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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
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FORM 10-K
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[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED SEPTEMBER 30, 2000
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
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COMMISSION FILE NUMBER 001-15951
AVAYA INC.
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A DELAWARE I.R.S. EMPLOYER
CORPORATION NO. 22-3713430
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211 MOUNT AIRY ROAD, BASKING RIDGE, NEW JERSEY 07920
TELEPHONE NUMBER 908-953-6000
SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT:
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TITLE OF EACH CLASS EXCHANGE ON WHICH REGISTERED
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Common Stock, par value $.01 per share New York Stock Exchange
Series A Junior Participating Preferred Stock Purchase
Rights New York Stock Exchange
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SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT: NONE.
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [X]
At November 30, 2000, the aggregate market value of the voting common
equity held by non-affiliates was approximately $3.3 billion.
At November 30, 2000, 282,314,887 common shares were outstanding.
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TABLE OF CONTENTS
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ITEM DESCRIPTION PAGE
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PART I
1. Business.................................................... 3
2. Properties.................................................. 27
3. Legal Proceedings........................................... 27
4. Submission of Matters to a Vote of Security-Holders......... 29
PART II
5. Market for Registrant's Common Equity and Related 29
Stockholder Matters.........................................
6. Selected Financial Data..................................... 29
7. Management's Discussion and Analysis of Financial Condition 30
and Results of Operations...................................
7A. Quantitative and Qualitative Disclosures About Market 47
Risk........................................................
8. Financial Statements and Supplementary Data................. 47
9. Changes in and Disagreements with Accountants on Accounting 84
and Financial Disclosure....................................
PART III
10. Directors and Executive Officers of the Registrant.......... 84
11. Executive Compensation...................................... 87
12. Security Ownership of Certain Beneficial Owners and 93
Management..................................................
13. Certain Relationships and Related Transactions.............. 94
PART IV
14. Exhibits, Financial Statement Schedules, and Reports on Form 98
8-K.........................................................
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This Annual Report on Form 10-K contains trademarks, service marks and
registered marks of Avaya and its subsidiaries, and other companies, as
indicated.
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PART I
ITEM 1. BUSINESS.
OVERVIEW
Avaya Inc. is 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 or in converged voice and data products. We have entered these product
areas relatively recently, and our multi-service networking product portfolio is
less complete than the portfolios of some of our competitors. We are
implementing a strategy focused on these products.
We support our customers with comprehensive global service offerings,
including remote diagnostics testing of our advanced systems, installation of
our products, on-site repair and maintenance. We believe our global service
organization is an important consideration for customers purchasing our systems
and software and is a source of significant revenue for us, primarily from
maintenance contracts. We also offer professional services for customer
relationship management and unified communications and value-added services for
the outsourcing of messaging and other portions of an enterprise's
communications system.
We intend to use our leadership positions in enterprise communications
systems and software, our broad portfolio of products and services and strategic
alliances with other technology and consulting services leaders to offer our
customers comprehensive eBusiness communications solutions. We are particularly
focused on delivering business communications that enable eBusiness. By
eBusiness, we mean the internal and external use of communications tools and
electronic networks, to interact, collaborate and transact business with an
enterprise's customers, suppliers, partners and employees. We currently offer
many of the advanced products that we believe are important components of
eBusiness communications solutions. We are focusing our strong research and
development capabilities on developing new and improved eBusiness communications
products and services.
We were incorporated under the laws of the State of Delaware under the name
"Lucent EN Corp." on February 16, 2000, as a wholly owned subsidiary of Lucent
Technologies Inc. As of June 27, 2000, our name was changed to "Avaya Inc." On
September 30, 2000, Lucent contributed its enterprise networking business to us
and distributed all of the outstanding shares of our capital stock to its
shareowners. We refer to these transactions in this Annual Report on Form 10-K
as the "distribution." Lucent was formed from the systems and technology units
that were formerly a part of AT&T Corp. and the research and development
capabilities of Bell Laboratories. On September 30, 1996, Lucent became
independent of AT&T when AT&T distributed all its Lucent shares to its
shareowners in a tax-free spinoff. Prior to the distribution, we had no material
assets or activities as a separate corporate entity. Following the distribution,
we became an independent public company, and Lucent has no continuing stock
ownership interest in us. Prior to the distribution, we entered into several
agreements with Lucent in connection with, among other things, intellectual
property, interim services and a number of on-going commercial relationships,
including product supply arrangements. Please see "-- Relationship Between
Lucent and Our Company After the Distribution" for a more detailed discussion of
these agreements.
Prior to the distribution, we operated as part of Lucent. In connection
with our separation from Lucent, we engaged in a comprehensive review of our
operations, including our organizational structure, products and services and
market segments, with a view toward improving our profitability and our business
performance in the near term. As a result of this review, we adopted a
restructuring plan, with an associated restructuring
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charge, in the fourth quarter of fiscal year 2000. As a result of our
restructuring plan and strategic initiatives, we intend to:
- reduce our costs of products and services;
- reduce our corporate overhead expenses;
- increase our investment in research and development;
- implement a tax strategy tailored to our operations as a stand-alone
company; and
- increase our revenue growth by focusing our sales and product development
efforts on the higher growth segments of our market.
An important component of our strategy is to market our advanced enterprise
communications products as essential components of comprehensive eBusiness
communications solutions. We believe the following trends are driving the
deployment of these advanced communications products:
- the adoption of eBusiness strategies by enterprises;
- increased focus on customer relationship management, or CRM;
- the extension of enterprises beyond their physical facilities to meet the
flexibility, speed to market and reach requirements needed to compete in
a global economy, due to the growth of eBusiness and advances in
networking and software applications; and
- the evolution toward converged voice and data networks.
We offer a broad array of communications systems, software and services
that enable enterprises to communicate with their customers, suppliers, partners
and employees through voice, Web, electronic mail, facsimile, Web chat sessions
and other forms of communication, across an array of devices. These devices
include telephones, computers, mobile phones and personal digital assistants. We
classify these products and services as Enterprise Voice Communications Systems,
Communications Applications, Multi-service Networking and Connectivity
Solutions. Enterprise Voice Communications Systems, Communications Applications
and Multi-Service Networking comprise our Communications Solutions segment. In
addition, our Services Segment is comprised of our customer service,
installation, maintenance and value added services offerings.
Our broad portfolio of products includes products we have developed
internally, products we have obtained through acquisitions, products
manufactured by third parties which we resell and products we have developed
through our strategic alliances with other technology leaders. Our products
range from systems designed for multinational enterprises with multiple
locations worldwide, thousands of employees and advanced communications
requirements to systems designed for enterprises with a regional or local
presence, a single location, and less extensive communications requirements. We
believe that the four primary considerations for an enterprise in selecting our
systems are:
- the reliability of the system;
- the availability and level of service offered around the world;
- the features or applications offered to an enterprise; and
- the system's scalability, or ability to add users, features or
applications as the needs of the enterprise change.
