels consistent with lower periods of demand. Gross margin was also negatively impacted due to a higher amount of sales generated from our indirect channel in the current period as compared with the prior year period. SELLING, GENERAL AND ADMINISTRATIVE. Selling, general and administrative ("SG&A") expenses decreased 21.8%, or $105 million, from $482 million for the third quarter of fiscal 2001 to $377 million for the same period of fiscal 2002. The decrease was primarily due to savings associated with our business restructuring initiatives, including lower staffing levels and terminated real estate lease obligations. In addition, we incurred lower marketing and promotional expenses in the current period. The decrease in SG&A is also attributable to our adoption of SFAS 142. Accordingly, we did not record any goodwill amortization in the third quarter of fiscal 2002 as compared with $11 million of goodwill amortization included in SG&A for the third quarter of fiscal 2001. Furthermore, the decline in SG&A is also due to the change in the estimated useful life of certain internal use software, which lowered depreciation expense by approximately $5 million in the third quarter of fiscal 2002. BUSINESS RESTRUCTURING CHARGES AND RELATED EXPENSES. Business restructuring expenses of $9 million in the third quarter of fiscal 2002 include $6 million of incremental period costs, such as relocation and consolidation costs, computer transition expenditures, and a $3 million asset impairment each associated with our prior restructuring initiatives. The $66 million of business restructuring charges and related expenses in the third quarter of fiscal 2001 included $46 million of incremental period costs associated with our separation from Lucent related primarily to computer system transition costs such as data conversion activities, asset transfers and training, and a $20 million asset impairment charge for the Shreveport facility in connection with our outsourcing of certain manufacturing operations to Celestica. RESEARCH AND DEVELOPMENT. Research and development ("R&D") expenses decreased 14.8%, or $20 million, from $135 million in the third quarter of fiscal 2001 to $115 million in the same quarter of fiscal 2002. Although R&D spending decreased, our investment in R&D as a percentage of revenue increased from 7.9% to 9.4% and represents our shift in spending on high growth areas of our business and reduced spending on more mature product lines. PURCHASED IN-PROCESS RESEARCH AND DEVELOPMENT. In the third quarter of fiscal 2001, we acquired substantially all of the assets of Quintus Corporation. The purchase price for this acquisition included certain technologies that had not reached technological feasibility and had no future alternative use 50 and, accordingly, were charged to expense immediately upon consummation of the acquisition. There was no charge in the three months ended June 30, 2002 for purchased in-process research and development. OTHER INCOME (EXPENSE), NET. Other income (expense), net decreased from $4 million of income in the third quarter of fiscal 2001 to $10 million of expense in the same period of fiscal 2002. The decrease of $14 million is primarily attributed to losses recognized on foreign currency transactions in the current period due to the decline in value of the U.S. dollar as compared with several foreign currencies, as well as higher interest income earned on cash balances in the prior year attributed to higher interest rates, and expense related to developments in legal proceedings. These decreases were offset by an increase in interest income earned on the Expanets line of credit during the entire current quarter while the prior period reflects interest income earned beginning in May 2001. INTEREST EXPENSE. Interest expense increased $6 million, from $10 million in the third quarter of fiscal 2001 to $16 million in the same quarter of fiscal 2002. The increase in interest expense is primarily due to a greater amount of debt outstanding at higher weighed average interest rates as compared with the third quarter of fiscal 2001. The increase in interest expense is also attributed to the amortization of discount and deferred financing costs related to the issuance of debt in fiscal 2002. This increase was partially offset by a $2 million reduction in interest expense resulting from a favorable impact from our interest rate swap agreements. PROVISION (BENEFIT) FOR INCOME TAXES. The effective tax benefit rate of 15.8% for the three months ended June 30, 2002 was lower than the U.S. statutory rate of 35% primarily due to changes in the geographical distribution of taxable income and losses. The effective tax provision rate of 42.2% for the three months ended June 30, 2001 was higher than the U.S. statutory rate of 35% primarily due to acquisition related costs. NINE MONTHS ENDED JUNE 30, 2002 COMPARED TO NINE MONTHS ENDED JUNE 30, 2001 The following table shows the change in revenue, both in dollars and in percentage terms:
NINE MONTHS ENDED JUNE 30, CHANGE ----------------------- ----------------------- 2002 2001 $ % -------- -------- -------- -------- (DOLLARS IN MILLIONS) Systems................................. $1,240 $1,799 $ (559) (31.1)% Applications............................ 521 702 (181) (25.8) Services................................ 1,600 1,733 (133) (7.7) Connectivity............................ 443 1,117 (674) (60.3) ------ ------ ------- Total operating segments............ $3,804 $5,351 $(1,547) (28.9)% ====== ====== =======
51 REVENUE. Revenue decreased 28.9%, or $1,547 million, from $5,351 million for the nine months ended June 30, 2001, to $3,804 million for the same period in fiscal 2002 due to sharp declines in revenue from our Connectivity Solutions and Systems segments, followed by lesser declines in our Applications and Services segments. Revenue declines in our core business, which is made up of Systems, Applications and Services, reflects a sharp decline in our customers' investments of capital in IT infrastructure, as well as a hesitation by our customers to commit to spending on IP telephony solutions in the near term in light of several recent product announcements. The protracted deterioration of the business and economic environments has been a major factor contributing to our customers' lack of spending on telephony equipment and related products. Widespread layoffs, high vacancy rates in commercial real estate and minimal business start-ups have each had a detrimental impact on our revenues. Sales through our indirect channel, which represent sales to distributors that are typically less profitable than sales made directly to our end-user customers through the direct channel, decreased to 40% of total revenue for the nine months ended June 30, 2002 from 43% in the prior year period. Systems revenue includes sales to small and midsized enterprises, which are made up of data switches and small to midsized telephony products, and sales to our large customers, referred to as Enterprise systems, which includes all enterprise telephony products, virtual private networks, and data LAN and WAN equipment. The Systems revenue decline of $559 million, which was experienced largely within the U.S., is composed of declines of $461 million in Enterprise Systems and $98 million in small to midsized enterprises. The decline in Enterprise Systems was due mainly to enterprise voice systems and, to a lesser extent, data equipment. Sales through our indirect channel, which represent sales to distributors that are typically less profitable for us as compared with sales made in the direct channel to end-use customers, increased to 56% of total Systems revenue for the nine months ended June 30, 2002 from 55% in the prior year period. Applications revenue declined by $181 million resulting from declines in sales volumes and is driven by the same economic factors and serves many of the same customers as the Systems segment. The uncertain economic climate has led our customers to defer their expansion and relocation plans. This reduction in revenue is attributed mainly to declines of $60 million in messaging revenues, $57 million in customer relationship management solutions, and $58 million in professional services. Sales through our indirect channel increased to 42% of total Applications revenue for the nine months ended June 30, 2002 from 36% in the prior year period. Services revenue decreased by $133 million resulting from the renegotiation of a maintenance contract in March 2002 with a major distributor which extended the term of the agreement, but lowered the monthly revenues. In addition, the economic constraint on discretionary spending resulted in a depressed demand for maintenance billed on a time and materials basis, and cuts in capital expenditures resulted in lower demand for equipment adds, moves and changes. Lower product sales resulted in fewer installations as well as less training and consulting services delivered to our customers. Sales through our indirect channel decreased to 17% of total Services revenue for the nine months ended June 30, 2002 from 21% in the prior year period. Connectivity Solutions revenue decreased by $674 million as a result of declines of $286 million in sales of ExchangeMAX-Registered Trademark- cabling for service providers, $251 million in sales of SYSTIMAX-Registered Trademark- structured cabling systems for enterprises, and $137 million related to electronic cabinets. ExchangeMAX sales dropped significantly due to a decline in sales volumes caused by a lack of capital spending by service providers combined with heavy discounting in the third quarter of fiscal 2002. The main contributors to the decline in SYSTIMAX revenues were a constraint on spending by our customers on large infrastructure projects, and the implementation, which began in the first half of fiscal 2002, of a strategic initiative to lower cable prices. Other contributing factors include pricing pressures resulting from excess cable manufacturing capacity and the concerted effort on the part of our distributors to reduce their inventory levels by filling sales orders with inventory from their existing 52 stock balances. In response to a decline in DSL (Digital Subscriber Line) and wireless site installations, which are the two main drivers behind sales of electronic cabinets, service providers have pulled back on spending related to electronic cabinets. Sales through our indirect channel increased to 77% of total Connectivity revenue for the nine months ended June 30, 2002 from 60% in the prior year period. Revenue within the U.S. decreased 30.9%, or $1,241 million, from $4,021 million for the nine months ended June 30, 2001 to $2,780 million for the same period in fiscal 2002. This decrease was primarily from declines of $575 million in Connectivity Solutions, $384 million in Systems, $151 million in Applications, and $131 million in Services. Outside the U.S., revenue decreased 23.0%, or $306 million, from $1,330 million for the nine months ended June 30, 2001 to $1,024 million for the same period in fiscal 2002. This decrease is primarily due to declines of $175 million in Systems, $99 million in Connectivity Solutions, $30 million in Applications and $2 million in Services. Revenue outside the U.S. for the nine months ended June 30, 2002 represented 26.9% of revenue compared with 24.9% in the same period of fiscal 2001. COSTS AND GROSS MARGIN. Total costs decreased 24.4%, or $744 million, from $3,044 million for the nine months ended June 30, 2001 to $2,300 million for the same period in fiscal 2002. Gross margin percentage decreased from 43.1% for the nine months ended June 30, 2001 as compared with 39.5% in the same period of fiscal 2002. The decrease in gross margin percentage was due almost entirely to the decline in Connectivity Solutions, which experienced a sharp decline in sales volumes while factory costs remained relatively fixed with the exception of several cost reduction initiatives including headcount reductions. The Systems segment also experienced a more moderate decline in gross margin percentage while Applications' gross margin percentage remained relatively flat. The decreases were partially offset by an increase in the Services segment gross margin percentage due to improved efficiencies gained from reducing headcount and employing a variable workforce approach to meet periods of high demand. In addition, a larger percentage of sales was generated through our indirect sales channel during the current year as compared with the prior year, which has negatively impacted gross margin. SELLING, GENERAL AND ADMINISTRATIVE. Selling, general and administrative ("SG&A") expenses decreased 25.2%, or $404 million, from $1,606 million for the nine months ended June 30, 2001 to $1,202 million for the same period of fiscal 2002. The decrease was primarily due to savings associated with our business restructuring initiatives, including lower staffing levels and terminated real estate lease obligations. In addition, during the nine months ended June 30, 2001, we incurred higher incentive compensation expense related to performance bonuses and higher marketing and promotional costs. Start-up expenses of $42 million were also incurred in the nine months ended June 30, 2001 related to establishing our brand in the marketplace. The decrease in SG&A is also attributable to our adoption of SFAS 142. Accordingly, we did not record any goodwill amortization in the nine months ended June 30, 2002 as compared with $29 million of goodwill amortization included in SG&A for the same period in fiscal 2001. The decline in SG&A is also due to the change in the estimated useful life of certain internal use software, which lowered depreciation expense by approximately $9 million in the nine months ended June 30, 2002. BUSINESS RESTRUCTURING CHARGES AND RELATED EXPENSES. Business restructuring charges and related expenses of $103 million for the nine months ended June 30, 2002 include a $84 million charge attributed to headcount reductions, $16 million for incremental period costs and $3 million for an asset impairment each associated with our prior restructuring initiatives. The $271 million of business restructuring charges and related expenses for the nine months ended June 30, 2001, included a $134 million business restructuring charge primarily for employee separation costs associated with the outsourcing of certain manufacturing operations to Celestica in the second quarter of fiscal 2001. In addition, we incurred $117 million of incremental period costs associated with our separation from Lucent related primarily to computer system transition costs such as data conversion activities, asset 53 transfers and training, and a $20 million asset impairment charge for the Shreveport facility in connection with our outsourcing to Celestica. RESEARCH AND DEVELOPMENT. Research and development ("R&D") expenses decreased 17.3%, or $74 million, from $428 million for the nine months ended June 30, 2001 to $354 million in the same period of fiscal 2002. Although R&D spending decreased, our investment in R&D as a percentage of revenue increased from 8.0% to 9.3% and represents our shift in spending on high growth areas of our business and reduced spending on more mature product lines. PURCHASED IN-PROCESS RESEARCH AND DEVELOPMENT. The $32 million expense reflects charges associated with our acquisitions of VPNet Technologies in February 2001, and substantially all of the assets of Quintus Corporation in April 2001. The purchase price for this acquisition included certain technologies that had not reached technological feasibility and had no future alternative use and, accordingly, were charged to expense immediately upon consummation of the acquisition. There was no charge in the nine months ended June 30, 2002 for purchased in-process research and development. OTHER INCOME (EXPENSE), NET. Other income, net decreased from $31 million of income for the nine months ended June 30, 2001 to $8 million of income in the same period of fiscal 2002. The decrease of $23 million is attributable to higher interest income earned on cash balances in the prior year attributed to higher interest rates as well as gains on assets sold in the first and second quarters of fiscal 2001, in addition to banking fees incurred in the current period. Higher losses recognized on foreign currency transactions in the current period due to the decline in value of the U.S. dollar as compared with several foreign currencies as well as expense related to developments in legal proceedings also contributed to the decrease in other income. These decreases were offset by an increase in interest income earned on the Expanets line of credit for the entire nine months ended June 30, 2002, while the prior year reflects interest income earned beginning in May 2001. INTEREST EXPENSE. Interest expense increased 10%, or $3 million, from $30 million for the nine months ended June 30, 2001 to $33 million for the same period in fiscal 2002. The increase in interest expense is largely attributed to a higher amount of weighted average debt outstanding as well as the amortization of discount and deferred financing costs related to the issuance of debt in the first and second quarters of fiscal 2002. This increase was partially offset by a lower weighted average interest rate during the nine months ended June 30, 2002 as compared with the same period last year and a $2 million favorable impact resulting from our interest rate swap agreements. PROVISION (BENEFIT) FOR INCOME TAXES. The effective tax benefit rate of 32.3% for the nine months ended June 30, 2002 was lower than the U.S. statutory rate of 35% primarily due to changes in the geographical distribution of taxable income and losses. The effective tax benefit rate of 16.3% for the nine months ended June 30, 2001 was lower than the U.S. statutory rate of 35% primarily due to acquisition related costs. LIQUIDITY AND CAPITAL RESOURCES STATEMENT OF CASH FLOWS DISCUSSION Avaya's cash and cash equivalents increased to $406 million at June 30, 2002 from $250 million at September 30, 2001. The increase resulted from $252 million of net cash provided by financing activities, partially offset by $96 million and $3 million of net cash used for investing and operating activities, respectively. Our net cash used for operating activities was $3 million for the nine months ended June 30, 2002 compared with $219 million for the same period in fiscal 2001. Net cash used for operating activities for the nine months ended June 30, 2002 was comprised of a net loss of $122 million adjusted for non-cash items of $354 million, and net cash used for changes in operating assets and liabilities of 54 $235 million. Net cash used for operating activities is mainly attributed to cash payments made on our accounts payable and other short term liabilities. In addition, usage of cash also resulted from payments made for our business restructuring related activities associated with employee separation costs, lease termination obligations and other exit costs. Furthermore, we reduced our payroll related liabilities. These changes were partially offset by receipts of cash on amounts due from our customers and a decrease in our inventory balance. Net cash used for operating activities for the nine months ended June 30, 2001 was comprised of a net loss of $24 million adjusted for non-cash items of $487 million, and net cash used for changes in operating assets and liabilities of $682 million. Net cash used for operating activities is primarily attributed to cash payments made on our accounts payable and for our business restructuring related activities. During the period, we also reduced our deferred revenue, and increased our inventory levels. The usage of cash was offset by cash receipts on our trade accounts receivable. Days sales outstanding in accounts receivable for the third quarter of fiscal 2002, excluding the effect of the securitization transaction discussed below, was 86 days versus 88 days for the second quarter of fiscal 2002. The improvement in the level of days sales outstanding is primarily attributable to the implementation of process improvements that resulted in increased collections on past due amounts and lower sales. Days sales of inventory on-hand for the third quarter of fiscal 2002 were 68 days versus 71 days for the second quarter of fiscal 2002. This decrease is primarily due to improved inventory management, decreased unit costs and adjustments to reflect inventory at market value. Our net cash used for investing activities was $96 million for the nine months ended June 30, 2002 compared with $292 million for the same period in fiscal 2001. The usage of cash in both periods resulted primarily from capital expenditures. Capital expenditures in fiscal 2002 included payments made for the renovation of our corporate headquarters facility, purchase of a corporate aircraft as a result of the termination of the aircraft sale-leaseback agreement as described below in "AIRCRAFT SALE-LEASEBACK", and upgrades of our information technology systems, including the purchase of internal use software. Capital expenditures in fiscal 2001 were due mainly to Avaya establishing itself as a stand-alone entity, including information technology upgrades and corporate infrastructure expenditures. In addition, in the current period, we used $6 million of cash for our acquisition of Conita Technologies, a leading supplier of voice-driven software applications for business, which occurred in the third quarter of fiscal 2002. In the prior period, we used $120 million of cash for our acquisitions of VPNet Technologies, Inc., a privately held developer of virtual private network solutions and devices, and substantially all of the assets of Quintus Corporation, a provider of comprehensive electronic customer relationship management solutions, which occurred in the second and third quarters of fiscal 2001, respectively. Net cash provided by financing activities was $252 million for the nine months ended June 30, 2002 compared with $487 million for the same period in fiscal 2001. Cash flows from financing activities in the current period were mainly due to $460 million and $435 million in gross proceeds from the issuance of the LYONs and the Senior Secured Notes, respectively. In addition, we received cash proceeds of $232 million from the issuance of our common stock, related to (i) the sale of 19.55 million shares of our common stock for $5.90 per share in a public offering, resulting in gross proceeds of approximately $115 million, (ii) the equity transactions entered into with the Warburg Entities described below, resulting in gross proceeds of $100 million, and (iii) purchases under our employee stock purchase plan. These receipts of cash were partially offset by $29 million of payments related to the issuance of these debt and equity offerings. In addition, we made net payments of $432 million for the retirement of commercial paper, $200 million towards the repayment of borrowings under our five-year credit facility, and $13 million for the repayment of other short-term borrowings. In connection with our election to terminate the accounts receivable securitization in March 2002, $200 million of collections of qualified trade accounts receivable were used to liquidate the financial institution's investment as described below in "Securitization of Accounts Receivable." Net cash 55 provided by financing activities for the nine months ended June 30, 2001 was mainly due to the receipt of $400 million in proceeds from the sale of our Series B convertible participating preferred stock and warrants to purchase our common stock, as well as $200 million of proceeds from the securitization of certain trade receivables and $36 million in proceeds resulting from the issuance of our common stock, primarily through our employee stock purchase plan. The receipt of proceeds in fiscal 2001 was partially offset by $140 million in net payments for the retirement of commercial paper and $9 million of debt assumed from our acquisition of VPNet. DEBT RATINGS Our ability to obtain external financing is affected by our debt ratings, which are periodically reviewed by the major credit rating agencies. During the second quarter of fiscal 2002, our commercial paper and long-term debt ratings were downgraded. Ratings as of June 30, 2002 are as follows (all ratings include a negative outlook):
Moody's: Commercial paper.......................................... No Rating Long-term senior unsecured debt........................... Ba3 Senior secured notes...................................... Ba2 Standard & Poor's: Commercial paper.......................................... No Rating Long-term senior unsecured debt........................... BB- Senior secured notes...................................... BB- Corporate credit.......................................... BB+
Any increase in our level of indebtedness or deterioration of our operating results may cause a further reduction in our current debt ratings. A further reduction in our current long-term debt rating by Moody's or Standard & Poor's could affect our ability to access the long-term debt markets, significantly increase our cost of external financing, and result in additional restrictions on the way we operate and finance our business. On July 31, 2002, Standard & Poor's placed our corporate credit rating on CreditWatch with negative implications. Standard & Poor's stated that their action is based on our continuing weak operating performance and concerns about our financial flexibility stemming from ongoing cash-based special charges and potential covenant amendments. Standard & Poor's noted that they intend to meet with us to discuss industry conditions as well as our operating cost structure, cash requirements and liquidity before reviewing the rating. There can be no assurance as to the outcome of this meeting. A security rating by the major credit rating agencies is not a recommendation to buy, sell or hold securities and may be subject to revision or withdrawal at any time by the rating agencies. Each rating should be evaluated independently of any other rating. COMMERCIAL PAPER PROGRAM During the second quarter of fiscal 2002, Standard & Poor's and Moody's downgraded our commercial paper rating several times and eventually withdrew their rating of our commercial paper at our request. This recent withdrawal of our commercial paper rating makes it impossible for us to access the commercial paper market, which until recently was our primary source of liquidity. As a result of the impact of the ratings downgrades on our ability to issue commercial paper, in February 2002, we borrowed $300 million under our five-year credit facility to repay commercial paper obligations. As of June 30, 2002, all remaining commercial paper obligations and the borrowing under the five-year credit facility had been repaid using proceeds from the offering of the Senior Secured Notes discussed below. 56 REVOLVING CREDIT FACILITIES We have two revolving credit facilities (the "Credit Facilities") with third party financial institutions. As of September 30, 2001, these Credit Facilities consisted of a $400 million 364-day Credit Facility that expires in August 2002 and an $850 million five-year Credit Facility that expires in September 2005. As required by the terms of the Credit Facilities, upon the closing of the offering of the Senior Secured Notes in March 2002, the Credit Facilities were reduced proportionately by an amount equal to the $425 million of proceeds, net of certain deferred financing costs, realized from the offering of the Senior Secured Notes. Accordingly, as of June 30, 2002, the Credit Facilities consist of a $561 million five-year Credit Facility and a $264 million 364-day Credit Facility. No amounts were outstanding under either Credit Facility as of June 30, 2002. Funds are available under our Credit Facilities for general corporate purposes and for acquisitions up to $150 million. Based on our current debt ratings, any borrowings under the Credit Facilities are secured, subject to certain exceptions, by security interests in our equipment, accounts receivable, inventory, and U.S. intellectual property rights and that of any of our subsidiaries guaranteeing our obligations under the Credit Facilities as described below. Borrowings are also secured by a pledge of the stock of most of our domestic subsidiaries and 65% of the stock of a foreign subsidiary that, together with its subsidiaries, holds the beneficial and economic right to utilize certain of our domestic intellectual property rights outside North America. The security interests would be suspended in the event our corporate credit rating was at least BBB by Standard & Poor's and our long-term senior unsecured debt rating was at least Baa2 by Moody's, in each case with a stable outlook. Our long-term senior unsecured debt is currently rated Ba3 by Moody's, and our corporate credit is currently on CreditWatch and rated BB+ by Standard & Poor's, each with a negative outlook. Any current or future domestic subsidiaries (other than certain excluded subsidiaries) whose revenues constitute 5% or greater of our consolidated revenues or whose assets constitute 5% or greater of our consolidated total assets will be required to guarantee our obligations under the Credit Facilities. We have no subsidiaries that currently meet these criteria. The Credit Facilities also include negative covenants, including limitations on affiliate transactions, restricted payments and investments and advances. The Credit Facilities also restrict our ability and that of our subsidiaries to incur debt, subject to certain exceptions. We are permitted to use the Credit Facilities to fund acquisitions in an aggregate amount not to exceed $150 million and can make larger acquisitions so long as the Credit Facilities are not used to fund the purchase price. In addition, the Credit Facilities require that in connection with any acquisition, no default under the Credit Facilities shall have occurred and be continuing or would result from such acquisition, and we shall be in compliance with the financial ratio test described below after giving pro forma effect to such acquisition. The Credit Facilities require us to maintain a ratio of consolidated Earnings Before Interest, Taxes, Depreciation and Amortization ("EBITDA") to interest expense consisting of the previous four consecutive fiscal quarters of not less than three to one for each quarter beginning with the period ending March 31, 2002 until September 30, 2002 and a ratio of not less than four to one at all times thereafter. We are also required to maintain consolidated EBITDA in the following amounts for each of the periods noted below: - $20 million for the quarter ended March 31, 2002; - $80 million for the two-quarter period ended June 30, 2002; - $180 million for the three-quarter period ended September 30, 2002; - $300 million for the four-quarter period ended December 31, 2002; and - $400 million for each four-quarter period thereafter. 57 For purposes of these calculations, we are permitted to exclude from the computation of consolidated EBITDA up to $163 million of restructuring charges, including asset impairment and other one time expenses to be taken no later than the fourth quarter of fiscal 2002 and any write down of intangibles associated with the adoption of SFAS 142. In addition, we may exclude certain business restructuring charges and related expenses taken in fiscal 2001. During the second and third quarters of fiscal 2002, we incurred $97 million of such business restructuring charges and related expenses. As of June 30, 2002, we were in compliance with all required covenants. Although we were in compliance with these covenants as of June 30, 2002, our continued revenue decline and the expected recording of the $150 million restructuring charge and related expenses described under "--Business Restructuring Charges and Related Expenses" would likely have prevented us from complying with these covenants as of September 30, 2002. Accordingly, we have recently received consents from the requisite lenders under the five-year credit facility to amend the terms of the facility. We do not intend to renew the 364-day credit facility expiring in August 2002. The amended five-year credit facility will require us to maintain a ratio of EBITDA to interest expense of: - 1.70 to 1 for each of the four quarter periods ending September 30, 2002, December 31, 2002 and March 31, 2003; - 2.25 to 1 for the four quarter period ending June 30, 2003; - 3.50 to 1 for the four quarter period ending September 30, 2003; and - 4.00 to 1 for the four quarter period ending December 31, 2003 and each four quarter period thereafter. In addition, the amended five-year credit facility will require us to maintain minimum EBITDA of: - $70 million for the three quarter period ending September 30, 2002; - $100 million for the four quarter period ending December 31, 2002; - $115 million for the four quarter period ending March 31, 2003; - $150 million for the four quarter period ending June 30, 2003; - $250 million for the four quarter period ending September 30, 2003; - $350 million for the four quarter period ending December 31, 2003; and - $400 million for each of the four quarter periods thereafter. The definition of EBITDA in the amended five-year credit facility will exclude an additional $100 million of business restructuring charges and related expenses to be taken no later than the third quarter of fiscal 2003. The total business restructuring related excludable amount of $166 million, which is made up of the additional $100 million under the amended credit facility plus $66 million remaining under the existing Credit Facilities, will enable us to exclude from the definition of EBITDA the $150 million business restructuring charge announced in July 2002 plus $15 million of period costs related to our prior restructuring initiatives. A substantial portion of these costs are expected to be incurred in the fourth quarter of fiscal 2002 and the first quarter of fiscal 2003. The initial aggregate commitments under the amended five-year credit facility will equal $561 million, but will be subject to mandatory reduction as follows: - reduced to $500 million on December 1, 2003; - reduced to $425 million on March 1, 2004; 58 - reduced to $350 million on June 1, 2004; and - reduced to $250 million on September 1, 2004. We will also be required to reduce the commitments by an amount equal to 100% of the net cash proceeds realized from the sale of any assets (other than the sale of our Connectivity Solutions business or the sale of our aircraft) and by an amount equal to 50% of the net cash proceeds realized from the issuance of debt, other than refinancing debt; provided, however, that in each case, we will not be required to reduce the commitments below an amount equal to $250 million less the amount of any cash used to redeem or repurchase the LYONs as described below. The amended five-year credit facility will provide that we may use up to $100 million of cash to redeem or repurchase the LYONs at any time as long as no default or event of default exists under the facility, no amounts are outstanding under the facility, the commitments are reduced in an amount equal to the cash amount used to redeem or repurchase the LYONs, and our cash balance is not less than $300 million after giving pro forma effect to the redemption or repurchase of the LYONs. The amendment will provide that the existing $150 million limitation on use of the facility for acquisitions or other investments will be reduced to $75 million. While we believe we will be able to meet these amended financial covenants, our revenue has been declining and any further decline in revenue may affect our ability to meet these financial covenants in the future. The terms of the amended five-year credit facility are subject to the execution of definitive amendments. We expect to complete the execution of the required amendments shortly. UNCOMMITTED CREDIT FACILITIES Through our foreign operations, we have entered into several uncommitted credit facilities totaling $82 million and $118 million, of which letters of credit of $27 million and $10 million were issued and outstanding as of June 30, 2002 and September 30, 2001, respectively. Letters of credit are purchased guarantees that ensure our performance or payment to third parties in accordance with specified terms and conditions. LYONS CONVERTIBLE DEBT In the first quarter of fiscal 2002, we sold through an underwritten public offering under a shelf registration statement an aggregate principal amount at maturity of approximately $944 million of LYONs due 2021. The proceeds of approximately $448 million, net of a $484 million discount and $12 million of underwriting fees, were used to refinance a portion of our outstanding commercial paper. The underwriting fees of $12 million were recorded as deferred financing costs and are being amortized to interest expense over a three-year period through October 31, 2004, which represents the first date holders may require us to purchase all or a portion of their LYONs. For the three and nine months ended June 30, 2002, $1 million and $3 million, respectively, of deferred financing costs were recorded as interest expense. The original issue discount of $484 million accretes daily at a rate of 3.625% per year calculated on a semiannual bond equivalent basis. We will not make periodic cash payments of interest on the LYONs. Instead, the amortization of the discount is recorded as interest expense and represents the accretion of the LYONs issue price to their maturity value. For the three and nine months ended June 30, 2002, $4 million and $11 million, respectively, of interest expense on the LYONs was recorded, resulting in an accreted value of $471 million as of June 30, 2002. The discount will cease to accrete on the LYONs upon maturity, conversion, purchase by us at the option of the holder, or redemption by 59 Avaya. The LYONs are unsecured obligations that rank equally in right of payment with all existing and future unsecured and unsubordinated indebtedness of Avaya. The LYONs are convertible into 35,333,073 shares of Avaya common stock at any time on or before the maturity date. The conversion rate may be adjusted for certain reasons, but will not be adjusted for accrued original issue discount. Upon conversion, the holder will not receive any cash payment representing accrued original issue discount. Accrued original issue discount will be considered paid by the shares of common stock received by the holder of the LYONs upon conversion. We may redeem all or a portion of the LYONs for cash at any time on or after October 31, 2004 at a price equal to the sum of the issue price and accrued original issue discount on the LYONs as of the applicable redemption date. Conversely, holders may require us to purchase all or a portion of their LYONs on October 31, 2004, 2006 and 2011 at a price equal to the sum of the issue price and accrued original issue discount on the LYONs as of the applicable purchase date. We may, at our option, elect to pay the purchase price in cash or shares of common stock, or any combination thereof. The fair value of the LYONs as of June 30, 2002 is estimated to be $350 million and is based on using quoted market prices and yields obtained through independent pricing sources for the same or similar types of borrowing arrangements taking into consideration the underlying terms of the debt. The indenture governing the LYONs includes certain covenants, including a limitation on our ability to grant liens on significant domestic real estate properties or the stock of our subsidiaries holding such properties. SENIOR SECURED NOTES In March 2002, we issued through an underwritten public offering under a shelf registration statement $440 million aggregate principal amount of 11 1/8% Senior Secured Notes due April 2009 (the "Senior Secured Notes") and received net proceeds of approximately $425 million, net of a $5 million discount and $10 million of issuance costs. Interest on the Senior Secured Notes is payable on April 1 and October 1 of each year beginning on October 1, 2002. We recorded interest expense related to the Senior Secured Notes of $12 million and $13 million for the three and nine months ended June 30, 2002, respectively. The $5 million discount is being amortized to interest expense over the seven-year term to maturity. The $10 million of issuance costs were recorded as deferred financing costs and are also being amortized to interest expense over the term of the Notes. The proceeds from the issuance were used to repay amounts outstanding under the five-year Credit Facility and for general corporate purposes. The Company may redeem the Senior Secured Notes, in whole or from time to time in part, at the redemption prices expressed as a percentage of principal amount noted below plus accrued and unpaid interest to the applicable redemption date, if redeemed during the twelve-month period beginning on April 1 of the following years:
YEARS PERCENTAGES - ----- ----------- 2006........................................................ 105.563% 2007........................................................ 102.781% 2008........................................................ 100.000%
The Senior Secured Notes are secured by a second priority security interest in the collateral securing our obligations under the Credit Facilities and our obligations under the interest rate swap agreements described below. In the event that (i) our corporate credit is rated at least BBB by Standard & Poor's and our long-term senior unsecured debt is rated at least Baa2 by Moody's, each without a negative outlook or its equivalent, or (ii) subject to certain conditions, at least $400 million of unsecured indebtedness is outstanding or available under the Credit Facilities or a bona fide successor credit facility, the security interest in the collateral securing the Senior Secured Notes will terminate. 60 The indenture governing the Senior Secured Notes includes negative covenants that limit our ability to incur secured debt and enter into sale/leaseback transactions. In addition, the indenture also includes conditional covenants that limit our ability to incur debt, enter into affiliate transactions, or make restricted payments or investments and advances. These conditional covenants will apply to us until such time that the Senior Secured Notes are rated at least BBB- by Standard & Poor's and Baa3 by Moody's, in each case without a negative outlook or its equivalent. The fair value of the Senior Secured Notes as of June 30, 2002 is estimated to be $407 million and is based on using quoted market prices and yields obtained through independent pricing sources for the same or similar types of borrowing arrangements taking into consideration the underlying terms of the debt. INTEREST RATE SWAP AGREEMENTS In April 2002, we entered into two interest rate swap agreements with a total notional amount of $200 million that qualify and are designated as fair value hedges in accordance with SFAS 133, "Accounting for Derivative Instruments and Hedging Activities." The swap agreements mature in April 2009 and were executed in order to: - convert a portion of the Senior Secured Notes fixed-rate debt into floating-rate debt; - maintain a capital structure containing appropriate amounts of fixed and floating-rate debt; and - reduce net interest payments and expense in the near-term. Under these agreements, we receive a fixed interest rate of 11.125% and pay a floating interest rate based on LIBOR plus an agreed-upon spread, which was equal to a weighed average interest rate of 7.25% as of June 30, 2002. The amount paid and the amount received is calculated based on the total notional amount of $200 million. Since the relevant terms of the swap agreements match the corresponding terms of the Senior Secured Notes, there is no hedge ineffectiveness. Accordingly, gains and losses on the swap agreements will fully offset the losses and gains on the hedged portion of the Senior Secured Notes, which are marked to market at each reporting date. As of June 30, 2002, we recorded the fair market value of the swaps of $8 million as other assets along with a corresponding increase to the hedged debt, both of which were recorded through other income (expense), net. Interest payments are recognized through interest expense and are made and received on the first day of each April and October, commencing on October 1, 2002 and ending on the maturity date. On the last day of each semi-annual interest payment period, the interest rate payment for the previous six months will be made based upon the six month LIBOR rate (in arrears) on that day, plus the applicable margin, as shown in the table below. Since the interest rate is not known until the end of each semi-annual interest period, estimates are used during such period based upon published forward-looking LIBOR rates. Any differences between the estimated interest expense and the actual interest payment are recorded to interest expense at the end of each semi-annual interest period. These interest rate swaps resulted in actual interest expense for the three and nine months ended June 30, 2002 of $4 million as compared with interest expense of $6 million had we not entered into the agreements. The following table outlines the terms of the swap agreements:
RECEIVE FIXED MATURITY DATE NOTIONAL AMOUNT INTEREST RATE PAY VARIABLE INTEREST RATE - ------------- --------------------- ------------- ----------------------------------- (DOLLARS IN MILLIONS) Six month LIBOR (in arrears) plus April 2009 $150 11.125% 5.055% spread Six month LIBOR (in arrears) plus April 2009 50 11.125% 5.098% spread ---- Total $200 ====
61 Each counterparty to the swap agreements is a lender under the Credit Facilities. Our obligations under these swap agreements are secured on the same basis as our obligations under the Credit Facilities. WARBURG TRANSACTIONS In October 2000, we sold to Warburg Pincus Equity Partners, L.P. and certain of its investment funds (the "Warburg Entities") four million shares of our Series B convertible participating preferred stock and warrants to purchase our common stock for an aggregate purchase price of $400 million. On March 21, 2002, we completed a series of transactions pursuant to which the Warburg Entities (i) converted all four million shares of the Series B preferred stock into 38,329,365 shares of our common stock based on a conversion price of $11.31 per share, which was reduced from the original conversion price of $26.71 per share, (ii) purchased an additional 286,682 shares of common stock by exercising a portion of the warrants at an exercise price of $34.73 per share resulting in gross proceeds of approximately $10 million, and (iii) purchased 14,383,953 shares of our common stock for $6.26 per share (the reported closing price of our common stock on the New York Stock Exchange on March 8, 2002), resulting in gross proceeds of approximately $90 million. In connection with these transactions, we incurred approximately $4 million of financing costs which were recorded as a reduction to additional paid-in capital. As of June 30, 2002, there were no shares of Series B preferred stock outstanding and, accordingly, the Series B preferred stock has ceased accruing dividends. As a result of these transactions, the Warburg entities hold approximately 53 million shares of our common stock, which represents approximately 15% of our outstanding common stock, and warrants to purchase approximately 12 million additional shares of common stock. These warrants have an exercise price of $34.73 of which warrants exercisable for 6,724,665 shares of common stock expire on October 2, 2004, and warrants exercisable for 5,379,732 shares of common stock expire on October 2, 2005. The conversion of the Series B preferred stock and the exercise of the warrants resulted in a charge to accumulated deficit of approximately $125 million, in addition to the $5 million accretion of the Series B preferred stock from January 1, 2002 through the date of conversion. This charge primarily represents the impact of reducing the preferred stock conversion price from $26.71 per share as originally calculated under the certificate of designations for the Series B preferred stock to $11.31 per share, as permitted under the certificate of designations. We recorded a total of $12 million of accretion for the period from October 1, 2001 through the date of conversion. PUBLIC OFFERING OF COMMON STOCK On March 15, 2002, we sold 19.55 million shares of common stock for $5.90 per share in a public offering. We received proceeds of approximately $112 million, which is net of approximately $3 million of underwriting fees reflected as a reduction to additional paid-in capital. SHELF REGISTRATION STATEMENT In May 2001, the Securities and Exchange Commission ("SEC") declared effective our shelf registration statement on Form S-3 registering $1.44 billion of common stock, preferred stock, debt securities or warrants to purchase debt securities, or any combination of these securities, in one or more offerings through May 2003. We have $430 million remaining as of June 30, 2002 under this registration statement for additional offerings and intend to use the proceeds from any sale of such securities for general corporate purposes, debt repayment and refinancing, capital expenditures and acquisitions. Our ability to issue debt securities may be constrained by the terms of our existing and future financing agreements, including the Credit Facilities and the indentures governing the LYONs and the Senior Secured Notes. In addition, our ability to issue debt or equity securities is dependent upon market conditions. 62 DEALER LINE OF CREDIT As discussed in "--Risks and Uncertainties," we have provided a short-term line of credit to our largest dealer, Expanets. The following table summarizes the amounts receivable from Expanets, including amounts outstanding under the line of credit, as of June 30, 2002 and September 30, 2001:
AS OF AS OF JUNE 30, 2002 SEPTEMBER 30, 2001 ------------- ------------------ (DOLLARS IN MILLIONS) Receivables................................................ $ 50 $117 Other current assets....................................... 47 81 ---- ---- Total amounts receivable from Expanets..................... $ 97 $198 ==== ==== Secured and unsecured components of the amounts receivable are as follows: Secured line of credit (included in receivables)........... $ 47 $ 71 Secured line of credit (included in other current assets).................................................. 22 50 ---- ---- Total secured line of credit............................. 69 121 Unsecured (included in receivables)...................... 28 77 ---- ---- Total amounts receivable from Expanets................... $ 97 $198 ==== ====
Amounts recorded in receivables represent trade receivables due from Expanets on sales of products and maintenance services. Amounts recorded in other current assets represent receivables due from Expanets for transitional services provided under a transitional services agreement. SECURITIZATION OF ACCOUNTS RECEIVABLE In June 2001, we entered into a receivables purchase agreement and transferred a designated pool of qualified trade accounts receivable to a special purpose entity ("SPE"), which in turn sold an undivided ownership interest in the pool of receivables to an unaffiliated financial institution for cash proceeds of $200 million. The receivables purchase agreement was terminated in March 2002 as described below. The financial institution is an affiliate of Citibank, N.A., a lender and the agent for the other lenders under the Credit Facilities and the counterparty to the $150 million interest rate swap. The designated pool of qualified receivables held by the SPE was pledged as collateral to secure the obligations to the financial institution. During the term of the receivables purchase agreement, we had a retained interest in the designated pool of receivables to the extent the value of the receivables exceeded the outstanding amount of the financial institution's investment. The carrying amount of our retained interest, which approximates fair value because of the short-term nature of the receivables, was recorded in other current assets. Collections of receivables were used by the SPE to repay the financial institution's investment in accordance with the receivables purchase agreement, and the financial institution in turn purchased, from time to time, new interests in receivables up to an aggregate investment at any time of $200 million. Effective March 15, 2002, we elected to terminate the receivables purchase agreement, which was scheduled to expire in June 2002. As a result of the early termination, purchases of interests in receivables by the financial institution ceased, and collections on receivables that constituted the designated pool of trade accounts receivable were used to liquidate the financial institution's $200 million investment under the agreement. As of June 30, 2002, the entire $200 million investment had been liquidated using collections of such receivables. No portion of the retained interest was utilized to liquidate the financial institution's remaining $126 million investment that had been outstanding at the beginning of the third quarter of fiscal 2002. Upon liquidation in full of the financial institution's investment on April 5, 2002, the remaining $109 million in retained interest was reclassified to receivables. As of September 30, 2001, we had a retained interest of $153 million in the SPE's designated pool of qualified accounts receivable. 63 AIRCRAFT SALE-LEASEBACK In March 2002, we elected to early terminate an aircraft sale-leaseback agreement and, pursuant to the terms of the agreement, we agreed to purchase the aircraft from the lessor for a purchase price equal to the unamortized lease balance of approximately $33 million. The closing of the purchase was completed in April 2002. CROSS ACCELERATION/CROSS DEFAULT PROVISIONS The agreement governing our $50 million interest rate swap and the indentures governing the LYONs and the Senior Secured Notes provide generally that an event of default under such agreements would result (i) if we fail to pay any obligation in respect of debt in excess of $100 million in the aggregate when such obligation becomes due and payable or (ii) if any such debt is declared to be due and payable prior to its stated maturity. The Credit Facilities provide generally that an event of default under such agreements would result (i) if we fail to pay any obligation in respect of any debt in excess of $100 million in the aggregate when such obligation becomes due and payable or (ii) if any event occurs or condition exists that would result in the acceleration, or permit the acceleration, of the maturity of such debt prior to the stated term. CONDITIONAL REPURCHASE OBLIGATIONS We sell products to various distributors that may obtain financing from unaffiliated third party lending institutions. In the event the lending institution repossesses the distributor's inventory of our products, we are obligated under certain circumstances to repurchase such inventory from the lending institution. Our obligation to repurchase inventory from the lending institution terminates 180 days from our date of invoicing to the distributor. The repurchase amount is equal to the price originally paid to us by the lending institution for the inventory. The amount reported to us from the two distributors who participate in these arrangements as their inventory on-hand was approximately $74 million as of June 30, 2002. We are unable to determine how much of this inventory was financed and, if so, whether any amounts have been paid to the lending institutions. Therefore, our repurchase obligation could be less than the amount of inventory on-hand. While there have not been any repurchases made by us under such agreements, we cannot assure you that we will not be obligated to repurchase inventory under these arrangements in the future. 64 FUTURE CASH NEEDS Our primary future cash needs will be to fund working capital, capital expenditures, debt service, pension obligations and our business restructuring charges and related expenses. We believe that our existing cash and cash flows from operations will be sufficient to meet these needs. If we do not generate sufficient cash from operations, we may need to incur additional debt. We currently anticipate making additional cash payments of approximately $78 million during the remainder of fiscal 2002 and $49 million in fiscal 2003 related to our past business restructuring initiatives. These total cash payments of $127 million are expected to be comprised of $71 million for employee separation costs, $42 million for lease obligations, $3 million for other exit costs and $11 million for incremental period costs, including computer transition expenditures, relocation and consolidation costs. In addition, the business restructuring charge we plan to record in the fourth quarter of fiscal 2002 is expected to result in the usage of cash of approximately $135 million which will be paid in the amounts of $34 million in the fourth quarter of fiscal 2002, $54 million in the first quarter of fiscal 2003, and the remaining $47 million largely by the end of fiscal 2003. The actual components of the fourth quarter fiscal 2002 charge, however, may vary because we are currently finalizing our restructuring plan. In order to meet our cash needs, we may from time to time, borrow under our credit facilities or issue other long or short-term debt, if the market permits such borrowings. We cannot assure you that any such financings will be available to us on acceptable terms or at all. Our ability to make payments on and to refinance our indebtedness, and to fund working capital, capital expenditures, strategic acquisitions, and our business restructuring will depend on our ability to generate cash in the future, which is subject to general economic, financial, competitive, legislative, regulatory and other factors that are beyond our control. Our credit facilities and the indentures governing the LYONs and the Senior Secured Notes impose and any future indebtedness may impose, various restrictions and covenants which could limit our ability to respond to market conditions, to provide for unanticipated capital investments or to take advantage of business opportunities. See also "--Risks and Uncertainties-- We may not have adequate or cost-effective liquidity or capital resources." We may from time to time seek to retire our outstanding debt through cash purchases and/or exchanges for equity securities, in open market purchases, privately negotiated transactions or otherwise. Such repurchases or exchanges, if any, will depend on the prevailing market conditions, our liquidity requirements, contractual restrictions and other factors. The amounts involved may be material. ENVIRONMENTAL, HEALTH AND SAFETY MATTERS We are subject to a wide range of governmental requirements relating to employee safety and health and to the handling and emission into the environment of various substances used in our operations. We are subject to certain provisions of environmental laws, particularly in the U.S., governing the cleanup of soil and groundwater contamination. Such provisions impose liability for the costs of investigating and remediating releases of hazardous materials at currently or formerly owned or operated sites. In certain circumstances, this liability may also include the cost of cleaning up historical contamination, whether or not caused by us. We are currently conducting investigation and/or cleanup of known contamination at seven of our facilities either voluntarily or pursuant to government directives. It is often difficult to estimate the future impact of environmental matters, including potential liabilities. We have established financial reserves to cover environmental liabilities where they are probable and reasonably estimable. Reserves for estimated losses from environmental matters are, depending on the site, based primarily upon internal or third party environmental studies and the extent of contamination and the type of required cleanup. Although we believe that our reserves are adequate to cover known environmental liabilities, there can be no assurance that the actual amount of 65 environmental liabilities will not exceed the amount of reserves for such matters or will not have a material adverse effect on our financial position, results of operations or cash flows. LEGAL PROCEEDINGS From time to time we are involved in legal proceedings arising in the ordinary course of business. Other than as described below, we believe there is no litigation pending against us that could have, individually or in the aggregate, a material adverse effect on our financial position, results of operations or cash flows. YEAR 2000 ACTIONS Three separate purported class action lawsuits are pending against Lucent, one in state court in West Virginia, one in federal court in the Southern District of New York and another in federal court in the Southern District of California. The case in New York was filed in January 1999 and, after being dismissed, was refiled in September 2000. The case in West Virginia was filed in April 1999 and the case in California was filed in June 1999, and amended in 2000 to include Avaya as a defendant. We may also be named a party to the other actions and, in any event, have assumed the obligations of Lucent for all of these cases under the Contribution and Distribution Agreement. All three actions are based upon claims that Lucent sold products that were not Year 2000 compliant, meaning that the products were designed and developed without considering the possible impact of the change in the calendar from December 31, 1999 to January 1, 2000. The complaints allege that the sale of these products violated statutory consumer protection laws and constituted breaches of implied warranties. A class has recently been certified in the West Virginia state court matter, but the other matters have not been so certified. The certified class includes those persons or entities that purchased, leased or financed the products in question. In addition, the court also certified as a subclass all class members who had service protection plans or other service or extended warranty contracts with Lucent in effect as of April 1, 1998, as to which Lucent failed to offer a Year 2000-compliant solution. The complaints seek, among other remedies, compensatory damages, punitive damages and counsel fees in amounts that have not yet been specified. At this time, we cannot determine whether that the outcome of these actions will have a material adverse effect on our financial position, results of operations or cash flows. In addition, if these cases are not resolved in a timely manner, they will require expenditure of significant legal costs related to their defense. COUPON PROGRAM CLASS ACTION In April 1998, a class action was filed against Lucent in state court in New Jersey, alleging that Lucent improperly administered a coupon program resulting from the settlement of a prior class action. The plaintiffs allege that Lucent improperly limited the redemption of the coupons from dealers by not allowing them to be combined with other volume discount offers, thus limiting the market for the coupons. We have assumed the obligations of Lucent for these cases under the Contribution and Distribution Agreement. The complaint alleges breach of contract, fraud and other claims and the plaintiffs seek compensatory and consequential damages, interest and attorneys' fees. The parties have entered into a settlement agreement that has been approved by the court pursuant to a written order. The period for submitting a claim notification expired July 15, 2002. We are in the process of winding up the administration of the resolution of this matter. See "Developments in Legal Proceedings" below for related disclosure. LUCENT SECURITIES LITIGATION In November 2000, three purported class actions were filed against Lucent in the Federal District Court for the District of New Jersey alleging violations of the federal securities laws as a result of the 66 facts disclosed in Lucent's announcement on November 21, 2000 that it had identified a revenue recognition issue affecting its financial results for the fourth quarter of fiscal 2000. The actions purport to be filed on behalf of purchasers of Lucent common stock during the period from October 10, 2000 (the date Lucent originally reported these financial results) through November 21, 2000. The above actions have been consolidated with other purported class actions filed against Lucent on behalf of its stockholders in January 2000 and are pending in the Federal District Court for the District of New Jersey. We understand that Lucent's motion to dismiss the Fifth Consolidated Amended and Supplemental Class Action Complaint in the consolidated action was denied by the court in June 2002. As a result of the denial of its motion to dismiss, we understand that Lucent has filed a motion for partial summary judgment, seeking a dismissal of a portion of the Fifth Consolidated Amended and Supplemental Class Action Complaint. The plaintiffs allege that they were injured by reason of certain alleged false and misleading statements made by Lucent in violation of the federal securities laws. The consolidated cases were initially filed on behalf of stockholders of Lucent who bought Lucent common stock between October 26, 1999 and January 6, 2000, but the consolidated complaint was amended to include purported class members who purchased Lucent common stock up to November 21, 2000. A class has not yet been certified in the consolidated actions. The plaintiffs in all these stockholder class actions seek compensatory damages plus interest and attorneys' fees. Any liability incurred by Lucent in connection with these stockholder class action lawsuits may be deemed a shared contingent liability under the Contribution and Distribution Agreement and, as a result, we would be responsible for 10% of any such liability. All of these actions are in the early stages of litigation and an outcome cannot be predicted and, as a result, we cannot assure you that these cases will not have a material adverse effect on our financial position, results of operations or cash flows. LICENSING ARBITRATION In March 2001, a third party licensor made formal demand for alleged royalty payments which it claims we owe as a result of a contract between the licensor and our predecessors, initially entered into in 1995, and renewed in 1997. The contract provides for mediation of disputes followed by binding arbitration if the mediation does not resolve the dispute. The licensor claims that we owe royalty payments for software integrated into certain of our products. The licensor also alleges that we have breached the governing contract by not honoring a right of first refusal related to development of fax software for next generation products. This matter is currently in arbitration. At this point, an outcome in the arbitration proceeding cannot be predicted and, as a result, there can be no assurance that this case will not have a material adverse effect on our financial position, results of operations or cash flows. REVERSE/FORWARD STOCK SPLIT COMPLAINTS In January 2002, a complaint was filed in the Court of Chancery of the State of Delaware against us seeking to enjoin us from effectuating a reverse stock split followed by a forward stock split described in our proxy statement for our 2002 Annual Meeting of Shareholders held on February 26, 2002. At the annual meeting, we obtained the approval of our shareholders of each of three alternative transactions: - a reverse 1-for-30 stock split followed immediately by a forward 30-for-1 stock split of our common stock; - a reverse 1-for-40 stock split followed immediately by a forward 40-for-1 stock split of our common stock; - a reverse 1-for-50 stock split followed immediately by a forward 50-for-1 stock split of our common stock. 