COMMUNICATIONS SOLUTIONS SEGMENT
ENTERPRISE VOICE COMMUNICATIONS SYSTEMS
We are a U.S. leader in sales of enterprise voice communications systems,
our core voice communications products. We offer a broad range of systems to
satisfy the communications needs of a diverse group of enterprises. We offer
systems designed for under five users, as well as systems that can be networked
to
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accommodate an almost unlimited number of users. Our systems are generally
designed to allow an enterprise to add or remove users and have optional
features, including over 450 in our most advanced systems, available to enable
an enterprise to activate additional features as its communications requirements
change. We also design our systems to be easy to administer and use. We provide
technical support and training to our customers, and offer the option of
purchasing remote diagnostic services for some of our products. These diagnostic
services help improve the reliability of an enterprise's systems because we can
identify, through the application of artificial intelligence, problems and
potential problems with that system, often before the customer realizes there
may be a problem.
Advanced systems. In September 2000, we introduced Enterprise Class
Internet Protocol Solutions, or ECLIPS, as a solution name for our most advanced
systems. The ECLIPS family of solutions:
- offers our customers the ability to integrate voice, email and fax
communications using the full range of Avaya solutions and applications
(such as the CentreVu(R) front office call center family of solutions and
the Avaya Unified Messenger(R) for Microsoft Exchange system) and
industry solutions over their converged voice and data networks;
- offers a highly reliable Internet Protocol, or IP, telephony application
over a converged voice, video and data network;
- offers a choice of IP enhancement to a customer's traditional private
branch exchange, or PBX, or an IP PBX, giving the customer the choice of
upgrading its existing equipment for IP communication or installing an IP
PBX on local and wide area networks and using it for voice as well as
data communication without sacrificing feature functionality;
- offers enhancements to the range of economically possible solutions and
applications by supporting remote workers with applications such as call
centers, networked voice mail, and unified messaging;
- increases reliability and availability by alternatively routing calls
over the public switched telephone network or the customer's IP wide area
network based on the availability and the performance of each connection;
and
- supports open standard interfaces, such as the International Telephony
Union, or ITU, standard H.323 for IP telephony over the Internet
Protocol, Computer Telephony Integration application programming
interfaces, Light Directory Access Protocol and the ITU Qsig signaling
standard for interoperability among systems from different vendors.
The first available products in the ECLIPS family of solutions are the
Avaya IP600 Internet Protocol Communication Server, the R300 Remote Office
Communicator, the Avaya DEFINITY(R) IP Solutions software, the Avaya 4612 and
4624 IP Telephones, and the IP Softphone. The Avaya IP600 offers full feature
functionality to the IP telephones that are installed on a customer's local or
wide area network. The Avaya R300 is a remote device that receives its
functionality over an IP network from the DEFINITY IP Solutions software or the
IP600 systems. It offers support for IP telephones and Softphones, analog and
digital multi button telephones, call center agent phones, and local analog and
digital connections on the public switched telephone network. In addition,
enterprises can use the Avaya R300 to extend their network from their larger
locations to their branch office without having to deploy a completely new
system. With the release of the new DEFINITY IP Solutions software, all of our
DEFINITY Enterprise Communications Servers can now be upgraded to provide their
full functionality to converged voice, data and video IP networks. This solution
provides a migration path to an IP infrastructure that minimizes disruption to
end-users while protecting their current infrastructure investments.
Avaya's new 4612 and 4624 IP Telephones bring a complete set of features to
converged voice and data networks. They are compatible with popular personal
computer collaboration and contact management tools and hearing aids and offer
customers flexibility to upgrade their phones by remote download of new software
applications. The Avaya IP Softphone is a software application that runs on a
personal computer and delivers business telephone functionality, offering an
attractive alternative for users that prefer to work solely with their personal
computer.
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Our DEFINITY Enterprise Communications Server is offered in a variety of
configurations in approximately 90 countries. Our DEFINITY product line is a
family of products that provides for a reliable network for voice communication
which offers integration with an enterprise's data network. Our DEFINITY servers
support a variety of voice and data applications such as call and customer
contact centers, messaging and interactive voice response, or IVR systems.
Interactive voice response systems allow an individual to access information in
the enterprise's computer databases or conduct transactions verbally or using a
touch-tone telephone. Our DEFINITY servers support open and standard interfaces
for computer telephony integration applications, which are advanced applications
that assist in the making, receiving or managing of telephone calls. Our
DEFINITY servers facilitate the ongoing transition at many enterprises from
private voice telephone systems to advanced systems that integrate voice and
data traffic and deploy increasingly sophisticated communications applications.
Converged voice and data products. Our DEFINITY product line includes the
DEFINITY IP Solutions and DEFINITY ATM, which both allow an enterprise with
separate voice and data networks to converge all or a portion of its voice
traffic on its data network. DEFINITY IP Solutions consist of software and
hardware that gives our DEFINITY products the capability to operate as:
- a gateway, or point of entry to a network;
- a gatekeeper, or provider of management and flow control across an
enterprise's different types of communications networks; and
- a multipoint conferencing unit, allowing telephone traffic to be carried
along with data in a single multiprotocol network.
In addition, DEFINITY IP Solutions monitors the network, and if, at any
time, the IP network's performance is not acceptable for voice, it will reroute
the voice traffic over its alternate voice network supporting the DEFINITY
system. An enterprise with an existing DEFINITY system may upgrade its system by
adding DEFINITY IP Solutions, and a purchaser of a new DEFINITY system has the
option to include DEFINITY IP Solutions as a part of its DEFINITY system or to
buy a DEFINITY system exclusively comprised of IP telephones. Additionally, our
DEFINITY ATM solution, among other capabilities, enables a customer to utilize a
single DEFINITY switch for voice communications in conjunction with its
asynchronous transfer mode, or ATM, network across multiple geographic
locations. This capability gives our customers the benefit of using
geographically dispersed human resources while getting the benefits of a
centralized family of application servers.
Primarily in Europe, Australia and Japan, we offer two other advanced
systems, the INDeX(TM) and Alchemy(TM) product lines, which are targeted to
small to mid-sized enterprises. These systems are price sensitive offerings and
provide a variety of integrated voice and data applications. INDeX, for
enterprises with 20 to 400 users, supports such functions as Internet Protocol
telephony and customer contact center capability with real time reporting and
IVR systems. Alchemy systems provide basic voice and data communication
capabilities in a single system for small to mid-sized enterprises with two to
192 users.
Additional systems. In addition to our advanced systems, we offer two
primary voice communications systems, our Merlin Magix(TM) and Partner(R)
product lines, targeted at small and mid-sized enterprises with less extensive
to moderately sophisticated communications requirements.
COMMUNICATIONS APPLICATIONS
We offer a broad range of communications applications products which
enhance an enterprise's interactions with its customers, suppliers, partners and
employees. These products include our CRM and voice and unified messaging
solutions. Unified messaging is an advanced messaging solution that delivers the
convenience and benefits of combining the storage of more than one type of
message, including voice, facsimile and electronic mail.
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Customer relationship management solutions. We offer products that are
essential components of many customer relationship management solutions,
including:
- call and customer contact center systems;
- customer self-service applications, including the integration of voice
communications;
- Web collaboration;
- electronic mail response management;
- Web chat; and
- workflow and business process automation products.
We also offer professional services that assist our customers in integrating our
products into their specific business environments and comprehensive customer
relationship management solutions. Typically, a customer that purchases our
customer relationship management products purchases customization and
integration services from our professional services group.