67 The complaint alleges, among other things, that the manner in which we plan to implement the transactions, as described in our proxy statement, violates certain aspects of Delaware law with regard to the treatment of fractional shares and that the description of the proposed transactions in the proxy statement is misleading to the extent it reflects such violations. The action purports to be a class action on behalf of all holders of less than 50 shares of our common stock. The plaintiff is seeking, among other things, damages as well as injunctive relief enjoining us from effecting the transactions and requiring us to make corrective, supplemental disclosure. In June 2002, the court denied the plaintiff's motion for summary judgment and granted our cross-motion for summary judgment. The plaintiff has since appealed the court's decision to the Delaware Supreme Court. Briefs are expected to be filed with the Delaware Supreme Court by the end of September 2002. We cannot provide assurance that this lawsuit will not impair our ability to implement any of the transactions. In April 2002, a complaint was filed against us in the Superior Court of New Jersey, Somerset County, in connection with the reverse/forward stock splits described above. The action purports to be a class action on behalf of all holders of less than 50 shares of our common stock. The plaintiff is seeking, among other things, injunctive relief enjoining us from effecting the transactions. In recognition of the then pending action in the Delaware Court of Chancery, the plaintiff voluntarily dismissed his complaint without prejudice. COMMISSION ARBITRATION DEMAND In July 2002, a third party representative made formal demand for arbitration for alleged unpaid commissions in an amount in excess of $10 million, stemming from the sale of products from our businesses that were formerly owned by Lucent involving the Ministry of Russian Railways. As the sales of products continue, the third party representative may likely increase its commission demand. The viability of this asserted claim is based on the applicability and interpretation of a representation agreement and an amendment thereto, which provides for binding arbitration. This matter is currently proceeding to arbitration. The matter is in the early stages and an outcome in the arbitration proceeding cannot be predicted. As a result, there can be no assurance that this case will not have a material adverse effect on our financial position, results of operations or cash flows. LUCENT CONSUMER PRODUCTS CLASS ACTIONS In several class action cases (the first of which was filed on June 24, 1996), plaintiffs claim that AT&T and Lucent engaged in fraud and deceit in continuing to lease residential telephones to consumers without adequate notice that the consumers would pay well in excess of the purchase price of a telephone by continuing to lease. The cases were removed and consolidated in federal court in Alabama, and were subsequently remanded to their respective state courts (Illinois, Alabama, New Jersey, New York and California). In July 2001, the Illinois state court certified a nationwide class of plaintiffs. The case in Illinois was scheduled for trial on August 5, 2002. Prior to commencement of trial, however, we had been advised that the parties agreed to a settlement of the claims on a class-wide basis. The proposed settlement has been preliminarily approved by the court. A notice and hearing will occur (within two to three months) to obtain a final approval of the settlement. Any liability incurred by Lucent in connection with these class action cases will be considered an exclusive Lucent liability under the Contribution and Distribution Agreement between Lucent and us and, as a result, we are responsible for 10% of any such liability in excess of $50 million. The amount for which we may be responsible will not be finally determined until the class claims period expires. See "Developments in Legal Proceedings" below for related disclosure. 68 PATENT INFRINGEMENT INDEMNIFICATION CLAIMS A patent owner has sued three customers of our managed services business for alleged infringement of a single patent based on the customers' voicemail service. These customers' voicemail service offerings are partially or wholly provided by our managed services business. As a consequence, these customers are requesting defense and indemnification from us in the lawsuits under their managed services contracts. This matter is in the early stages and we cannot yet determine whether the outcome of this matter will have a material adverse effect on its financial position, results of operations or cash flows. DEVELOPMENTS IN LEGAL PROCEEDINGS Subsequent to the issuance of our earnings press release for the third quarter of fiscal 2002 on July 22, 2002, we recorded adjustments to our financial statements as of and for the three and nine months ended June 30, 2002 in connection with certain developments in two litigation matters that occurred after the issuance of our earnings press release. In connection with the matter described under the caption "Coupon Program Class Action" above, the period for submitting a claim in that action expired on July 15, 2002. In late July, we made a final determination of our obligations in this matter by aggregating all claim notifications received with a postmark dated on or before the July 15, 2002 deadline. Based on this review, we determined that the estimated reserve for this matter recorded in the other liabilities section of our Balance Sheet as of June 30, 2002 exceeded the amount of actual aggregate claims received by approximately $4 million and, accordingly, we reversed this amount to other income (expense), net in our Statement of Operations for the three and nine months ended June 30, 2002. In addition, in August 2002, we were advised that a settlement had been reached in the matters involving Lucent and AT&T described under the caption "Lucent Consumer Products Class Actions" above. The proposed settlement has been preliminarily approved by the Illinois state court. Any liability borne by Lucent in connection with these class action cases will be considered an exclusive Lucent liability under the Contribution and Distribution Agreement between Lucent and us and, as a result, we are responsible for 10% of any such liability in excess of $50 million. We recorded an estimated liability in the other liabilities section of our Balance Sheet as of June 30, 2002 of approximately $6 million in connection with this settlement. The expense for such liability was recorded to other income (expense), net in our Statement of Operations for the three and nine months ended June 30, 2002. The $6 million represents our current estimate of our liability in this matter, although the amount for which we may ultimately be responsible will not be finally determined until the claims period expires. EUROPEAN MONETARY UNIT ("EURO") In 1999, most member countries of the European Union established fixed conversion rates between their existing sovereign currencies and the European Union's new currency, the euro. This conversion permitted transactions to be conducted in either the euro or the participating countries' national currencies through December 31, 2001. In January 2002, the new currency was issued, and legacy currencies are currently being withdrawn from circulation. By February 28, 2002, all member countries were expected to have permanently withdrawn their national currencies as legal tender and replaced their currencies with euro notes and coins. As of December 31, 2001, all of the member countries of the European Union in which we conduct business had converted to the euro. The conversion has not had, and we do not expect it to have, a material adverse effect on our consolidated financial position, results of operations or cash flows. 69 THE APPLICATION OF CRITICAL ACCOUNTING POLICIES Our consolidated financial statements are based on the selection and application of accounting principles generally accepted in the United States of America, which require us to make estimates and assumptions about future events that affect the amounts reported in our financial statements and the accompanying notes. Future events and their effects cannot be determined with absolute certainty. Therefore, the determination of estimates requires the exercise of judgment. Actual results could differ from those estimates, and any such differences may be material to the financial statements. A description of all of our significant accounting policies used are described in Note 2 of the Notes to Consolidated Financial Statements included in our Annual Report on Form 10-K for the fiscal year ended September 30, 2001 filed with the SEC. We believe that the following policies may involve a higher degree of judgment and complexity in their application and represent the critical accounting policies used in the preparation of our financial statements. If different assumptions or conditions were to prevail, the results could be materially different from our reported results. REVENUE RECOGNITION--Most of our sales require judgments principally in the areas of customer acceptance, returns assessments and collectibility. The assessment of collectibility is particularly critical in determining whether or not revenue should be recognized in the current market environment. In addition, a significant amount of our revenue is generated from sales of product to distributors. As such, our provision for estimated sales returns and other allowances and deferrals requires significant judgment. COLLECTIBILITY OF ACCOUNTS RECEIVABLE--In order to record our accounts receivable at their net realizable value, we must assess their collectibility. A considerable amount of judgment is required in order to make this assessment including an analysis of historical bad debts and other adjustments, a review of the aging of our receivables and the current creditworthiness of our customers. We have recorded allowances for receivables which we feel are uncollectible, including amounts for the resolution of potential issues such as disputed invoices, customer satisfaction claims and pricing discrepancies. However, depending on how such potential issues are resolved, or if the financial condition of our customers were to deteriorate and their ability to make required payments became impaired, increases in these allowances may be required. INVENTORIES--In order to record our inventory at its lower of cost or market, we assess the ultimate realizability of our inventory which requires us to make judgments as to future demand and compare that with the current or committed inventory levels. Where we have determined that the future demand is lower than our current inventory levels, we have adjusted our inventory forecasts to reflect that demand. Additionally, we review our usage and inventory levels and record a provision to adjust our inventory balance based on our historical usage and inventory turnover. It is possible that we may need to adjust our inventory balance in the future based on the dynamic nature of this relationship. In addition, we have outsourced the manufacturing of substantially all of our Systems and Applications products. We are not obligated to purchase products from our outsourced manufacturer in any specific quantity, except as we outline in forecasts or orders for products required to be manufactured by the outsourced manufacturer. We may be obligated to purchase certain excess inventory levels from our outsourced manufacturer that could result from our actual sales of product varying from forecast. LONG-LIVED ASSETS--We have recorded property, plant and equipment, intangible assets, and capitalized software costs at cost less accumulated depreciation or amortization. The determination of useful lives and whether or not these assets are impaired involves significant judgment. Effective October 1, 2001, we adopted Statement of Financial Accounting Standards No. 142, "Goodwill and Other Intangible Assets" ("SFAS 142") which requires that goodwill and certain other intangible assets having indefinite lives no longer be amortized to earnings, but instead be subject to periodic testing for impairment. We have reviewed the classification of our existing goodwill and other intangible assets, reassessed the useful lives previously assigned to other intangible assets, and 70 discontinued amortization of goodwill. We also tested goodwill for impairment by comparing the fair value of our reporting units to their carrying value. Under these transition provisions, there was no goodwill impairment as of October 1, 2001. The provisions of SFAS 142 require that goodwill of a reporting unit be tested for impairment on an annual basis or between annual tests if an event occurs or circumstances change that would more likely than not reduce the fair value of a reporting unit below its carrying amount. We intend to conduct the required impairment review for fiscal 2002 during the fourth quarter of fiscal 2002, at which time, if an impairment is identified, it will be recognized as a charge to the Statement of Operations. In making this assessment, we rely on a number of factors including operating results, business plans, economic projections, anticipated future cash flows, transactions and market place data. If market conditions become less favorable, future cash flows, the key variable in assessing the impairment of long-lived assets, may decrease and, as a result, an impairment charge may need to be recognized. DEFERRED TAX ASSETS--We currently have significant deferred tax assets which we periodically review for recoverability. A valuation allowance was recorded to reduce the carrying amounts of our deferred tax assets where it is more likely than not that such assets will not be realized. Realization of our deferred tax assets is principally dependent upon our achievement of projected future taxable income. Our judgments regarding future profitability may change due to future market conditions, our ability to successfully implement our business restructuring plan and other factors. Changes in our judgment, if any, may require material adjustments to these deferred tax asset balances. BUSINESS RESTRUCTURING CHARGES--During fiscal 2000, 2001, and the second quarter of fiscal 2002, we recorded significant reserves in connection with our spin off from Lucent, the outsourcing of certain manufacturing facilities, the acceleration of our restructuring plan originally adopted in September 2000, and our efforts to improve our business performance in response to the continued industry-wide slowdown. These reserves include estimates related to employee separation costs, lease termination obligations and other exit costs. Although we do not anticipate significant changes, the actual costs may differ materially from these estimates resulting in additional charges or reversals. PENSION AND POSTRETIREMENT BENEFIT COSTS--Our pension and postretirement benefit costs are developed from actuarial valuations. Inherent in these valuations are key assumptions provided by us to the actuaries including discount rates, expected return on plan assets and rate of compensation increases. In selecting the rates and returns, we are required to consider current market conditions, including changes in interest rates. Material changes in our pension and postretirement benefit costs may occur in the future in addition to changes resulting from fluctuations in our related headcount due to changes in the assumptions. COMMITMENTS AND CONTINGENCIES--We are subject to legal proceedings related to environmental, product, employment, intellectual property, licensing and other matters. In addition, we are subject to indemnification claims by Lucent under the terms of the contribution and distribution agreement. In order to determine the amount of reserves required, we assess the likelihood of any adverse judgments or outcomes to these matters as well as potential ranges of probable losses. A determination of the amount of reserves required for these contingencies are made after analysis of each individual issue. The required reserves may change in the future due to new developments in each matter or changes in approach such as a change in settlement strategy. Assessing the adequacy of any reserve for matters for which we may have to indemnify Lucent is especially difficult, as we do not control the defense of those matters. In addition, estimates are made for our repurchase obligations related to products sold to various distributors who obtain financing from certain third party lending institutions. Actual repurchases resulting from these obligations could differ materially from our estimates. 71 PURCHASED IN-PROCESS RESEARCH AND DEVELOPMENTS COSTS--In connection with our acquisitions in fiscal 2001, a portion of the purchase prices were allocated to purchased in-process research and development and immediately expensed at acquisition since the related technology had not yet reached technological feasibility and had no future alternative uses. We believe that the estimated in-process research and development amounts so determined represented fair value and did not exceed the amount a third party would have paid for the projects. However, if the projects are not successful or completed in a timely manner, our product pricing and growth rates may not be achieved and we may not realize the financial benefits expected from the projects. ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK. See Avaya's Annual Report filed on Form 10-K for the fiscal year ended September 30, 2001 (Item 7A). At June 30, 2002, there has been no material change in this information other than the interest rate swap agreements disclosed in Note 8 "Short-Term Borrowings and Long-Term Debt" to the unaudited interim consolidated financial statements. As a result of the interest rate swap agreements, we are subject to interest rate risk. 72 PART II ITEM 1. LEGAL PROCEEDINGS. See Note 13--"Commitments and Contingencies" to the unaudited interim consolidated financial statements. ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS. None. ITEM 3. DEFAULTS UPON SENIOR SECURITIES. None. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS. None. ITEM 5. OTHER INFORMATION. None. ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K. (a) Exhibits: 3.1 Amended and Restated By-laws of Avaya Inc., as amended on July 18, 2002. 10.1 Avaya Involuntary Separation Plan for Senior Officers. 99.1 Certification of Donald K. Peterson pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. 99.2 Certification of Garry K. McGuire pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. (b) Reports on Form 8-K: The following Current Report on Form 8-K was filed by us during the fiscal quarter ended June 30, 2002: 1. June 5, 2002--Item 5. Other Events--Avaya furnished restated segment amounts as of and for the fiscal year ended September 30, 2001 to conform to the Company's new operating segment presentation. 73 SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. AVAYA INC. By: /s/ CHARLES D. PEIFFER ----------------------------------------- Charles D. Peiffer CONTROLLER (PRINCIPAL ACCOUNTING OFFICER)
August 14, 2002 74 EX-3.1 3 a2086868zex-3_1.txt EXHIBIT 3.1 EXHIBIT 3.1 AMENDED AND RESTATED BY-LAWS OF AVAYA INC. (formerly known as Lucent EN Corp.) APPROVED NOVEMBER 2, 2000 AS AMENDED JULY 18, 2002 ARTICLE I OFFICES AND RECORDS SECTION 1.01. DELAWARE OFFICE. The principal office of the Avaya Inc. (the "CORPORATION") in the State of Delaware shall be located in the City of Wilmington, County of New Castle, and the name and address of its registered agent is The United States Corporation Company. SECTION 1.02. OTHER OFFICES. The Corporation may have such other offices, either within or without the State of Delaware, as the board of directors of the Corporation (the "BOARD OF DIRECTORS", and each member thereof, a "DIRECTOR") may designate or as the business of the Corporation may from time to time require. SECTION 1.03. BOOKS AND RECORDS. The books and records of the Corporation may be kept outside the State of Delaware at such place or places as may from time to time be designated by the Board of Directors. ARTICLE II STOCKHOLDERS SECTION 2.01. ANNUAL MEETING. The annual meeting of the stockholders of the Corporation shall be held on such date and at such time as may be fixed by resolution of the Board of Directors. SECTION 2.02. SPECIAL MEETING. Except as otherwise required by law and subject to the rights of the holders of any class or series of stock having a preference over the common stock, par value $0.01 per share, of the Corporation (the "COMMON STOCK") as to dividends or upon liquidation, special meetings of stockholders of the Corporation for any purpose or purposes may be called only by (a) the Board of Directors pursuant to a resolution stating the purpose or purposes thereof approved by a majority of the total number of Directors which the Corporation would have if there were no vacancies (the "WHOLE BOARD"), or (b) by the Chairman of the Board of Directors (the "CHAIRMAN OF THE BOARD"). In addition, prior to the Trigger Date (as defined in the Restated Certificate of Incorporation of the Corporation (the "CERTIFICATE OF INCORPORATION")), the Corporation will call a special meeting of stockholders promptly upon request by Lucent Technologies Inc., a Delaware corporation ("LUCENT") if such entity is a stockholder of the Corporation. No business other than that stated in the notice shall be transacted at any special meeting. SECTION 2.03. PLACE OF MEETING. The Board of Directors or the Chairman of the Board, as the case may be, may designate the place, if any, of meeting for any annual meeting or for any special meeting of the stockholders. If no designation is so made, the place of meeting shall be the principal office of the Corporation. SECTION 2.04. NOTICE OF MEETING. Notice, stating the place, day and hour of the meeting and the purpose or purposes for which the meeting is called, shall be delivered by the Corporation not less than 10 calendar days nor more than 60 calendar days before the date of the meeting, either personally, by mail or by other lawful means, to each stockholder of record entitled to vote at such meeting. If mailed, such notice shall be deemed to be delivered when deposited in the United States mail with postage thereon prepaid, addressed to the stockholder at such person's address as it appears on the stock transfer books of the Corporation. Such further notice shall be given as may be required by law. Only such business shall be conducted at a special meeting of stockholders as shall have been brought before the meeting pursuant to the Corporation's notice of meeting. Meetings may be held without notice if all stockholders entitled to notice are present (except when stockholders entitled to notice attend the meeting for the express purpose of objecting, at the beginning of the meeting, because the meeting is not lawfully called or convened), or if notice is waived by those not present in accordance with Section 6.04. Any previously scheduled meeting of the stockholders may be postponed, and any special meeting of the stockholders may be canceled, by resolution of the Board of Directors upon public notice given prior to the date previously scheduled for such meeting of stockholders. SECTION 2.05. QUORUM AND ADJOURNMENT; VOTING. Except as otherwise provided by law or by the Certificate of Incorporation, the holders of a majority of the voting power of all outstanding shares of the Corporation entitled to vote generally in the election of Directors (the "VOTING STOCK"), represented in person or by proxy, shall constitute a quorum at a meeting of stockholders, except that when specified business is to be voted on by a class or series of stock voting as a class, the holders of a majority of the shares of such class or series shall constitute a quorum of such class or series for the transaction of such business. The chairman of the meeting may adjourn the meeting from time to time, whether or not there is such a quorum. No notice of the time and place of adjourned meetings need be given except as required by law. The stockholders present at a duly called meeting at which a quorum is present may continue to transact business until adjournment, notwithstanding the withdrawal of enough stockholders to leave less than a quorum. SECTION 2.06. PROXIES. At all meetings of stockholders, a stockholder may vote by proxy executed in writing (or in such manner prescribed by the General Corporation Law of the State of Delaware (the "DGCL")) by the stockholder, or by such person's duly authorized attorney in fact. SECTION 2.07. NOTICE OF STOCKHOLDER BUSINESS AND NOMINATIONS. (a) ANNUAL MEETINGS OF STOCKHOLDERS. (i) Nominations of persons for election to the Board of Directors and the proposal of business to be considered by the stockholders may be made at an annual meeting of stockholders (A) pursuant to the Corporation's notice of meeting pursuant to Section 2.04, (B) by or at the direction of the Board of Directors, (C) by any stockholder of the Corporation who was a stockholder of record at the time of giving of notice provided for in this By-Law, who is entitled to vote at the meeting and who complies with the notice procedures set forth in this By-Law, or (D) in respect of the which the record date is prior to the Trigger Date, by Lucent. (ii) For nominations or other business to be properly brought before an annual meeting by a stockholder pursuant to clause (C) of paragraph (a)(i) of this Section 2.07, the stockholder must have given timely notice thereof in writing to the Secretary of the Corporation and such other business must otherwise be a proper matter for stockholder action. To be timely, a stockholder's notice shall be delivered to the Secretary of the Corporation at the principal executive offices of the Corporation not later than the close of business on the 45th calendar day nor earlier than the close of business on the 75th calendar day prior to the first anniversary of the preceding year's annual meeting; provided, however, that in the event that the date of the annual meeting is more than 30 calendar days before or more than 60 calendar days after such anniversary date, notice by the stockholder to be timely must be so delivered not earlier than the close of business on the 75th calendar day prior to such annual meeting and not later than the close of business on the later of the 45th calendar day prior to such annual meeting or the 10th calendar day following the calendar day on which public announcement of the date of such meeting is first made by the Corporation. For purposes of determining whether a stockholder's notice shall have been delivered in a timely manner for the annual meeting of stockholders in 2002, the first anniversary of the previous year's meeting shall be deemed to be February 15, 2002. In no event shall the public announcement of an adjournment of an annual meeting commence a new time period for the giving of a stockholder's notice as described above. Such stockholder's notice shall set forth (A) as to each person whom the stockholder proposes to nominate for election or reelection as a Director all information relating to such person that is required to be disclosed in solicitations of proxies for election of Directors in an election contest, or is otherwise required, in each case pursuant to Regulation 14A under the Securities Exchange Act of 1934, as amended (the "EXCHANGE ACT") and Rule 14a-11 thereunder (including such person's written consent to being named in the proxy statement as a nominee and to serving as a Director if elected); (B) as to any other business that the stockholder proposes to bring before the meeting, a brief description of the business desired to be brought before the meeting, the text of the proposal or business (including the text of any resolutions proposed for consideration and in the event that such business includes a proposal to amend these By-Laws, the language of the proposed amendment), the reasons for conducting such business at the meeting and any material interest in such business of such stockholder and the beneficial owner, if any, on whose behalf the proposal is made; and (C) as to the stockholder giving the notice and the beneficial owner, if any, on whose behalf the nomination or proposal is made (1) the name and address of such stockholder, as they appear on the Corporation's books, and of such beneficial owner, (2) the class and number of shares of the Corporation which are owned beneficially and of record by such stockholder and such beneficial owner, (3) a representation that the stockholder is a holder of record of stock of the Corporation entitled to vote at such meeting and intends to appear in person or by proxy at the meeting to propose such business or nomination, and (4) a representation whether the stockholder or the beneficial owner, if any, intends or is part of a group which intends (x) to deliver a proxy statement and/or form of proxy to holders of at least the percentage of the Corporation's outstanding capital stock required to approve or adopt the proposal or elect the nominee and/or (y) otherwise to solicit proxies from stockholders in support of such proposal or nomination. The foregoing notice requirements shall be deemed satisfied by a stockholder if the stockholder has notified the Corporation of his or her intention to present a proposal at an annual meeting in compliance with Rule 14a-8 (or any successor thereof) promulgated under the Exchange Act and such stockholder's proposal has been included in a proxy statement that has been prepared by the Corporation to solicit proxies for such annual meeting. The Corporation may require any proposed nominee to furnish such other information as it may reasonably require to determine the eligibility of such proposed nominee to serve as a Director. (iii) Notwithstanding anything in the second sentence of paragraph (a)(ii) of this Section 2.07 to the contrary, in the event that the number of Directors to be elected to the Board of Directors is increased and there is no public announcement by the Corporation naming all of the nominees for Director or specifying the size of the increased Board of Directors at least 55 calendar days prior to the first anniversary of the preceding year's annual meeting, a stockholder's notice required by this By-Law shall also be considered timely, but only with respect to nominees for any new positions created by such increase, if it shall be delivered to the Secretary at the principal executive offices of the Corporation not later than the close of business on the 10th calendar day following the day on which such public announcement is first made by the Corporation. (b) SPECIAL MEETINGS OF STOCKHOLDERS. Only such business shall be conducted at a special meeting of stockholders as shall have been brought before the meeting pursuant to the Corporation's notice of meeting under Section 2.04. Nominations of persons for election to the Board of Directors may be made at a special meeting of stockholders at which Directors are to be elected pursuant to the Corporation's notice of meeting (i) by or at the direction of the Board of Directors, or (ii) provided that the Board of Directors has determined that Directors shall be elected at such meeting, by any stockholder of the Corporation who is a stockholder of record at the time of giving of notice provided for in this By-Law, who shall be entitled to vote at the meeting and who complies with the notice procedures set forth in this By-Law, or prior to the Trigger Date, by Lucent. In the event the Corporation calls a special meeting of stockholders for the purpose of electing one or more Directors to the Board of Directors, any stockholder may nominate a person or persons (as the case may be), for election to such position(s) as specified in the Corporation's notice of meeting pursuant to such clause (ii), if the stockholder's notice required by paragraph (a)(ii) of this Section 2.07 shall be delivered to the Secretary at the principal executive offices of the Corporation not earlier than the close of business on the 75th calendar day prior to such special meeting and not later than the close of business on the later of the 45th calendar day prior to such special meeting or the 10th calendar day following the day on which public announcement is first made of the date of the special meeting and of the nominees proposed by the Board of Directors to be elected at such meeting. In no event shall the public announcement of an adjournment of a special meeting commence a new time period for the giving of a stockholder's notice as described above. (c) GENERAL. (i) Only such persons who are nominated in accordance with the procedures set forth in this Section 2.07 shall be eligible to serve as Directors and only such business shall be conducted at a meeting of stockholders as shall have been brought before the meeting in accordance with the procedures set forth in this By-Law. Except as otherwise provided by law, the Certificate of Incorporation or these By-Laws, the chairman of the meeting shall have the power and duty to determine whether a nomination or any business proposed to be brought before the meeting was made or proposed, as the case may be, in accordance with the procedures set forth in this Section 2.07 (including whether the stockholder or beneficial owner, if any, on whose behalf the nomination or proposal is made solicited (or is part of a group which solicited) or did not so solicit, as the case maybe, proxies in support of such stockholder's nominee or proposal in compliance with such stockholder's representation as required by clause (a)(ii)(C)(4) of this Section 2.07) and, if any proposed nomination or business is not in compliance with this By-Law, to declare that such defective proposal or nomination shall be disregarded. Notwithstanding the foregoing provisions of this Section 2.07, if the stockholder (or a qualified representative of the stockholder) does not appear at the annual or special meeting of stockholders of the Corporation to present a nomination or business, such nomination shall be disregarded and such proposed business shall not be transacted, notwithstanding that proxies in respect of such vote may have been received by the Corporation. (ii) For purposes of this By-Law, "public announcement" shall mean disclosure in a press release reported by the Dow Jones News Service, Associated Press or comparable national news service or in a document publicly filed by the Corporation with the Securities and Exchange Commission pursuant to Section 13, 14 or 15 (d) of the Exchange Act. (iii) Notwithstanding the foregoing provisions of this Section 2.07, a stockholder shall also comply with all applicable requirements of the Exchange Act and the rules and regulations thereunder with respect to the matters set forth in this Section 2.07. Nothing in this Section 2.07 shall be deemed to affect any rights (a) of stockholders to request inclusion of proposals in the Corporation's proxy statement pursuant to Rule 14a-8 under the Exchange Act or (b) of the holders of any series of preferred stock of the Corporation ("PREFERRED STOCK") to elect Directors under an applicable Preferred Stock Designation (as defined in the Certificate of Incorporation). SECTION 2.08. PROCEDURE FOR ELECTION OF DIRECTORS; REQUIRED VOTE. Election of Directors at all meetings of the stockholders at which Directors are to be elected shall be by ballot, and, subject to the rights of the holders of any series of Preferred Stock to elect Directors under an applicable Preferred Stock Designation, a plurality of the votes cast thereat shall elect Directors. Except as otherwise provided by law, the Certificate of Incorporation, Preferred Stock Designation, applicable stock exchange rules or other rules and regulations applicable to the Corporation or these By-Laws, in all matters other than the election of Directors, the affirmative vote of a majority of the voting power of the shares present in person or represented by proxy at the meeting and entitled to vote on the matter shall be the act of the stockholders. SECTION 2.09. INSPECTORS OF ELECTIONS; OPENING AND CLOSING THE POLLS. (a) The Board of Directors by resolution shall appoint, or shall authorize an officer of the Corporation to appoint, one or more inspectors, which inspector or inspectors may include individuals who serve the Corporation in other capacities, including, without limitation, as officers, employees, agents or representatives, to act at the meetings of stockholders and make a written report thereof. One or more persons may be designated as alternate inspector(s) to replace any inspector who fails to act. If no inspector or alternate has been appointed to act or is able to act at a meeting of stockholders, the chairman of the meeting shall appoint one or more inspectors to act at the meeting. Each inspector, before discharging such person's duties, shall take and sign an oath faithfully to execute the duties of inspector with strict impartiality and according to the best of such person's ability. The inspector(s) shall have the duties prescribed by law. (b) The date and time of the opening and the closing of the polls for each matter upon which the stockholders will vote at a meeting shall be announced at the meeting by the person presiding over the meeting. The Board of Directors may adopt by resolution such rules and regulations for the conduct of the meeting of stockholders as it shall deem appropriate. Except to the extent inconsistent with such rules and regulations as adopted by the Board of Directors, the person presiding over any meeting of stockholders shall have the right and authority to convene and to adjourn the meeting, to prescribe such rules, regulations and procedures and to do all such acts as, in the judgment of such presiding officer, are appropriate for the proper conduct of the meeting. Such rules, regulations or procedures, whether adopted by the Board of Directors or prescribed by the presiding officer of the meeting, may include, without limitation, the following: (i) an agenda or order of business for the meeting; (ii) rules and procedures for maintaining order at the meeting and the safety of those present; (iii) limitations on attendance at or participation in the meeting to stockholders of record of the Corporation, their duly authorized and constituted proxies or such other persons as the chairman of the meeting shall determine; (iv) restrictions on entry to the meeting after the time fixed for the commencement thereof; and (v) limitations on the time allotted to questions or comments by participants. The presiding officer at any meeting of stockholders, in addition to making any other determinations that may be appropriate to the conduct of the meeting, shall, if the facts warrant, determine and declare to the meeting that a matter or business was not properly brought before the meeting and if such presiding officer should so determine, such person shall so declare to the meeting that any such matter or business not properly brought before the meeting shall not be transacted or considered. Unless and to the extent determined by the Board of Directors or the person presiding over the meeting, meetings of stockholders shall not be required to be held in accordance with the rules of parliamentary procedure. ARTICLE III Board of Directors SECTION 3.01. GENERAL POWERS. The business and affairs of the Corporation shall be managed by or under the direction of the Board of Directors. In addition to the powers and authorities by these By-Laws expressly conferred upon them, the Board of Directors may exercise all such powers of the Corporation and do all such lawful acts and things as are not by statute or by the Certificate of Incorporation or by these By-Laws required to be exercised or done by the stockholders. SECTION 3.02. REGULAR MEETINGS. A regular meeting of the Board of Directors shall be held without other notice than this By-Law in conjunction with the annual meeting of stockholders. The Board of Directors may, by resolution, provide the time and place for the holding of additional regular meetings without other notice than such resolution. SECTION 3.03. SPECIAL MEETINGS. Special meetings of the Board of Directors shall be called at the request of the Chairman of the Board, the President or a majority of the Board of Directors then in office. The person or persons authorized to call special meetings of the Board of Directors may fix the place and time of the meetings. SECTION 3.04. NOTICE. Notice of any special meeting of Directors shall be given to each Director at such person's business or residence in writing by hand delivery, first-class or overnight mail or courier service, telegram or facsimile transmission, orally by telephone or any