According to a June 2000 Gartner Group report, we are a U.S. leader in
sales of call center systems based on their estimates that our sales of systems
in 1999 represented approximately 28% of total U.S. sales and our call center
systems support approximately 46% of the total number of U.S. customer agent
seats. We are particularly strong in the sale of systems that support over 400
agent seats where we hold, according to Gartner Group, a 53% market share. We
also are a leading provider of IVRs. According to a June 2000 Cahners In-Stat
report, we are the leader in interactive voice response products, having 20% of
the total global sales of interactive voice response systems sold in 1999.
Customer contact centers
Our core product offerings are hardware and software systems and software
applications for customer contact centers, which are a key component of many
customer relationship management solutions. By customer contact center, we are
referring to the customer service and support function served by the combination
of customer agents, an enterprise's voice and data communications systems, as
well as an enterprise's related software applications, such as software
applications designed to respond to customer requests for information and to
service their needs. Database servers, which contain customer records, product
information and trouble-shooting tips, and any related peripheral equipment,
such as the agent's telephone and personal computer are also integrated into the
customer contact center system. The integration of multimedia interactions into
traditional call centers has led to the emergence of customer contact centers.
We use the term contact center to refer to traditional call centers, which
primarily manage an enterprise's interactions with customers via the telephone,
and to contact centers that allow a customer to interact with an enterprise
using multiple mediums of communication, including electronic mail, access from
a Web site, chat rooms, interactive voice response systems, telephone calls and
facsimiles. For example, our customer contact center products can be implemented
so that a potential customer can browse through our customer's existing Web
page, enter a chat room and then click on an icon to reach the customer service
representative. Our customer contact center solutions include software that
manages customer interactions from the initial point of contact through the
operational functions, such as order processing and billing, to fulfillment of
the transaction with the customer, as well as any subsequent accounting or
tracking that needs to be done.
Our customer contact centers are scaleable and can support as few as ten
customer service representatives in a single location, to thousands of customer
service representatives spanning multiple physical locations. We have
traditionally sold our solutions to large and mid-sized enterprises in single or
multiple locations. Due to the growth of eBusiness and the increased focus on
customer relationship management, however, we are expanding our focus to include
selling our products to smaller enterprises which are seeking to enhance
relationships with customers, suppliers, partners and employees and to improve
operational efficiencies through automation of some customer service and
back-office functions.
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A contact center requires a variety of hardware, such as an enterprise
communications server or switch to route traffic. Our core customer contact
center voice communications applications currently work only with our DEFINITY
servers. We are developing new versions of some of these products to be
compatible with servers of multiple vendors. Our customers' comprehensive
customer relationship management solution typically includes automated sales and
services systems that are linked to contact center technology, complemented by
one or more databases that store the information generated through the automated
sales system and contact center. Our customer contact center solutions integrate
with other third party applications and major databases, such as Oracle and
Sybase.
Stand-alone customer relationship management applications
We offer a number of products that can be used either as part of a customer
contact center or on a stand-alone basis. Our customer self-service products
include interactive voice response systems and Web-based self-service
applications. We also offer our workflow and business process automation
applications separately from our customer contact center solutions to perform
functions such as order processing, billing, document processing and accounts
payable integration. These applications are often used by government agencies
and companies in the financial services, health care, and utilities industries.
Key customer relationship management product offerings
We offer a broad range of applications to meet the needs of enterprises of
various types and sizes. These products can be implemented for specific,
stand-alone functionality and can also be implemented in combinations for
broader solutions. For example, the CentreVu product line for contact centers
can be expanded with products including CRM Central(TM) 2000 proactive customer
contact systems and interactive voice response product lines. CRM Central 2000
adds workflow and advanced computer telephony applications to our CentreVu
portfolio. CRM Central 2000 can also be used stand-alone for multimedia business
process automation functionality. Our applications are generally customized for
each enterprise by our professional services consultants. Our product portfolio
includes the following customer contact center solutions and stand-alone
products:
- CentreVu. Our CentreVu product line is a suite of customer contact
products offering predictive and adaptive routing of inbound customer
interactions, including our patented Advocate(TM) software. CentreVu also
offers capabilities to support other types of customer interactions, such
as Web chat, Internet Protocol telephony and electronic mail management
which enterprises can utilize as they slowly expand towards servicing
their customers with multi-media interactions. This suite of products
effectively manages contact centers and enables enterprises to pursue
their business strategies through the integration of Internet-based
interactions. Customers are then able to interact with the enterprise in
the manner they prefer. Our CentreVu product line also includes software
that intelligently routes inbound communications to the agent best suited
to handle the interaction, based on service levels, business rules,
customer profiles and the agent's skill set, work load and usage and
software which allows agents to operate from remote locations. This suite
of voice communications applications can only be used on our DEFINITY
servers.
- CRM Central 2000. Our CRM Central 2000 software is a suite of
applications designed for enterprises that interact with their customers
over a variety of communications media and provides the related office
management required to process and fulfill customer requests. These
interactions include telephone calls, Internet Protocol telephony, Web
chat, data sharing, Web collaboration and electronic mail management and
response activities. This suite of solutions is in an early stage of
adoption by customers. CRM Central 2000 is an integrated solution which
is comprised of five key software components, the combination of which
provide customized, integrated capabilities for managing
customer-oriented work process across an enterprise and helping an
enterprise build lasting, profitable customer relationships. Our current
version of CRM Central 2000 can integrate with many third party
applications, such as interactive voice response systems and can be used
with our DEFINITY server to support voice communications. We are
developing a new version which will be able to integrate voice
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communications on other vendors' servers. This application can be used
either on a stand-alone basis or as part of a customer contact center.
- Viewstar(R). Our Viewstar X workflow and business process software
automates the business processes associated with delivering quality
customer service and is typically used on a stand-alone basis. Viewstar
reduces costs and shortens turn around times for critical business
applications such as loan origination, claims processing and order entry.
- Mosaix(R). Our Mosaix product line automates and synchronizes the
outbound and inbound telephone calls in contact centers and includes
associated call progress analysis tools. Sophisticated calling "campaign"
management and unique call blending applications with multiple options
for integrating inbound and outbound calls are enabled through these
products. Mosaix allows an enterprise to handle sporadic inbound call
overloads and to reduce down time of the customer service agents.
- CONVERSANT(R). Our CONVERSANT Interactive Voice Response System is an
integrated solution that automates common customer interactions for
customers to choose service options themselves, enables people to speak
with computers over the telephone and supports eBusiness with access to
self-service applications. This system can assume some of an enterprise's
repetitive and time consuming tasks such as giving directions or hours of
operation or faxing back order confirmations, which reduces the number of
customer agents an enterprise needs and allows agents to handle matters
which require their knowledge and personal attention. Some small and
mid-sized companies use this product as a stand-alone self-service
application. Further, CONVERSANT can be run with DEFINITY or with other
vendors' servers.
- eIVR(R). Avaya offers E-Interactive Voice Response, or eIVR, for
customers needing a smaller version of IVR software that interfaces with
our Legend and Partner communications systems. eIVR is a customer
relationship management tool that combines IVR technology with the Web
and a customer's phone system.
Professional Services for Customer Relationship Management
We have a team of approximately 900 consultants dedicated to assisting
enterprises in improving their customer relationship management, technology and
execution. Our services range from designing and implementing an enterprise's
customer relationship management technology strategy to setting up and
integrating software applications that an enterprise purchases from us as part
of its customer contact center. Our consultants also work with our sales force
in selling our customer relationship management products.