other lawful means. If mailed by first-class mail, such notice shall be deemed adequately delivered when deposited in the United States mails so addressed, with postage thereon prepaid, at least 5 calendar days before such meeting. If by telegram, overnight mail or courier service, such notice shall be deemed adequately delivered when the telegram is delivered to the telegraph company or the notice is delivered to the overnight mail or courier service company at least 24 hours before such meeting. If by facsimile transmission, such notice shall be deemed delivered adequately delivered when the notice is transmitted at least 12 hours before such meeting. If by telephone, by hand delivery or by other lawful means, the notice shall be given at least 12 hours prior to the time set for the meeting. Neither the business to be transacted at, nor the purpose of, any regular or special meeting of the Board of Directors need be specified in the notice of such meeting, except for amendments to these By-Laws, as provided under Section 8.01. A meeting may be held at any time without notice if all the Directors are present (except when Directors attend for the express purpose of objecting, at the beginning of the meeting, because it is not lawfully called or conveyed) or if those not present waive notice of the meeting either before or after such meeting. SECTION 3.05. ACTION BY CONSENT OF BOARD OF DIRECTORS. Any action required or permitted to be taken at any meeting of the Board of Directors or of any committee thereof may be taken without a meeting if all members of the Board of Directors or committee, as the case may be, consent thereto in accordance with applicable law. SECTION 3.06. CONFERENCE TELEPHONE MEETINGS. Members of the Board of Directors or any committee thereof may participate in a meeting of the Board of Directors or such committee by means of conference telephone or other communications equipment by means of which all persons participating in the meeting can hear each other, and such participation in a meeting shall constitute presence in person at such meeting. SECTION 3.07. QUORUM. Subject to Article VII of the Certificate of Incorporation, a whole number of Directors equal to at least a majority of the Whole Board shall constitute a quorum for the transaction of business, but if at any meeting of the Board of Directors there shall be less than a quorum present, a majority of the Directors present may adjourn the meeting from time to time without further notice. The act of the majority of the Directors present at a meeting at which a quorum is present shall be the act of the Board of Directors. SECTION 3.08. EXECUTIVE AND OTHER COMMITTEES. (a) The Board of Directors may designate an Executive Committee to exercise, subject to applicable provisions of law, all the powers of the Board of Directors in the management of the business and affairs of the Corporation when the Board of Directors is not in session, including without limitation the power to declare dividends, to authorize the issuance of the Corporation's capital stock and to adopt a certificate of ownership and merger pursuant to Section 253 of the DGCL, and may, by resolution similarly adopted, designate one or more other committees. The Executive Committee and each such other committee shall consist of one or more Directors. The Board of Directors may designate one or more Directors as alternate members of any committee, who may replace any absent or disqualified member at any meeting of the committee. Any such committee, other than the Executive Committee (the powers of which are expressly provided for herein), may to the extent permitted by law exercise such powers and shall have such responsibilities as shall be specified in the designating resolution. In the absence or disqualification of any member of such committee or committees, the member or members thereof present at any meeting and not disqualified from voting, whether or not constituting a quorum, may unanimously appoint another member of the Board of Directors to act at the meeting in the place of any such absent or disqualified member. Each committee shall keep written minutes of its proceedings and shall report such proceedings to the Board of Directors when required. (b) A majority of any committee may determine its action and fix the time and place of its meetings, unless the Board of Directors shall otherwise provide. Notice of such meetings shall be given to each member of the committee in the manner provided for in Section 3.04. The Board of Directors shall have power at any time to fill vacancies in, to change the membership of, or to dissolve any such committee. Nothing herein shall be deemed to prevent the Board of Directors from appointing one or more committees consisting in whole or in part of persons who are not Directors; provided, however, that no such committee shall have or may exercise any authority of the Board of Directors. SECTION 3.09. RECORDS. The Board of Directors shall cause to be kept a record containing the minutes of the proceedings of the meetings of the Board of Directors and of the stockholders, appropriate stock books and registers and such books of records and accounts as may be necessary for the proper conduct of the business of the Corporation. ARTICLE IV OFFICERS SECTION 4.01. ELECTED OFFICERS. The elected officers of the Corporation shall be a Chairman of the Board, a Chief Executive Officer, a President, a Secretary, a Treasurer, and such other officers (including, without limitation, Senior Vice Presidents and Executive Vice Presidents and Vice Presidents) as the Board of Directors from time to time may deem proper. The Chairman of the Board shall be chosen from among the Directors. All officers elected by the Board of Directors shall each have such powers and duties as generally pertain to their respective offices, subject to the specific provisions of this Article IV. Such officers shall also have such powers and duties as from time to time may be conferred by the Board of Directors or by any committee thereof. The Board of Directors or any committee thereof may from time to time elect, or the Chairman of the Board or President may appoint, such other officers (including one or more Vice Presidents, Controllers, Assistant Secretaries and Assistant Treasurers), as may be necessary or desirable for the conduct of the business of the Corporation. Such other officers and agents shall have such duties and shall hold their offices for such terms as shall be provided in these By-Laws or as may be prescribed by the Board of Directors or such committee or by the Chairman of the Board or President, as the case may be. SECTION 4.02. ELECTION AND TERM OF OFFICE. The elected officers of the Corporation shall be elected annually by the Board of Directors at the regular meeting of the Board of Directors held in conjunction with the annual meeting of the stockholders. If the election of officers shall not be held at such meeting, such election shall be held as soon thereafter as convenient. Each officer shall hold office until such person's successor shall have been duly elected and shall have qualified or until such person's death or until he shall resign or be removed pursuant to Section 4.08. SECTION 4.03. CHAIRMAN OF THE BOARD. The Chairman of the Board shall preside at all meetings of the stockholders and of the Board of Directors. The Chairman of the Board shall be responsible for the general management of the affairs of the Corporation and shall perform all duties incidental to such person's office which may be required by law and all such other duties as are properly required of him by the Board of Directors. He shall make reports to the Board of Directors and the stockholders, and shall see that all orders and resolutions of the Board of Directors and of any committee thereof are carried into effect. The Chairman of the Board may also serve as an officer of the Corporation, if so elected by the Board of Directors. The Directors also may elect a Vice-Chairman to act in the place of the Chairman of the Board upon his or her absence or inability to act. SECTION 4.04. CHIEF EXECUTIVE OFFICER; PRESIDENT. (a) The Chief Executive Officer shall act in a general executive capacity and shall assist the Chairman of the Board in the administration and operation of the Corporation's business and general supervision of its policies and affairs. The Chief Executive Officer, if he or she is also a Director, shall, in the absence of or because of the inability to act of the Chairman of the Board (or any Vice-Chairman), perform all duties of the Chairman of the Board and preside at all meetings of stockholders and of the Board of Directors. (b) The President shall have such powers and duties as may be delegated to him or her by the Chairman of the Board, the Board or the Chief Executive Officer. The President shall perform the duties and exercise the powers of the Chief Executive Officer in the event of the Chief Executive Officer's absence or disability. SECTION 4.05. VICE PRESIDENTS. Each Senior Vice President and Executive Vice President and any Vice President shall have such powers and shall perform such duties as shall be assigned to him by the Board of Directors or by the President. SECTION 4.06. (a) TREASURER. The Treasurer shall exercise general supervision over the receipt, custody and disbursement of corporate funds. The Treasurer shall cause the funds of the Corporation to be deposited in such banks as may be authorized by the Board of Directors, or in such banks as may be designated as depositories in the manner provided by resolution of the Board of Directors. The Treasurer shall have such further powers and duties and shall be subject to such directions as may be granted or imposed from time to time by the Board of Directors, the Chairman of the Board or the President. (b) The Treasurer may designate one or more Assistant Treasurers who shall have such of the authority and perform such of the duties of the Treasurer as may be assigned to them by the Board of Directors, the Chairman of the Board or the Treasurer. During the Treasurer's absence or inability, the Treasurer's authority and duties shall be possessed by such Assistant Treasurer(s) as the Board of Directors, the Chairman or Vice Chairman of the Board or the President may designate. SECTION 4.07. SECRETARY. (a) The Secretary shall keep or cause to be kept in one or more books provided for that purpose, the minutes of all meetings of the Board of Directors, the committees of the Board of Directors and the stockholders; the Secretary shall see that all notices are duly given in accordance with the provisions of these By-Laws and as required by law; shall be custodian of the records and the seal of the Corporation and affix and attest the seal to all stock certificates of the Corporation (unless the seal of the Corporation on such certificates shall be a facsimile, as hereinafter provided) and affix and attest the seal to all other documents to be executed on behalf of the Corporation under its seal and shall see that the books, reports, statements, certificates and other documents and records required by law to be kept and filed are properly kept and filed; and in general, shall perform all the duties incident to the office of Secretary and such other duties as from time to time may be assigned to the Secretary by the Board of Directors, the Chairman of the Board or the President. (b) The Secretary may designate one or more Assistant Secretaries who shall have such of the authority and perform such of the duties of the Secretary as may be provided in these By-Laws or assigned to them by the Board of Directors or the Chairman of the Board or by the Secretary. During the Secretary's absence or inability, the Secretary's authority and duties shall be possessed by such Assistant Secretary or Assistant Secretaries as the Board of Directors, the Chairman of the Board, the President or a Vice Chairman of the Board of Directors may designate. SECTION 4.08. REMOVAL. Any officer elected by the Board of Directors may be removed by the affirmative vote of a majority of the Board of Directors or by a Committee of Directors appointed from time to time by the Board whenever, in the judgment of the Board or of such Committee, as applicable, the best interests of the Corporation would be served thereby. Any officer appointed by the Chairman of the Board or the President may he removed by him or her whenever, in such person's judgment, the best interests of the Corporation would be served thereby. No elected officer shall have any contractual rights against the Corporation for compensation by virtue of such election beyond the date of the election of such person's successor, such person's death, such person's resignation or such person's removal, whichever event shall first occur, except as otherwise provided in an employment contract or under an employee benefit plan. SECTION 4.09. VACANCIES. A newly created elected office and a vacancy in any elected office because of death, resignation, or removal may be filled by the Board of Directors for the unexpired portion of the term at any meeting of the Board of Directors. Any vacancy in an office appointed by the Chairman of the Board or the President because of death, resignation, or removal may be filled by the Chairman of the Board or the President. ARTICLE V Stock Certificates and Transfers SECTION 5.01. STOCK CERTIFICATES AND TRANSFERS. The interest of each stockholder of the Corporation shall be evidenced by certificates for shares of stock in such form as the Corporation may from time to time prescribe. The shares of the stock of the Corporation shall be transferred on the books of the Corporation by the holder thereof in person or by such person's attorney, upon surrender for cancelation of certificates for at least the same number of shares, with an assignment and power of transfer endorsed thereon or attached thereto, duly executed, with such proof of the authenticity of the signature as the Corporation or its agents may reasonably require. The certificates of stock shall be signed, countersigned and registered in such manner as the Board of Directors may by resolution prescribe or as may otherwise be permitted by applicable law, which resolution may permit all or any of the signatures on such certificates to be in facsimile. In case any officer, transfer agent or registrar who has signed or whose facsimile signature has been placed upon a certificate has ceased to be such officer, transfer agent or registrar before such certificate is issued, it may be issued by the Corporation with the same effect as if he were such officer, transfer agent or registrar at the date of issue. Notwithstanding the foregoing provisions regarding share certificates, the Corporation may provide that, subject to the rights of stockholders under applicable law, some or all of any or all classes or series of the Corporation's common or any preferred shares may be uncertificated shares. SECTION 5.02. LOST, STOLEN OR DESTROYED CERTIFICATES. No certificate for shares of stock in the Corporation shall be issued in place of any certificate alleged to have been lost, destroyed or stolen, except on production of such evidence of such loss, destruction or theft and on delivery to the Corporation of a bond of indemnity in such amount, upon such terms and secured by such surety, as the Board of Directors or any financial officer may in its or such person's discretion require. ARTICLE VI Miscellaneous Provisions SECTION 6.01. FISCAL YEAR. The fiscal year of the Corporation shall begin on the first day of October and end on the last day of September of each year. SECTION 6.02. DIVIDENDS. The Board of Directors may from time to time declare, and the Corporation may pay, dividends on its outstanding shares in the manner and upon the terms and conditions provided by law and the Certificate of Incorporation. SECTION 6.03. SEAL. The corporate seal shall have inscribed thereon the words "Corporate Seal," the year of incorporation and the word "Delaware." SECTION 6.04. WAIVER OF NOTICE. Whenever any notice is required to be given to any stockholder or Director under the provisions of the DGCL or these By-Laws, a waiver thereof given in accordance with applicable law shall be deemed equivalent to the giving of such notice. Neither the business to be transacted at, nor the purpose of, any annual or special meeting of the stockholders or the Board of Directors or committee thereof need be specified in any waiver of notice of such meeting. SECTION 6.05. AUDITS. The accounts, books and records of the Corporation shall be audited upon the conclusion of each fiscal year by an independent certified public accountant selected by the Board of Directors, and it shall be the duty of the Board of Directors to cause such audit to be done annually. SECTION 6.06. RESIGNATIONS. Any Director or any officer, whether elected or appointed, may resign at any time by giving written notice of such resignation to the Chairman of the Board, the President, or the Secretary, and such resignation shall be deemed to be effective as of the close of business on the date said notice is received by the Chairman of the Board, the President, or the Secretary, or at such later time as is specified therein. No formal action shall be required of the Board of Directors or the stockholders to make any such resignation effective. ARTICLE VII CONTRACTS, PROXIES, ETC. SECTION 7.01. CONTRACTS. Except as otherwise required by law, the Certificate of Incorporation, a Preferred Stock Designation, or these By-Laws, any contracts or other instruments may be executed and delivered in the name and on the behalf of the Corporation by such officer or officers of the Corporation as the Board of Directors may from time to time direct. Such authority may be general or confined to specific instances as the Board of Directors may determine. The Chairman of the Board, the President or any Senior Vice President, Executive Vice President or Vice President may execute bonds, contracts, deeds, leases and other instruments to be made or executed or for or on behalf of the Corporation. Subject to any restrictions imposed by the Board of Directors or the Chairman of the Board, the President or any Senior Vice President, Executive Vice President or Vice President of the Corporation may delegate contractual powers to others under such person's jurisdiction, it being understood, however, that any such delegation of power shall not relieve such officer of responsibility with respect to the exercise of such delegated power. SECTION 7.02. PROXIES. Unless otherwise provided by resolution adopted by the Board of Directors, the Chairman of the Board, the President or any Senior Vice President, Executive Vice President or Vice President may from time to time appoint an attorney or attorneys or agent or agents of the Corporation, in the name and on behalf of the Corporation, to cast the votes which the Corporation may be entitled to cast as the holders of stock or other securities in any other entity, any of whose stock or other securities may be held by the Corporation, at meetings of the holders of the stock or other securities of such other entity, or to consent in accordance with applicable law, in the name of the Corporation as such holder, to any action by such other entity, and may instruct the person or persons so appointed as to the manner of casting such votes or giving such consent, and may execute or cause to be executed in the name and on behalf of the Corporation and under its corporate seal or otherwise, all such proxies or other instruments as he may deem necessary or proper in the premises. ARTICLE VIII Amendments SECTION 8.01. AMENDMENTS. The By-Laws may be altered or repealed and new By-Laws may be adopted (a) at any annual or special meeting of stockholders by the affirmative vote of the holders of a majority of the voting power of the stock issued and outstanding and entitled to vote thereat, provided, however, that any proposed alteration or repeal of, or the adoption of any By-Law inconsistent with, Section 2.02 or 2.07 by the stockholders shall require the affirmative vote of the holders of at least 80% of the voting power of all Voting Stock then outstanding, voting together as a single class, and provided, further, however, that, in the case of any such stockholder action at a special meeting of stockholders, notice of the proposed alteration, repeal or adoption of the new By-Law or By-Laws must be contained in the notice of such special meeting, or (b) by the affirmative vote of a majority of the Whole Board. I HEREBY CERTIFY that the foregoing is a full, true, and correct copy of the By Laws of Avaya Inc., a Delaware corporation, as in effect on the date hereof. Dated: July 18, 2002 /s/ Pamela F. Craven - ----------------------------- Name: Pamela F. Craven Title: Secretary, Senior Vice President, and General Counsel EX-10.1 4 a2086868zex-10_1.txt EXHIBIT 10.1 EXHIBIT 10.1 AVAYA INVOLUNTARY SEPARATION PLAN FOR SENIOR OFFICERS PLAN DOCUMENT AND SUMMARY PLAN DESCRIPTION (EFFECTIVE OCTOBER 13, 2001) THIS DOCUMENT, LIKE ALL AVAYA PLANS, PERSONNEL POLICIES OR PRACTICES, IS NOT A CONTRACT OF EMPLOYMENT. IT IS NOT INTENDED TO CREATE, AND IT SHOULD NOT BE CONSTRUED TO CREATE, ANY CONTRACTUAL RIGHTS, EITHER EXPRESS OR IMPLIED, BETWEEN ANY PARTICIPATING COMPANY AND ITS EMPLOYEES. THE PRACTICES AND PROCEDURES DESCRIED IN THIS DOCUMENT MAY BE CHANGED, ALTERED, MODIFIED OR DELETED AT ANY TIME, WITH OR WITHOUT PRIOR NOTICE. EMPLOYMENT AT AVAYA IS "AT-WILL". THIS MEANS THAT EMPLOYEES HAvE THE RIGHT TO QUIT THEIR EMPLOYMENT AT ANY TIME AND FOR ANY REASON, AND AVAYA HAS THE RIGHT TO TERMINATE ANY EMPLOYEE, AT ANY TIME AND FOR ANY REASON. IN THE EVENT THERE IS A CONFLICT BETWEEN STATEMENTS IN THE SEPARATION PLAN AND THE TERMS OF ANY BENEFIT PLAN, POLICY, OR PRACTICE WITH RESPECT TO THE BENEFITS PROVIDED THEREIN, THE APPLICABLE BENEFIT PLAN, POLICY OR PRACTICE WILL CONTROL. tHE BOARD OF DIRECTORS OF AVAYA INC. (OR ITS DELEGATE) RESERVES THE RIGHT, AT ANY TIME, TO MODIFY, SUSPEND, CHANGE, OR TERMINATE AVAYA'S BENEFIT PLANS, PoLICIES OR PRACTICES. Page 1 of 16 October 13, 2001 AVAYA INVOLUNTARY SEPARATION PLAN FOR SENIOR OFFICERS PLAN DOCUMENT AND SUMMARY PLAN DESCRIPTION A. OVERVIEW The Avaya Involuntary Separation Plan for Senior Officers (the "Plan"), amended and restated effective as of October 13, 2001, as set forth herein, is designed to provide a specific payment and certain benefit enhancements to eligible Senior Officers of Avaya Inc. ("Avaya" or the "Company") and its affiliated companies and subsidiaries (collectively "Participating Companies") whose employment is involuntarily terminated under conditions described in the Plan. B. TYPE OF PLAN Under Section 3(1) of the Employee Retirement Income Security Act of 1974, as amended ("ERISA"), this Plan is classified and is to be interpreted as an employee welfare benefit plan for purposes of providing specified post employment payments and other benefits. C. PLAN PARTICIPATION You are a participant in this Plan (a "Participant") if you are a regular full-time Senior Officer, who is on the active roll of the Company (including employees on loan to other organizations, receiving benefits under the Avaya Short Term Disability Plan ("STD") or on a leave of absence with guaranteed reinstatement rights), and you have been designated "At Risk" under the Avaya Force Management Program ("FMP") Guidelines in effect at that time. For the purposes of this Plan, "At Risk" under the FMP Guidelines means a company initiated termination other than for "cause," which is defined as follows: (1) conviction (including a plea of guilty or nolo contendere) of a felony or any crime of theft, dishonesty or moral turpitude; or (2) gross omission or gross dereliction of any statutory or common law duty of loyalty to the Company, or (3) any other violation of Avaya's Code of Conduct. "At Risk " shall not include any termination that is caused by, as a result of or otherwise related to a "Change in Control" as defined in the Avaya Inc. Special Severance Plan. Employees whose termination is caused by, as a result of or otherwise related to a Change in Control are not eligible to participate in this Plan. For purposes of this Plan, a Senior Officer is an Avaya Senior Officer who reports directly to the Chief Executive Officer. The Chief Executive Officer is not a Senior Officer for the purposes of this Plan. For purposes of this Plan, Net Credited Service ("NCS") shall be determined in accordance with the Avaya Pension Plan For Salaried Employees. If a Participant is not Page 2 of 16 October 13, 2001 eligible for the Avaya Pension Plan For Salaried Employees, NCS shall be equal to the Participant's time on the U.S. payroll of Avaya or any member of its controlled group of corporations (within the meaning of section 414(b) of the Internal Revenue Code of 1986, as amended), while the corporation is part of the control group, excluding any leave of absence or disability leave. The Vice President - Compensation and Benefits of Avaya or his delegate shall determine if and when this Plan, and to what organizations, positions and groups of employees, this Plan is to be applied. D. ELIGIBILITY TO RECEIVE BENEFITS If you are a Participant, you are eligible to receive the benefits described in Section F upon the involuntary termination of your employment pursuant to the terms of this Plan, on your Scheduled Off-Payroll Date as set forth in Section E. E. SCHEDULED OFF-PAYROLL DATE Your Scheduled Off-Payroll Date will be the date that is specified in the written notice you receive confirming your designation as "At Risk", which date will be thirty (30) days from the date of that notice. It is expected that, subject to the transition requirements of your business organization, you will use all accrued unused vacation prior to your Scheduled Off-Payroll Date. If you are unable to do so because of business transition needs, you will be paid for unused vacation days for the current calendar year and any carry-over days approved prior to the beginning of the current fiscal year. You will not receive pay in lieu of floating holidays and designated holidays if these days are not taken prior to terminating employment, unless required by state law. F. PLAN PAYMENTS AND BENEFITS The Post-Employment Payments and Benefits described in this Section F of the Plan constitute the exclusive post-employment payments and benefits that a Senior Officer who is terminated under the FMP guidelines is entitled to receive and are provided in lieu of any post-employment benefits available under any other applicable severance plan, program, policy, individually negotiated separation agreement or other individual arrangement of or with a Participating Company. 1. POST-EMPLOYMENT PAYMENT A Participant who becomes eligible to receive benefits under this Plan, shall be entitled to receive a Post-Employment Payment under this Section F.1. in the amount of one hundred and fifty percent (150%), of final annual base salary if the Participant elects to sign and does not revoke a Termination Agreement and Release in accordance with the provisions of Section G of this Plan. Page 3 of 16 October 13, 2001 2. ANNUAL INCENTIVE You may be eligible to receive a pro rata portion of your short-term incentive payment. The portion of the incentive payment to which you will be entitled will be determined in accordance with existing practice and the terms of any short-term incentive plan providing for such payments, subject to both company and individual performance. 3. STOCK OPTIONS Vesting or cancellation of stock options, restricted stock units or other long-term awards granted prior to your actual termination date shall be in accordance with the terms and conditions of the Avaya Inc. Long Term Incentive Program or other long-term incentive plan or program pursuant to which you have been provided options and your award agreements. 4. FINANCIAL COUNSELING If you are not Service Pension eligible, you will continue to be eligible for Company paid financial counseling services for three (3) months after the month in which your employment terminates, up to your prorated benefit amount. If you are Service Pension eligible, you will be entitled to financial counseling services for one full year from your actual termination date up to your annual benefit amount in accordance with current practice. 5. OUTPLACEMENT SERVICES You will be entitled to receive individual services of a Company paid outplacement consultant for one year from your off roll date, in accordance with customary practice for Senior Officers. 6. OTHER PERQUISITES All other Senior Officer Perquisites will end as of your last day on the active payroll. These include, but are not limited to: monthly car allowances, use of company chauffeurs, aircraft, executive travel, etc. 7. METHOD OF PAYMENT To receive your Post-Employment Payment, you must sign the Termination Agreement and Release (Exhibit "A") and return it to the Executive Compensation and Benefits Manager of Avaya within forty-five days of your actual termination date. The Post Employment Payment shall be paid in a lump sum within 45 days after receipt of the validly executed and delivered Termination Agreement and Release, but not sooner than the expiration of the seven (7) day revocation period during which you may revoke Page 4 of 16 October 13, 2001 the Termination Agreement and Release. Revocation during that period will result in ineligibility for payment. G. TERMINATION AGREEMENT AND RELEASE A Participant who is otherwise eligible to receive a Post Employment Payment under Section F.1 shall not be entitled to receive any of such benefits until the Participant has signed a Termination Agreement and Release (a copy of which is attached hereto as Exhibit "A") which releases and discharges Avaya, its benefit committees, and all of its affiliates, subsidiaries, resulting new entities, and the respective successors and assigns, and the respective shareholders, officers, directors, employees and members of all of the named entities from all claims, demands or causes of action of any kind whatsoever arising out of your employment and the termination of your employment. H. WITHHOLDINGS The amount of the Post-Employment Payment paid pursuant to this Plan is subject to the withholding of federal, state and local taxes, FICA (Social Security taxes), and FUTA and SUTA (unemployment taxes) at the time of payment and will be reported on IRS form W-2. Payment will not be reduced for contributions to, or be recognized under, any Avaya employee or Senior Officer benefit plan or program. I. PAYMENT UPON DEATH, DISABILITY OR LEAVE OF ABSENCE 1. DEATH If you should die on or before your actual termination date, no payments will be made or benefits provided under this Plan. You will be treated as if you had died as an active employee and your estate or your beneficiaries will be entitled to the customary benefits payable upon the death of an active Senior Officer. If you should die after your actual termination date, but before payment is made, your Post-Employment Payment, if applicable, will be made to your lawful spouse or, if you are not survived by a lawful spouse, to your estate in a single lump sum as soon as practicable after your death, provided you or the executor of your estate has signed and has not revoked a Termination Agreement and Release in accordance with the provision of Section G of this Plan. 2. DISABILITY AND LEAVES OF ABSENCE If you are receiving disability benefits or you are on a leave of absence with a right to guaranteed reinstatement prior to terminating employment, any payments under this Plan to you shall be computed and paid as follows: (a) EMPLOYEES RECEIVING DISABILITY BENEFITS: Page 5 of 16 October 13, 2001 No payment under this Plan will be made until your employment is formally terminated at the time your benefits under the Short Term Disability Plan stop. Any payments due under this Plan shall be reduced by the full amount of any disability benefits paid subsequent to your Scheduled Off-Payroll Date. (b) EMPLOYEES ON A LEAVE OF ABSENCE WITH GUARANTEED RIGHT OF REINSTATEMENT: Payments computed under this Plan will not be payable until after your employment is formally terminated at the conclusion of your leave of absence. J. FORFEITURE You will forfeit all or a portion of your benefits, including the benefits listed under section K, under the following circumstances: 1. RE-EMPLOYMENT If, within one year of your actual termination date, you become employed by: (i) Avaya, or (ii) any entity within Avaya's controlled group of corporations within the meaning of Section 1563 of the Internal Revenue Code or (iii) any other company which participates in Avaya's U.S. pension plans or (iv) any of the successors or assigns of any of them, you will be required to repay to Avaya that portion of the Post-Employment Payment which relates to the part of the year that you are re-employed. That portion will be determined as follows: the Post-Employment Payment will be multiplied by a fraction, the numerator of which is the number of complete months (of the 12 month period following your actual termination date) during which you were re-employed and the denominator of which is 12. The result will be the amount that you must repay to the Company. 2. DISPOSITIONS AND OUTSOURCING If, in connection with, as a result of or in anticipation of a disposition or a sale of any portion of the stock or assets of Avaya or an outsourcing of any of Avaya's products, services, processes or other business concerns a Participant is offered an opportunity, (i) to perform services as an employee with the purchaser or service provider or (ii) to provide consulting services or to otherwise render services to a purchaser or service provider as an employee, independent contractor, consultant or in any other capacity, full- or part- time, at any time within the ninety (90) day period immediately following the participant's termination of employment with the Company, then such participant must repay the entire Post Employment Payment described in Section F to the Company from which his or her employment was terminated and will cease receiving benefits described in section K effective as of the date of such hiring. 3. VIOLATION OF AVAYA CODE OF CONDUCT OR PROPRIETARY INFORMATION Page 6 of 16 October 13, 2001 Notwithstanding any other provision of this Plan, if, as determined by the Vice President - Compensation and Benefits of Avaya, you violate Avaya's Code of Conduct and/or fail to continue to fulfill your obligations not to disclose the Company's private, confidential or proprietary information, you shall not be entitled to receive a payment or if payment has been made you will be required to repay the Post Employment Payment in its entirety to the Company. K. MEDICAL, LIFE INSURANCE, AND OTHER BENEFITS The provisions regarding medical, dental, and life insurance coverages are outlined below. For a description of the provisions of such coverages, including administration of or rights of Participants under any of Avaya's health (include COBRA rights) or life insurance plans, please consult the applicable plan documents, which control, and the respective Summary Plan Descriptions for active and retired employees. In the event there is a conflict between the material in this Plan and the terms of the respective benefit plan documents, the benefit plan documents will control and govern the operation of such plans. Avaya reserves the right to modify, suspend, change or terminate the benefit plans described in this Section K at any time and without prior notice to Participants. 1. SERVICE PENSION ELIGIBLE EMPLOYEES If you are eligible to retire with a service pension under the service based program of the Avaya Inc. Pension Plan for Salaried Employees or the Avaya Inc. Pension Plan, health and life insurance coverage will be available under the provisions that normally apply to retiring service pensioners. 2. NON-SERVICE PENSION ELIGIBLE EMPLOYEES Certain other benefits are continued for non-service pension eligible Participants as described below: (a) MEDICAL EXPENSE PLAN If you have five or more years of Net Credited Service ( NCS) the Company will pay for your coverage to continue on the same basis as for active employees under the Medical Expense Plan for six (6) months after the month in which your employment terminates. After that, you can continue coverage under COBRA for up to an additional twelve (12) months by paying the COBRA rate of 102%. If you have at least one year but less than five years of NCS, the Company will pay for your coverage to continue on the same basis as for active employees under the Medical Expense Plan for three (3) months after the month in which your employment terminates. After that, you can continue coverage under COBRA for up to an additional fifteen (15) months by paying the COBRA rate of 102%. Page 7 of 16 October 13, 2001 If you have less than one year of NCS, you can continue Medical Expense Plan coverage under COBRA for up to 18 months after the month in which your employment terminates by paying the COBRA rate of 102%. If you are enrolled in an HMO at termination, your HMO coverage will be continued for the same period as described above. All coverage continued for you and your eligible dependents will be the same as the coverage provided while you were an active employee, subject to the terms of the Medical Expense Plan and provided that you continue to pay your share of the cost of the HMO premium. You should immediately notify the COBRA administrator if you become covered under another group health plan. (b) DENTAL EXPENSE PLAN You may continue plan coverage under the Dental Expense Plan under COBRA for up to 18 months after the month in which your employment terminates by paying the COBRA rate of 102% of the applicable premium for coverage. NOTE: THE COMPANY PROVIDES PARTICIPANTS WITH UP TO 18 MONTHS OF CONTINUING HEALTH CARE COVERAGE (MEDICAL EXPENSE PLAN, DENTAL EXPENSE PLAN, AND HEALTH CARE REIMBURSEMENT ACCOUNT PLAN) UNDER COBRA WHEN THEY LEAVE THE ACTIVE PAYROLL, AT THE PARTICIPANT'S EXPENSE. THE 18 MONTHS OF CONTINUING COBRA COVERAGE WILL RUN CONCURRENTLY WITH THE PERIODS DESCRIBED ABOVE. THE PARTICIPANT WILL RECEIVE A COBRA PACKAGE AFTER HE OR SHE LEAVES THE ACTIVE PAYROLL, INCLUDING APPROPRIATE CURRENT HEALTH CARE COVERAGE OPTIONS AND BILLING INFORMATION. (c) LIFE INSURANCE If you are not Service Pension eligible, your coverage under the Avaya Inc. Executive Life Insurance Program will continue, at your expense, for as long as you continue to pay the premiums after the month in which your employment actually terminates. If you are Service Pension eligible and participate in the service based program of the Avaya Inc Pension Plan for Salaried employees your coverage under the Avaya Inc. Executive Life Insurance Program will continue based on the following schedule. At retirement, your pre-retirement executive life insurance will be reduced by 10%. Over each of the next four years, another 10% reduction will be made at the anniversary of your retirement date until a 50% level is achieved. This coverage will be paid by the company. You will be subject to imputed income based on the amount of life coverage provided. (d) SUPPLEMENTARY LIFE INSURANCE. Regardless of retirement eligibility, your coverage of one to five times total annual pay can be continued by paying your premiums directly to the insurance carrier. Please contact MetLife at 888-466-8659. (e) DEPENDENT GROUP LIFE INSURANCE Page 8 of 16 October 13, 2001 You may continue plan coverage under the Avaya Inc. Dependent Group Life Insurance Plan for up to three (3) months after the month in which your employment terminates by paying the group premium directly to the insurance carrier. At the end of the three (3) month period, you can request conversion to an individual policy by contacting MetLife, the insurance carrier, at 888-466-8659. (f) ACCIDENTAL LOSS INSURANCE DEATH AND DISMEMBERMENT. Your coverage for up to one times total annual pay (as defined in the Avaya Inc. Group Life Insurance Program) will continue, at Company expense, for six (6) months after the month in which your employment terminates. (g) SUPPLEMENTARY ACCIDENTAL LOSS INSURANCE. You may continue your coverage of one to five times total annual pay (as defined in the Avaya Inc. Group Life Insurance Program) for up to six (6) months after the month in which your employment terminates by paying the group premium directly to the insurance carrier. Please contact MetLife at 888-466-8659. Accidental Loss Insurance cannot be converted to an individual policy. (h) DEPENDENT ACCIDENTAL LOSS INSURANCE You may continue coverage under the Avaya Inc. Dependent Accidental Loss Insurance Plan for up to three (3) months after the month in which your employment terminates by paying the group premium directly to the insurance carrier. Dependent Accidental Loss Insurance cannot be converted to an individual policy. (i) LONG-TERM CARE You may elect to continue coverage through the carrier by paying the group premium directly to the carrier. (j) REIMBURSEMENT ACCOUNTS You may continue to submit claims incurred through your last day on the payroll up to the amount elected for that plan year in the Avaya Inc. Health Care Reimbursement Account Plan (HCRA). You may also continue to submit claims incurred through the end of the plan year up to the amount contributed through your last day on the payroll in the Avaya Child/Elder Care Reimbursement Account Plan (CECRA). Claims under both programs may be submitted through April 15 of the following year after your termination. You may choose to continue to participate in the Avaya Health Care Reimbursement Account Plan, through COBRA, on an after-tax basis by making monthly deposits to the account. (k) VOLUNTARY BENEFITS PROGRAM Coverage under the Voluntary Benefit Program, which includes vision coverage, legal plans, financial planning and property and casualty insurance, may be continued Page 9 of 16 October 13, 2001 through RealLife benefits. Vision coverage continuation will be offered to you through COBRA. Please contact RealLife Benefits for details and portability rules. (l) DISABILITY PROGRAMS Coverage under the employee's short term disability programs ends on the last day of employment. Employees who are receiving short term disability benefits must waive any rights they may otherwise have to continued short or long term disability benefits in order to receive the benefits described in Section F. 3. END OF COVERAGE Other than as extended above, all coverage ceases at the end of the month in which your employment terminates. Notwithstanding the above, all coverage set forth above automatically ends when you become eligible for group coverage under another plan of any other employer or other organization or if you fail to pay a required premium or if the conditions set forth in Section J are met. 4. OTHER BENEFIT PLAN AGREEMENTS. If you were an employee of any entity at the time the stock or assets of such entity were acquired by the Company, and you became an employee of the Company through such acquisition, any agreements entered into by the Company, which apply to Participants, will control, where relevant, with respect to the benefits available to you under the Plan. L. BENEFIT CLAIM AND APPEAL PROCEDURES 1. CLAIM PROCEDURE Any Participant in the Plan, or a person duly authorized by a Participant, may file a claim in writing for benefits under this Plan if the Participant believes he or she has not received benefits to which he or she was entitled under the Plan. Such a claim may only relate to a matter under the Plan and not any matter under the FMP Guidelines or any other Participating Company policy, practice or guideline. The written claim should be sent to the Vice President - Compensation and Benefits of Avaya, Room 3W316, 211 Mt. Airy Road, Basking Ridge, NJ 07920. The written claim should be sent within 60 days of the date of the occurrence of facts giving rise to the claim. If the claim is denied, in whole or in part, the claimant will receive written notice from the Vice President, Compensation and Benefits or his delegate. The information will be Page 10 of 16 October 13, 2001 provided within 90 days of the date the claim was received. The written notice will include: - - the specific reason or reasons for the denial; - - specific reference to pertinent Plan provisions on which the denial was based; - - a description of any additional material or information necessary to perfect the claim and an explanation of why such material or information is necessary; and - - appropriate information as to the steps to be taken if the Participant, spouse, heirs or estate or representative desires to submit the claim for review. In some cases, more than 90 days may be needed to make a decision. In such cases, the claimant will be notified in writing, within the initial 90-day period, of the reason more time is needed. An additional 90 days may be taken to make the decision if the claimant is sent such a notice. The extension notice will show the date by which the decision will be sent. If no response is received within the 90-day period, the claim is considered denied. 