Typically, a customer that purchases our customer relationship management
products purchases consulting services from us. We also provide subject matter
advice to systems integrators as part of an overall customer relationship
management strategy, as well as to provide guidance to achieve the integration
of multi-vendor solutions.
Voice and unified messaging solutions. We offer a wide variety of voice
messaging and unified messaging solutions designed to serve the telephone call
answering, voice, facsimile and unified messaging communications needs of
enterprises. Unified messaging facilitates access to messages through the most
convenient device, including Internet browsers, LAN-based personal computers and
wireline or wireless telephones, using text-to-speech technology for telephonic
e-mail retrieval. These products are marketed under a number of brands,
including our primary brands, Octel(R) Messaging and INTUITY(TM) AUDIX(R)
Messaging. The ease and speed of our voice and facsimile messaging can improve
an enterprise's efficiency by allowing messages to be sent instantly to teams,
groups or an entire workforce across multiple locations. All of our messaging
servers can be networked, over the Internet or public or private voice networks,
to provide enterprise-wide voice and facsimile messaging through a single
system.
We are the worldwide leader in sales of voice messaging systems. According
to an April 2000 Cahners In-Stat report, our sales of voice messaging systems in
1999 represented approximately 28% of voice messaging mailbox capacity shipped
worldwide. This latter share is almost twice that of our nearest competitor. By
the end of fiscal year 1999, we had sold over 200,000 systems worldwide since
1993, representing a total of over
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100 million messaging mailboxes. Our broad family of messaging products is
serving enterprises today with systems that range from supporting as few as two
users to systems supporting up to 50,000 users and networks of over 100,000
users. Messaging systems include message servers and their associated server
software and messaging-based applications. These systems are configured both as
stand-alone servers or as embedded software or hardware in communications
servers. Many of our messaging systems are compatible with the voice
communications systems of other vendors so that an enterprise may choose our
messaging system as the standard for all its locations. Most of our products
provide spoken prompts in multiple languages for greeting callers and for user
retrieval of messages and are compatible with international standards.
Our unified messaging capability, which accommodates voice, facsimile and
electronic mail messages, is available for our Octel Messaging and INTUITY AUDIX
systems and is also provided by our innovative Avaya Unified Messenger for
Microsoft Exchange, developed in cooperation with Microsoft Corporation. The
Avaya Unified Messenger system is a unified messaging system software solution
that stores voice and facsimile messages directly in a user's Microsoft Exchange
electronic mailbox and enables user access to this mailbox by telephone or fax
machine or a Microsoft Exchange interface on the user's personal computer. The
Avaya Unified Messenger system provides a single directory, common
administration and a single system for all voice, facsimile and electronic mail
messages and is intended to enhance productivity by combining pertinent task
information in a single working environment. The Avaya Unified Messenger system
allows the user to filter incoming calls and route those calls based on the
user's preference.
Our messaging systems also support a number of enhanced business
applications. Using auto-attendant features, OctelDesigner(TM) and
OctelAccess(TM) Server systems, customers have implemented telephone-based
transaction processing, workflow and business process management applications.
These applications include purchase order approvals, sales tracking and
automated customer service. We have recently begun to offer commercially the Web
Communications Server for our Merlin Magix small business system to provide a
small business with a complete Web presence, including hosted Web home pages and
electronic commerce support for on-line customer purchases.
Internet Protocol applications and conferencing. We offer new
communications solutions that use the advantages of the Internet Protocol
operating on the Internet, wireless networks and telephone networks. These
solutions are being designed to serve new areas of customer communications
needs. One of these solutions is our iCosm(TM) suite of unified communications
applications. iCosm enables a personal communications portal for enterprise
employees and is intended to work with new applications for scheduling meetings
with others, filtering incoming calls, organizing, scheduling and routing
incoming calls and messages, scheduling and conducting voice and video
conferencing with others, and conducting advanced multimedia business
collaboration and content sharing. iCosm solutions are intended for use both on
standard enterprise servers and application service providers. Several iCosm
applications are currently available.
We also provide audio, video and data conferencing systems for enterprises
of varying sizes. These products enable customers to conduct multimedia
communication sessions with a geographically dispersed workforce or across
company boundaries. Through partners and internal development, we offer our
customers a broad portfolio of multimedia collaboration solutions, backed by the
full support capability of our nationwide services organization. Our products
include the feature-rich multipoint conferencing unit, a highly-reliable server
for multipoint video conferencing. We also offer the DEFINITY AnyWhere software
product, which, when used in conjunction with our DEFINITY server, enables
spontaneous audio and data conferencing capability for office workers and
telecommuters. Through our purchase of products from third party manufacturers,
we have broadened our portfolio to include a family of industry-leading video
endpoints and a line of highly-scaleable audio conferencing products, ranging
from 24 to 1,152 endpoints.
Professional Services for Unified Communications
We provide professional services to ensure successful integration of our
unified communications products and applications into our customers' specific
business environments. Typically, a customer that purchases our communications
servers and applications requires assistance with their integration and
implementation. Since enterprises are increasingly looking to outsource their
integration needs, we believe that our ability to provide
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these services is an important consideration in selecting our communications
applications. In addition to our geographically deployed associates, we also
have alliances with systems integrators that are trained to implement our
applications.
We provide presales support as well as design and implementation for our
messaging systems solutions. These products include the Octel Messaging and
INTUITY AUDIX systems. In this space, we implement messaging-based applications
that run on stand-alone servers as well as applications that are embedded
software. These solutions include unified messaging, Internet access to voice
mail, and enhanced business applications. Utilizing OctelDesigner and the
OctelAccess Server, we have created innovative telephone applications for
industries including financial service providers, health care providers,
government agencies, and retailers.
MULTI-SERVICE NETWORKING
We offer a portfolio of products to support multi-service network
infrastructures which carry voice, video and data traffic over any of the
protocols supported by the Internet on local area, wide area and wireless
networks. We are not a leader in multi-service networking products or in
converged voice and data products. We have entered these product areas
relatively recently, and our multi-service networking product portfolio is less
complete than the portfolios of some of our competitors. We are implementing a
strategy focused on these products.
Local area network solutions. Our Cajun(TM) switches support voice, video
and data traffic over a local area network, or LAN. Each switch is designed for
interoperability with the hardware of numerous other vendors and is comprised of
hardware and software that enable the switch to perform configuration, fault
management and traffic prioritization functions. Configuration is the adding,
deleting and modifying of connections and supported addresses within a network.
Fault management is the detection and correction of network faults.
Prioritization is the capability to consider the nature of the requirements of
various transmissions to determine the relative order and priority of dealing
with several different types of transmissions. Some transmissions, such as voice
transmissions, tolerate little to no delay for quality reasons and a higher
level of priority is assigned to those transmissions. Our Cajun switches offer
leading uplink capabilities providing connection over ATM backbones to our
Ethernet LAN switches, due to their performance and traffic prioritization
capabilities.
Our Cajun switches also support additional advanced applications, such as
our switch monitoring, known as SMON, the industry standard network monitoring
software for switched network infrastructures, which was developed by Lucent.
SMON is an open standard application which allows simultaneous real time
monitoring of traffic across multiple switches in a network. As an analytical
tool, SMON enables network managers to review global traffic across an entire
network as well as individual connectivity between two users.
Our wireless products provide the ability to operate both indoors and
outdoors, scale from small to large installations, and provide traffic
prioritization. These products enable wireless LAN connectivity across
facilities such as retail stores, warehouses, schools, universities and
hospitals where wiring is costly, difficult to install and clients demand
mobility or flexibility.
Wide area network solutions. We offer wide area network solutions,
including Access Point virtual private network firewall products for
enterprises. A virtual private network allows an enterprise to transport voice,
video or data over a public or shared network at a level of security
substantially equivalent to the traffic traveling over that enterprise's own
private network. This increased level of security is accomplished through
encryption and encapsulation of this voice, video or data traffic into a format
which is protected from unauthorized access. Our wide area network access
products are sold to many types of enterprises and are designed to meet varying
access needs. Our virtual private network routers are used primarily by
enterprises with remote workers and branch or home offices, and by enterprises
using Internet wide area network service. Like our switches, our wide area
network access products are compatible with a variety of industry products and
provide excellent security, scalability and reliability.
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In addition, we offer firewall hardware and software which function as a
security mechanism to limit the exposure of a network to unauthorized
infiltration. The firewall regulates internal and external network resources and
filters network content. Our firewall products have been designed to meet the
testing standards of the U.S. federal government and allow for a single
administrator to manage multiple firewalls for an entire network from a single
location.
Policy management software. We offer automated policy management software
called RealNet Rules(TM). RealNet Rules allows network managers to define,
manage and enforce policies which establish priorities and levels of security
for network traffic, based on parameters such as traffic type, application or
user identification. Examples include a policy which gives voice traffic
priority over data traffic in a network, a policy which gives finance
applications priority at the end of a reporting period, a policy that gives
bandwidth priorities to designated users, such as senior management, or policies
that restrict access to sensitive applications, such as human resources
applications, to only authorized users. Our policy management software products
are designed to allow a single administrator to set policies for all users and
locations from a central location.
AVAYA HOSTED SOLUTIONS
Avaya Hosted Solutions, introduced in October 2000, offer communications
solutions, an emerging category of hosted applications that allow application
service providers, Internet service providers, building service providers and
other next generation service providers, or xSPs, to expand their services
beyond Web hosting to include a broad array of communications applications,
including hosted IP telephony, contact centers, messaging, and collaboration.
These eBusiness communications solutions are complete, integrated solutions that
enable service providers to quickly deliver a comprehensive set of
communications features to enterprises over a highly reliable and secure
multi-service infrastructure, while simultaneously reducing the complexity of
their own implementation and time to market. As part of Avaya Hosted Solutions,
we sell our communication solutions, many of which are market leaders, to xSPs
who will in turn offer these solutions on a service fee basis to end users'
enterprise customers.
Avaya Hosted Solutions include:
- Avaya Hosted Enterprise IP Telephony, a prepackaged communications bundle
that allows xSPs to deliver sophisticated telephony services to
enterprises;
- Avaya Hosted Virtual Telephony, a suite of Avaya's remote communications
applications which enable telecommuters and remote workers to access the
communications capabilities available in the office;
- Avaya Hosted Contact Center Solution, a fully integrated and completely
outsourced contact center; and
- Avaya Hosted Collaboration Solutions, which allows xSPs to offer
enterprise customers completely outsourced collaborative conferencing
services, such as video conferencing, distance learning, streaming video
and video broadcast applications.
CONNECTIVITY SOLUTIONS SEGMENT
We market our SYSTIMAX(R) SCS product line of structured cabling systems
primarily to enterprises of various sizes for wiring phones, workstations,
personal computers, local area networks and other communications devices through
their buildings or across their campuses and our ExchangeMAX product line
primarily to central offices of service providers, such as telephone companies
or Internet service providers. We also offer electronic cabinets to enclose an
enterprise's electronic devices and equipment.
SYSTIMAX structured cabling systems. We estimate, based on a Phillips
InfoTech report in 1999, which is the most recent report currently available,
that we are the worldwide leader in sales of structured cabling systems to
enterprises. We primarily market these products under the brand name SYSTIMAX.
Our SYSTIMAX cabling systems provide high speed multifunctional local area
network interconnections within a single building or a campus through an
infrastructure of copper or fiber cabling and associated connecting apparatus.
The SYSTIMAX copper and fiber apparatus portfolio includes a broad line of
distribution boxes,
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interconnects, shelves, racks, connectors and outlets necessary to connect and
manage large building infrastructure networks.
The current SYSTIMAX product line includes PowerSum and GigaSPEED(R), which
are copper cable systems, and LazrSPEED(R) and OptiSPEED(TM), which are optical
fiber cable systems. PowerSum(TM) and OptiSPEED each support up to one gigabit
transmission and are targeted to price sensitive customers. GigaSPEED and
LazrSPEED are the performance leaders in their respective markets. GigaSPEED
allows the implementation of gigabit ephernet, a high performance protocol for
data transmission, within a building using low cost network electronics.
LazrSPEED is the first multimode solution offering 10 gigabit capability for
distances up to 300 meters for enterprise networks. We provide a warranty that
our SYSTIMAX cabling systems will support an enterprise's standards-based
applications and that our products are free of manufacturing defects for 20
years.
ExchangeMAX structured cabling system. We sell our ExchangeMAX structured
cabling systems primarily to central offices of service providers such as
telephone companies or Internet service providers. Central offices are locations
that house switches to serve the subscribers of a service provider. Our
ExchangeMAX system combines our family of high quality central office
connectivity products with an overall system architecture to support the copper
and fiber cable distribution networks of a central office. Our products include
copper distributing frames, copper cable, connectors, patchcords and cable
management software. The ExchangeMAX product line is engineered to meet the
site-specific needs of our customers, and may be utilized either to address the
discreet maintenance and upgrading needs of a central office or to serve as the
foundation of a central office's comprehensive wire center modernization.
Electronic cabinets. An electronic cabinet is a sturdy environmental
enclosure designed to house electronics devices and passive equipment, both in
the outside plant and inside buildings. The product line consists of enclosures
designed for traditional telecommunication access applications, digital
subscriber line, or DSL, applications and wireless applications.
SERVICES SEGMENT
CUSTOMER SERVICE, INSTALLATION AND MAINTENANCE
We have customer service, installation and maintenance organizations in the
United States and internationally, with approximately 11,650 employees engaged
in these services as of September 30, 2000. Our service organization is designed
to provide a comprehensive set of services in support of direct and indirect
channels. We provide these services globally either directly or through our
distribution partners. Installation generally is included in the purchase price
of our products, and most of our products, other than our Connectivity
Solutions, have a one year warranty. For additional service, our customers can
elect to enter into maintenance contracts with us or, if they do not choose to
enter into such contracts, may have us provide service for them on a time and
materials basis.