2. APPEAL PROCEDURE A claimant may use this procedure to appeal a denied claim if: - - no reply at all is received by the claimant within 90 days after filing the claim; - - a notice has extended the time an additional 90 days and no reply is received within 180 days after filing the claim; or - - written denial of the claim for benefits or other matters is received within the proper time limit and the claimant wishes to appeal the written denial. If a claim for benefits is denied, in whole or in part, either expressly or by virtue of the Participant not having received a reply, the Participant, or other duly authorized person may appeal the denial in writing within 60 days after the denial is or should have been received. Written request for review of any denied claim or any other disputed matter should be sent directly to Avaya Inc. Attn: Employee Benefits Committee, Room 3C315, 211 Mount Airy Road, Basking Ridge, NJ 07920. The Avaya Inc. Employee Benefits Committee (the "EBC") serves as the final review committee under the Plan for all Participants. The EBC has sole and complete discretionary authority to determine conclusively for all parties and in accordance with the terms of the documents or instruments governing the Plan, and all questions arising from the administration of the Plan and interpretation of all plan provisions, determination of all questions relating to participation of eligible employees and eligibility for benefits, determination of all relevant facts, the amount and type of benefits payable to any Participant, spouse, heirs or estate, and the construction of all terms of the Plan. All determinations and decisions of the EBC are conclusive and binding on all parties and not subject to further review. Unless the EBC sends notice in writing that the claim is a special case needing more time, the EBC will conduct a review and decide on the appeal of the denied claim within 60 days after receipt of the written request for review. If more time is required to make Page 11 of 16 October 13, 2001 a decision, the EBC may have 60 days, a total of 120 days, to make its decision. If the claimant sends a written request of a denied claim, the claimant has the right to: (i) Review pertinent Plan documents which may be obtained by following the procedures described in this Plan document, and (i) Send to the EBC a written statement of the issues and any other documents in support of the claim for benefits or other matters under review. The EBC decision shall include specific reasons for the decision as well as specific references to the pertinent Plan provisions on which the decision is based. If the EBC does not give its decision on review within the appropriate time span, the claimant may consider the claim denied. PLEASE NOTE THAT THE PLAN REQUIRES THAT A PARTICIPANT PURSUE ALL THE CLAIM AND APPEAL RIGHTS DESCRIBED ABOVE BEFORE SEEKING ANY OTHER LEGAL RECOURSE REGARDING CLAIMS FOR BENEFITS. M. ERISA RIGHTS STATEMENT All employees eligible for benefits under this Plan are Plan Participants. Participants in this Plan are entitled to certain rights and protection under ERISA. ERISA provides that all Plan Participants shall be entitled to: Examine, without charge, at the office of the Plan Administrator, at 211 Mt. Airy Road, Basking Ridge, NJ 07920, the Plan documents and copies of all documents filed by this Plan with the U.S. Department of Labor, such as detailed annual reports. A reasonable fee or charge may be imposed for such copies. In addition to creating rights for Plan Participants, ERISA imposes duties upon the people who are responsible for the operation of employee benefits plans. The people who operate this Plan, called "fiduciaries" of this Plan, have a duty to do so prudently and in the interest of all Plan Participants. No one, including a Participant's employer or any other person may fire or otherwise discriminate against a Participant in any way for the purpose of preventing a Participant from obtaining a benefit or exercising rights under ERISA. If any claim for a Plan benefit is denied, in whole or in part, the person whose claim was denied must receive a written explanation of the reason for the denial. Such a person has the right to have the Vice President, Compensation and Benefits or his delegate and/or the EBC review and reconsider that claim (see Section Q, entitled "Benefit Claim and Appeal Procedures"). Under ERISA, there are steps to take to enforce the above rights. For instance, if materials from this Plan are requested but not received within 30 days, the person making the request may file suit in a federal court. In such cases, the court may require the Participating Company to provide the materials and pay that person up to $110 a day until the materials are received, unless they were not sent because of reasons beyond the control of the Company. Anyone whose claim for benefits is denied after final review or ignored, in whole or in part, may file suit in a state or federal court. Anyone who is discriminated against for asserting rights under this Plan may seek Page 12 of 16 October 13, 2001 assistance from the U.S. Department of Labor or may file suit in a federal court, but an action relating to a claim for benefits may not be filed prior to exhausting the claim and appeal procedure under this Plan. The court will decide who will pay court costs and legal fees. If that person is successful, the court may order the party that was sued to pay these costs and fees. If that person loses, the court may order him or her to pay these costs and fees if, for example, it finds that the claim was frivolous. Anyone who has questions about this Plan should contact the Plan Administrator, Executive Compensation and Benefits Manager at, 211 Mt. Airy Road, Basking Ridge, NJ 07920. Anyone who has questions about this statement of Participants' rights, or about rights under ERISA, should contact the nearest office of the U.S. Labor - Management Services Administration, Department of Labor. N. PLAN ADMINISTRATOR Avaya Inc., 211 Mount Airy Road, Room 1E100, Basking Ridge, NJ 07920, is the Plan Administrator of the Plan. Avaya and each of its subsidiary companies that are covered by the Plan have delegated administrative authority and responsibility to the Avaya Inc. Employee Benefits Committee ("EBC"). The EBC is located at Avaya Inc. Room 3W431, 211 Mt. Airy Rd, Basking Ridge, NJ 07920. The Vice President, Compensation and Benefits of Avaya or his delegate is the named fiduciary of this Plan who makes determinations concerning when and to what positions or groups payments should be made in Avaya. The EBC is also a named fiduciary and is the final review committee under the Plan. O. EMPLOYER AND PLAN IDENTIFICATION NUMBERS This Plan is identified by the following number under Internal Revenue Service rules: Employer ID # 22-3713430 assigned by the IRS. Plan # 531 assigned by Avaya. P. AMENDMENT AND TERMINATION. Pursuant to Section 402(b)(3) of the Employee Retirement Income Security Act of 1974, as amended ("ERISA"), the Board of Directors of Avaya Inc. ("Board"), or its authorized representative pursuant to delegated authority ("Delegate"), may from time to time amend, modify or change this Plan at any time, and the Board or its Delegate may Page 13 of 16 October 13, 2001 terminate this Plan at any time. Plan amendments may include, but are not limited to, elimination or reduction in the level or type of benefits provided to any class or classes of employees (and their spouses and dependents). Q. PLAN DOCUMENTS This document is both the Summary Plan Description and the official Plan document which regulates the operation of this Plan. R. LEGAL PROCESS. Process can be served on the Plan or Avaya Inc., as Plan Administrator, by directing such legal service to Avaya Inc., 211 Mt. Airy Road, Room 3W631, Basking Ridge, NJ 07920, Attention: Vice President - Compensation and Benefits S. ASSIGNMENT OR ALIENATION No payment or benefits under this Plan or any right or interest in such payments or benefits shall be assignable or subject in any manner to anticipation, alienation, sale, transfer, assignment, claims of creditors, garnishment, pledge, execution, attachment or encumbrance of any kind, including, but not limited to, pursuant to any domestic relations order (within the meaning of Section 206(d)(3) of ERISA and Section 414(p)(1)(B) of the Internal Revenue Code) and any such attempted disposition shall be null and void. The payment and benefits hereunder or the right to receive future payment or benefits under the Plan may not be anticipated, alienated, sold, transferred, assigned, pledged, executed upon, encumbered, or subjected to any charge or legal process; no interest or right to receive a payment or benefit may be taken either voluntarily or involuntarily, for the satisfaction of the debts of, or other obligation or claims against such person or entity, including judgment or claims for alimony, support, separate maintenance and claims in bankruptcy proceedings. T. TERMS AND CONDITIONS OF EMPLOYMENT. This document is not a contract of employment. It is not intended to create, and it should not be construed to create, any contractual rights, either express or implied, between you and the Company. The employment relationship between the Company and the employees covered by the Plan is "at-will". This means that employees have the right to quit their employment at any time and for any reason, and the Company reserves the right to terminate any employee's employment, with or without cause, at any time for any reason. Page 14 of 16 October 13, 2001 T. FUNDING. Payments made under the Plan will be paid out of the general assets of the Company. U. CONTROLLING LAW. The Plan shall be construed, administered and governed according to the laws of the State of New Jersey, except to the extent preempted by federal law, which shall in that case control. Page 15 of 16 October 13, 2001 "Exhibit A" [GRAPHIC] ---------------- TERMINATION AGREEMENT & RELEASE In consideration of the fact that I have voluntarily and of my own free will elected to accept a Post Employment Payment and that Avaya Inc. ("Avaya Inc." or "the Participating Company") has agreed to pay me the Post Employment Payment, subject to the terms and limitations of the Avaya Inc. Involuntary Separation Plan for Senior Officers, I acknowledge and agree to the following: 1. I have been told by the Participating Company, and I understand, that I may elect, at my option, to receive a Post Employment Payment, but that my election to receive the Post Employment Payment is expressly conditioned upon my signing a Termination Agreement and Release on or after the date of my termination from the Participating Company, and returning it to my Force Management Coordinator. 1. I realize that there are various state and federal laws that govern my employment relationship with the Participating Company and/or prohibit employment discrimination on the basis of age, color, race, gender, sexual preference/orientation, marital status, national origin, mental or physical disability, religious affiliation or veteran status and that these laws are enforced through the courts and agencies such as the Equal Employment opportunity Commission, Department of Labor and State Human Rights Agencies. Such laws include, but are not limited to, Title VII of the Civil Rights Act of 1964, the Age Discrimination in Employment Act, as amended, 42 U.S.C. Section 1981, and state and local laws prohibiting discrimination on the basis of age, etc. In consideration of the Post Employment Payment provided for in this Termination Agreement and Release, I intend to give up any rights I may have under these or any other laws with respect to my employment and termination of employment at the Participating Company and acknowledge that the Participating Company (including its subsidiaries and affiliates) has not (a) discriminated against me, (b) breached any express or implied contract with me, or (c) otherwise acted unlawfully toward me. 1. On behalf of myself, my heirs, executors, administrators, successors and assigns, I release and discharge Avaya Inc. (including any "resulting new entity" as defined in the Separation Plan), the various Avaya Inc. Benefit Committees, and their successors, assigns, subsidiaries, affiliates, shareholders, directors, officers, representatives, agents and employees (collectively "Releasees") from any and all claims (including claims for attorneys' fees and costs), charges, actions and causes of action with respect to, or arising out of, my employment or termination of employment with the Participating Company. This includes, but is not limited to, claims arising under federal, state, or local laws prohibiting age, color, race, gender, sexual preference/orientation, marital status, national origin, mental or physical disability, religious affiliation or veteran status or any other forms of discrimination or claims growing out of the Participating Company's termination of its employees. It also includes claims based on theories of contract or tort, whether based on common law or otherwise. This agreement does not limit my right to file charges with government agencies, but with respect to any charges that have been or may be filed concerning events or actions relating to my employment or the termination of my employment and which occurred on or before the date of this Termination Agreement and Release, I additionally waive and release any right I may have to recover in any lawsuit or proceeding brought by me, an administrative agency, or any other person on my behalf or which includes me in any class. (For employees working in California) Section 1542 of the Civil Code of the State of California states: "A general release does not extend to claims which the creditor does not know or suspect to exist in his favor at the time of executing the Release, which if known by him must have materially affected his settlement with the debtor." Notwithstanding the provisions of Section 1542, and for the purpose of implementing a full and complete release and discharge of all Releases, I expressly acknowledge that this Termination Agreement and Release is intended to include not only claims that are known, anticipated or disclosed, but also claims that are unknown, unanticipated and undisclosed. 1. Subject to Paragraph 5 herein, I covenant and agree not to bring any action, suit or administrative proceeding contesting the validity of this Termination Agreement and Release or attempting to negate, modify or reform it, nor to sue any Releasee for any reason arising out of my employment or termination thereof. 1. I understand that this Termination Agreement and Release in no way affects any rights I may have for benefits under the Avaya Inc. Pension Plan for Salaried Employees (APPSE) or the Avaya Inc. Pension Plan (APP). 2. I have no knowledge of any wrongdoing involving improper or false claims against a federal or state governmental agency, or other wrongdoing that involves me or other present or former Participating Company employees. Page 16 of 16 October 13, 2001 1. The construction, interpretation and performance of this Termination Agreement and Release shall be governed by the laws of the state in which I am working on the date of my termination from the Participating Company's payroll, except that state's conflict of laws rules. 1. In the event that any one or more of the provisions contained in this Termination Agreement and Release shall for any reason be held to be unenforceable in any respect under the law of any state or of the United States of America, such unenforceability shall not affect any other provisions of this Release, but, with respect only to that jurisdiction holding the provision to be unenforceable, this Release shall then be construed as if such unenforceable provision or provisions had never been contained herein. 1. I understand that, pursuant to the Older Workers Benefit Protection Act of 1990, I have the right and have been advised to consult with an attorney before signing the Termination Agreement and Release, I have 45 days to consider the Release before signing it, and I may revoke the Release within seven (7) calendar days after signing it. For revocation to be effective, written notice must be received by the Participating Company no later than the close of business on the seventh day after I sign this Termination Agreement and Release. I understand that this revocation can be made by delivering the written notice of revocation to the Executive Compensation and Benefits Manager (below). 1. This Termination Agreement and Release contains the entire agreement between the Participating Company and me and fully supersedes any and all prior agreement or understandings pertaining to the subject matter hereof. I represent and acknowledge that in executing this Termination Agreement and Release, I have not relied upon any representation or statement not set forth herein made by any of the Releases or by any of the Release's agents, representatives or attorneys with regard to the subject matter of this Agreement. 1. All defined terms used in this Termination Agreement and Release shall have the same meaning as the Separation Plan. BY SIGNING THIS TERMINATION AGREEMENT AND RELEASE, I STATE THAT; I HAVE READ IT; I UNDERSTAND IT AND KNOW THAT I AM GIVING UP IMPORTANT RIGHTS; I AGREE WITH EVERYTHING IN IT; I WAS ADVISED TO, AND I AM AWARE OF MY RIGHT TO CONSULT AN ATTORNEY BEFORE SIGNING IT; AND I HAVE SIGNED IT KNOWINGLY AND VOLUNTARILY. - ------------------------------------------------------ Employee Signature Return this Release to: Avaya Inc. Executive Comp and Benefits Attn: Jill Bergently Room 1E100 211 Mt.Airy Road Basking Ridge, NJ 07920 - ------------------------------------------------------ Employee Name Printed - ------------------------------------------------------ Home Phone Number Page 17 of 16 October 13, 2001 - ------------------------------------------------------ Social Security Number - ------------------------------------------------------ Personnel Number - ------------------------------------------------------ Date (this date must be the termination date or later) IN ORDER TO BE VALID, THIS RELEASE MUST BE SIGNED AND RETURNED ON OR AFTER THE TERMINATION DATE, BUT NOT LATER THEN 45 DAYS AFTER THE TERMINATION DATE Page 18 of 16 October 13, 2001 EX-99.1 5 a2086868zex-99_1.txt EXHIBIT 99.1 EXHIBIT 99.1 CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350, AS ADOPTED PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002 In connection with the Quarterly Report of Avaya Inc. (the "Company") on Form 10-Q for the period ending June 30, 2002 as filed with the Securities and Exchange Commission on the date hereof (the "Report"), I, Donald K. Peterson, Chairman and Chief Executive Officer of the Company, certify, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, to my knowledge, that: (1) The Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934; and (2) The information contained in the Report fairly presents, in all material respects, the financial condition and result of operations of the Company. /s/ DONALD K. PETERSON - ------------------------------------------- Donald K. Peterson CHAIRMAN AND CHIEF EXECUTIVE OFFICER
August 14, 2002 EX-99.2 6 a2086868zex-99_2.txt EXHIBIT 99.2 EXHIBIT 99.2 CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350, AS ADOPTED PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002 In connection with the Quarterly Report of Avaya Inc. (the "Company") on Form 10-Q for the period ending June 30, 2002 as filed with the Securities and Exchange Commission on the date hereof (the "Report"), I, Garry K. McGuire, Chief Financial Officer and Senior Vice President, Operations of the Company, certify, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, to my knowledge, that: (1) The Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934; and (2) The information contained in the Report fairly presents, in all material respects, the financial condition and result of operations of the Company. /s/ GARRY K. MCGUIRE - ------------------------------------------- Garry K. McGuire CHIEF FINANCIAL OFFICER AND SENIOR VICE PRESIDENT, OPERATIONS
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