U.S. Services
Our U.S. service organization is comprised of our Field Services
Organization, our National Customer Care Centers and our Technical Services
Organization, with approximately 10,700 employees as of September 30, 2000. Some
of these employees are now working on an on-call basis as described under
"Employees." Installation and repair of our products are performed primarily by
our Field Services Organization. Account support in the United States is
conducted primarily through our National Customer Care Centers. Technical
support and maintenance under contracts for our voice communications products
are provided by our Technical Services and Field Services Organizations. We use
Lucent and our distribution partners to service our converged voice and data
products. We are currently establishing our own internal data service
capabilities, using as a base, the data service technicians and managers that
were transferred to us from Lucent in connection with the distribution.
Field Services Organization. Our Field Services Organization provides
installation, on-site repair and move, add and change services for our
customers, and represents the largest part of our U.S. services
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organization. This organization is uniform across the 48 contiguous states,
which allows our national accounts to receive the same type and level of support
in each location. Most of our Field Services Organization employees are based in
the field, performing site visits to customer premises. When on-site technical
presence is required for a repair, a customer service representative from our
Technical Services Organization will dispatch a technician or a team of
technicians from our Field Services Organization, which provides installation
and provisioning support to the customer. Installation and aftermarket moves,
adds and changes will be dispatched to the Field Services Organization from a
National Customer Care Center. At installation of a system, our Field Services
Organization, directly or through third parties, also provides training on the
system that is tailored to the individual needs of our customers to assist them
in maximizing performance of our products.
National Customer Care Centers. We have three primary National Customer
Care Centers in the United States, as well as several smaller centers for
specific market segments such as centers that service some of our federal
government customers. Our National Customer Care Centers serve as the hub of our
domestic customer service operations. Customers can contact us at these centers
to place orders for parts relating to our products or systems or to request
other services. As needed, service representatives at these centers route calls
from customers to the appropriate office such as requests for maintenance
contracts or repairs, which are directed to the Technical Services Organization.
Our billing and collection activities also are administered at our National
Customer Care Centers.
In addition to supporting our customers, our National Customer Care Centers
are designed to generate revenue for us. Our customer service representatives at
these centers have frequent interactions with our customers and are trained to
market product and systems upgrades during these interactions, routing to the
account teams as appropriate. We also generate revenue from customers which do
not have maintenance contracts with us but which call our National Customer Care
Centers seeking moves, adds and changes to their systems. Our customer service
representatives will dispatch technicians to these customers to provide the
services requested and these customers will in turn be billed for the
technicians' time and the materials used.
Technical Services Organization. We have three Technical Services
Organization Centers in the United States. Customers can contact us at these
centers to obtain remote technical assistance, request on-site technical
support, or request maintenance or repair services.
In addition to routine maintenance and support, we offer our customers a
remote diagnostic service which is administered by our Technical Service
Centers. We have developed systems that can access a customer's systems
remotely, whether purchased directly from us or from one of our distribution
partners, and can identify, through the application of artificial intelligence,
problems and potential problems with that system often before the customer
realizes that there may be a problem. We can often solve the problems that we
identify without the customer ever knowing that we intervened. If we cannot
solve the problem remotely, we arrange to have a technician from our Field
Services Organization dispatched to the customer's premises to provide the
necessary solution. This service is covered under the terms of the customer's
maintenance contracts, and is charged on an hourly time and materials basis if
the customer is not under our warranty or maintenance terms. Maintenance
contracts are administered and contract entitlement verification is conducted by
our Technical Services Organization. Generally, these maintenance contracts have
terms of one to four years and are entered into when a customer purchases one of
our systems. The more complex the product or system, the more likely the
customer will enter into a maintenance contract.
For our less sophisticated products and systems, customers enter into
maintenance contracts or, more often, receive service from us on a time and
materials basis or from third parties. We have entered into agreements with
Expanets, Inc., by which we have sold them the maintenance contracts for some of
our less sophisticated products and have allowed them to provide maintenance
services to those customers to which they sell products and systems, or
customers which do not have maintenance contracts with us. We have agreed to
provide outsourcing services for the maintenance contracts we transferred to
Expanets until March 31, 2003, and for remote diagnostics and maintaining
technical support for their contracts until March 31, 2005.
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Our Data Services Organization provides technical support, installation,
integration and managed services for our data networking and converged
customers. Our Data Support Organization is comprised of remote support
personnel working in concert with our field-deployed engineers. This
organization can support products of multiple vendors and holds many industry
certifications.
International Services
Our international service organization is comprised of Field Services
Organizations, a Global Support Organization and a Customer Support Center which
provide installation, maintenance and customer service support, with
approximately 950 employees, as of September 30, 2000.
Field Services Organizations. We have our own Field Services Organizations
in 21 countries. Our Field Services Organizations currently provide
installation, on-site and remote maintenance, and some training for our voice
and data products. These organizations primarily support customers which have
purchased from us directly. In those countries in which we have no direct
services presence, customers of our products rely on local distribution partners
which have been trained and certified by us. Our Field Services Organizations
supplement their engineer and technician resource requirements via the use of
sub-contractors on an as needed basis for responsive service levels and broad
geographic coverage.
Customer service also is currently performed by the Field Services
Organizations. Their services include customer call receipt, contract
entitlement verification, quoting of service rates, administering of maintenance
agreements, providing remote maintenance support on communications systems and
software applications, dispatching engineers and technicians and billing and
collection. Some of these activities will be transitioned to our Customer
Support Centers in the future.
Global Support Organization. Similar to our U.S. Technical Services
Organization, our Global Support Organization is a network of support centers
which provide remote technical and engineering support to the Field Services
Organizations, distributors and resellers and select multi-national customers
with multi-national maintenance agreements. This organization is comprised of
twelve regional centers, which we call "Centers of Excellence," which are
located to provide wide geographic coverage to our international customers.
These twelve centers provide a higher level of skilled technical and
engineering support to Field Services Organizations and distribution partners on
complex communications products, such as voice, data and video and application
solutions for both installation and maintenance services. Each Center of
Excellence utilizes a sophisticated suite of desktop technology, tools and
software applications to deliver high quality, effective remote support. Our
distribution partners are responsible for providing installation and basic
maintenance support to their customers for products sold by them. Our Global
Support Organization provides remote installation and maintenance support to the
international services organizations and our network of international
distribution partners.
Customer Support Centers. We have established a Customer Care Center in
our Europe, Middle East and Africa region and expect to open an additional
Customer Care Center in our Asia Pacific region by the end of 2001. We intend
the level of customer service to be provided at our Customer Care Centers to
include servicing requests received via telephone, facsimile and electronic
mail, receipt of product orders, order fulfillment and tracking, contract
management and administration, contract entitlement verification, invoicing,
billing and collection. We expect some of the support functions currently
performed by the Field Service Organizations also will migrate to the Customer
Support Centers by the end of 2001.
VALUE-ADDED SERVICES
Our value-added services are outsourcing services we provide to both
enterprises and to communications service providers, such as local exchange
carriers, or telephone companies, or Internet service providers, worldwide to
operate and maintain a portion of their communications systems.
Our enterprise customers which use our value-added services are generally
large and mid-sized businesses. For enterprise customers, we provide outsourcing
of messaging systems, portions of voice
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communications systems and contact centers. We offer these customers a full
range of maintenance, management and support services. We provide either managed
services where the customer owns the communications system or outsourcing
services where we both manage and own the communications system. Our services
include fault management, including maintenance and help desk support; remote
provisioning and administration, such as establishment of voice mail boxes;
remote monitoring; and recording, reporting and billing.
For service providers, we primarily outsource the operation of their
messaging systems. We outsource messaging systems for established service
providers, emerging service providers and other competitive local exchange
carriers. Currently, we derive the majority of our revenue in value-added
services from customers in the United States.
We contract with our clients to provide these services, in varying levels,
under agreements that require us to meet service level requirements that vary
from agreement to agreement. Fee arrangements vary by contract, but are
generally made on a per unit or per subscriber basis. These agreements typically
have terms ranging from five to seven years with varying termination provisions.
CUSTOMERS, SALES AND DISTRIBUTION
CUSTOMERS
A broad set of enterprises ranging from large, multinational enterprises to
small and mid-sized enterprises to governments and schools are our customers.
They include established enterprises, dot.coms and other start-up ventures, as
well as service providers, including application service providers and Internet
service providers. We have thousands of customers, and no single customer
represented more than 10% of our revenue for fiscal 2000.
SALES AND DISTRIBUTION
In fiscal 2000, we derived 79% or approximately $6.1 billion of our total
revenue from sales in the United States and 21% or approximately $1.6 billion
from international sales. Our products other than our SYSTIMAX structured
cabling systems are sold both directly and through our worldwide network of
distribution partners. Our SYSTIMAX structured cabling systems are sold only
indirectly through a worldwide network of distribution partners. Our ExchangeMAX
structured cabling systems and our value-added messaging services are sold to
service providers and enterprises worldwide. With respect to service providers,
our value-added services are marketed primarily through the Lucent service
provider sales organization and we are currently analyzing alternatives to our
current distribution channel. We also have a Government Solutions Group that
focuses on sales of our products and services, including our connectivity
solutions, to government and government agencies in the United States and
internationally.
Our multi-channel sales organization, including our direct sales force and
our network of distribution partners, is described below.
Direct sales. Our worldwide direct sales organization markets and sells
our voice, data, messaging and customer relationship management products and
services, as well as our value-added services. As of September 30, 2000, our
worldwide sales organization was comprised of approximately 5,200 individuals,
including managers, sales representatives, technical and operational support
personnel, and indirect channel support. Within the United States, the majority
of our large, end-user customers are served directly through direct sales
account managers. Outside the United States, we conduct direct sales focused on
large enterprises in major areas, including Western Europe, South America,
Mexico, Australia, Central America and Russia with other customers and
geographic areas served by our network of distribution partners. Our account
managers are responsible for selling our systems, software and professional
services as well as managing customer relationships on an on-going basis. Until
recently, the majority of our account managers focused on our voice
communications products. We are implementing programs to train our account
managers also to sell our multi-service networking products, communications
applications and eBusiness solutions. We believe our sales force has developed
relationships with many of the large, multinational enterprises that are likely
to seek
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advanced, comprehensive eBusiness solutions. We intend to improve the efficiency
and expand the capacity and capabilities of the direct sales force by utilizing
our growing network of global partners to provide product fulfillment and to
deliver high quality local service on a worldwide basis.
Within this sales organization, our Government Solutions Group focuses on
sales of our products and services to governments and government agencies
worldwide. In the United States, the Government Solutions Group is responsible
for selling our entire line of products and services to federal government
agencies. Internationally, the Government Solutions Group sells our products and
services both to foreign governments and to federal government offices located
outside of the United States.
Indirect Sales. We have a worldwide network of distribution partners which
comprise our indirect sales channel. When selling our products indirectly, we
primarily sell our products through approximately 20 distributors worldwide from
whom our network of approximately 2,800 dealers, value-added resellers and
system integrators purchase and resell our products to the end user. Our
relationships with distributors, dealers, value-added resellers and systems
integrators for our voice and data products and our structural cabling systems
are generally not exclusive. We typically enter into agreements with our
distributors, dealers and value-added resellers that generally set forth sales
quotas and service levels, with terms of one to two years and rights to
terminate by either party upon 120 days notice. Specific terms vary from
agreement to agreement. We are in the process of developing formal global
alliance agreements with our systems integrator partners. We intend that these
agreements will be structured as joint-development, joint-marketing and/or
joint-sales-and-delivery agreements. We expect these agreements will vary by
alliance.
DISTRIBUTORS
Distributors generally purchase products from us directly and pass those
products on to dealers, value-added resellers and system integrators which sell
our products to the end user. Internationally, distributors also may support our
direct sales by supplying or installing products sold by our account managers.
As of September 30, 2000, we had relationships with approximately 10
distributors in the United States and approximately 10 distributors
internationally that resulted in sales of our systems and software, which were
material relative to total distributor sales. Many of our distributors only
resell our products to resellers such as dealers and value-added resellers and
do not sell to the end-user customer.
DEALERS, VALUE-ADDED RESELLERS AND SYSTEMS INTEGRATORS
Dealers and value-added resellers primarily purchase our products from our
network of distributors to sell our products to customers on a retail basis. As
of September 30, 2000, we had relationships with approximately 1,200 dealers and
value-added resellers in the United States. Approximately 800 of these
distribution partners sell one or more of our voice products and approximately
300 sell one or more of our converged voice and data products. Internationally,
we generally have relationships with dealers and value-added resellers on a
country-by-country basis, with the number per country ranging based on the sales
potential.
Our principal U.S. dealer is Expanets, which in March 2000 purchased the
sales function of our voice communications systems for small and mid-sized
enterprises with 250 or fewer employees. Expanets is the largest dealer for this
market segment in the United States. These sales were formerly conducted by us
using a direct sales force of approximately 1,800 employees, including sales
associates, sales support and management, substantially all of whom were
transferred to Expanets. This sale was part of our strategy to use multiple
distribution channels designed to better serve our customers by using their
preferred distribution channel. We believe small to mid-sized enterprises
increasingly prefer to purchase through distributors, dealers, value-added
resellers and systems integrators rather than from our direct sales force
because the distribution partners are better able to focus on their specific
customer segment and can provide a variety of technologies and services aimed at
small and mid-sized enterprises. Our sale to Expanets was also part of our
efforts to focus our direct sales force on segments of the market that we can
more cost effectively serve.
Systems integrators generally design complete, made-to-order communications
and eBusiness communications systems and solutions, often utilizing the products
of several manufacturers. Systems integrators
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primarily recommend our systems and software to customers as part of a system,
and we bill the customers directly. They also purchase products from our
distribution partners directly for incorporation into their systems. We have
partnered with both local systems integrators, which provide services catered to
the individual needs of our geographically diverse customer base, as well as
regional and global systems integrators to meet the technology and application
driven needs of our large, multinational customers. As of September 30, 2000, we
had relationships with approximately 23 global systems integrators, as well as
with smaller local and regional system integrators.
SYSTIMAX STRUCTURED CABLING SALES CHANNEL
Substantially all of our SYSTIMAX structured cabling systems are sold
through our approximately 50 distributors, and a majority of these sales are
through two of these distributors. The distributors sell both to our worldwide
network of approximately 2,400, dealers, value-added resellers, systems
integrators and contractors and to end-user customers. If our relationship with
either of our two main distribution partners should terminate, we may experience
short-term delays in the United States, but we believe we could use other
parties to replace these distributors. Internationally, we generally have
relationships with our distribution partners on a country-by-country basis, with
the number per country ranging based on the sales potential.
RESEARCH AND DEVELOPMENT
We intend to invest an amount equal to approximately 9% of our total
revenue in fiscal 2001 in research and development. These investments represent
a significant increase over our investments in research and development over the
previous three fiscal years, which was approximately 6% of total revenue for
each of those years. Historically, as a part of Lucent, we were allocated a
portion of Lucent's basic research, which did not necessarily directly benefit
our business. In the future, our investments in research and development will
have a greater focus on our products.
In October 2000, we formed Avaya Labs, a world-class research and
development organization with over 3,000 research and development professionals
who were formerly part of Lucent's Bell Laboratories, one of the world's leading
research and development institutions. Avaya Labs includes a basic research
organization of 50 professionals, which we intend to grow to 100 professionals,
focused on technologies that will result in innovative products and services.
We plan on using our substantial investment in research and development to
develop new systems and software related to business communications
applications, customer relationship management innovations, messaging solutions,
personalized information portals, business infrastructure and architectures, Web
centers, hosted solutions, data networks and services for Avaya's customers.
These new systems and software will augment our current product offerings so
that, together with our strategic alliances and services, we can offer our
customers comprehensive eBusiness communications solutions. Avaya Labs will
continue to seek opportunities to work with technology leaders from other
companies and educational and research institutions to develop uniform
technological standards as the building blocks for future communications and
related enterprise systems.
MANUFACTURING AND SUPPLIES
Currently, we employ approximately 5,000 employees to perform our
manufacturing in 11 facilities located in China, France, India, Ireland, Israel,
the United Kingdom, the United States, Australia and Venezuela. Of these
employees, approximately 2,900 employees are engaged in the manufacturing of our
connectivity solutions product offerings in four facilities located in China,
the United States, Australia and Venezuela. As part of our manufacturing
initiative, we intend to outsource substantially all of our manufacturing,
including assembly and testing, other than the manufacturing of our connectivity
solutions product offerings. Our manufacturing initiative may be delayed or
prohibited by a legal proceeding brought by a governmental agency, which may
disrupt our operations or result in unanticipated costs. Please see "Legal
Proceedings" for a description of this legal proceeding.
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Products which we purchase from third party manufacturers do not constitute
a significant portion of our total revenue. Due to an industry-wide shortage of
certain ceramic components, we have experienced delays in shipments of certain
of our Cajun switches, resulting in a backlog in orders for such products. Our
sole supply source for these components is the primary supplier of such
components to the industry. We are negotating with this supplier to obtain
greater quantities of the components, but we cannot assure you that we will be
successful in securing sufficient supply to meet our needs or that our inability
to supply a sufficient number of switches to meet demand on a timely basis, or
at all, will not have an adverse effect on our results of operations.
Except as provided in the proceeding paragraph, we believe we have adequate
sources for the supply of the components of our products and for the finished
products that we purchase from these third parties. We currently have only a
single source of supply for several of our wide area network multi-service
networking products, including the Access Point virtual private network product,
PacketStar AX ATM access servers, SuperPipe multi-service routers, Max3000
access switches and our firewall/virtual private network gateway products. As
part of the distribution, we entered into a long-term relationship with Lucent
to purchase some of these products as well as other local area networking
products. In addition, we purchase the fiber components of our SYSTIMAX
structured cabling systems and our wireless local area networking products from
Lucent. Also, we entered into an agreement with Lucent for the supply of various
semiconductor components. These contracts are terminable upon customary terms
such as material breach or insolvency. We intend to continue to purchase our
ClearTrac(TM) frame relay voice access devices from Clarent Corporation and our
wide area networking devices from Paradyne Corporation. Our contract with
Clarent Corporation allows us to purchase similar products from alternative
manufacturers as needed. Our contract with Paradyne restricts our ability to
purchase similar products. Each contract expires in 2001 and is terminable upon
customary terms such as material breach or insolvency. We intend to renegotiate
each of these contracts prior to their expiration. We also intend to expand our
own wide area network capabilities.
If we were unable to purchase products for which we have a single source of
supply, it would be difficult to replace them and our competitive position in
supplying converged voice and data products would be harmed. Because of the
growing importance of converged voice and data products, our overall competitive
position also may be harmed if a termination occurs unless we develop our own
products or find other similar products on a timely basis. We may offer
additional products for sale in the future purchased from a single source of
supply.
For detailed descriptions of the products described in this section, please
see "-- Products and Solutions."
COMPETITION
The market for communications systems and software is quickly evolving,
highly competitive and subject to rapid technological change. Because we offer a
wide range of systems and software for several types of enterprises, we have a
broad range of competitors. Many of our competitors are substantially larger
than we are and have significantly greater financial, sales, marketing,
distribution, technical, manufacturing and other resources. Competition for one
or more of our communications systems and software, other than our structured
cabling systems, include products manufactured or marketed by a number of large
communications equipment suppliers, including Nortel Networks Corporation, Cisco
Systems, Inc., Siemens Aktiengesellschaft, Alcatel and LM EricssonAB, as well as
by a number of other companies, some of which focus on particular segments of
the market such as customer relationship management. Some of our other
competitors include Aspect Communication Corporation and NEC Corporation. Our
structured cabling systems' primary competitors are ADC Telecommunications,
Inc., Telect Corporation, Siecor Corporation, Marconi plc, Nordx/CDT, Commscope,
Inc. and Belden Inc. Our professional services compete primarily with services
from vendors such as Nortel Networks Corporation, eLoyalty Corporation,
PricewaterhouseCoopers LLC, Cap Gemini S.A., IBM Global Services, Oracle
Corporation and Alcatel that offer similar products and professional services.
Our value-added services compete with Cisco Systems, Inc., Williams
Communications Group, Inc., Nortel Networks Corporation, Siemens
Aktengesellschaft, Ericcson, Ameritech Corporation and
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Verizon Communications Inc. We expect to face increasing competitive pressures
from both current and future competitors in the markets we serve.
Our competitive position varies depending on the segment of our market. We
are a leader worldwide in messaging and structured cabling systems and the U.S.
leader in call center and enterprise communications systems. With respect to
multi-service networking products, we are relatively new and our product
portfolio is less complete than that of many of our competitors. Our
professional services and value-added service groups primarily serve customers
which purchase our systems and software and are relatively small as compared to
our competitors. We believe that the Lucent name has significant value and has
enhanced our competitive position historically. It is too early to assess
whether the change of our name to Avaya will affect our competitive position. We
have agreements with Lucent that allow us to use Lucent's name and logo and to
verbally describe our previous relationship with Lucent for a period of time
following the distribution. Please see "-- Patents, Trademarks and Other
Intellectual Property" for a discussion of these agreements.
Technological developments and consolidation within the communications
industry result in frequent changes to our group of competitors. The principal
competitive factors in the product segment of our market include:
- product features and reliability;
- customer service and technical support.
- relationships with distributors, value-added resellers and systems
integrators;
- an installed base of similar or related products;
- relationships with buyers and decision makers;
- price;
- brand recognition;
- the ability to integrate various products into a customer's existing
network; and
- the ability to be among the first to introduce new products.
The principal competitive factors in the professional services segment of
our market include:
- focus on the customer's specific needs;
- project management and change management skills;
- business model as well as technical architecture and information systems
design skills;
- product-specific expertise;
- eBusiness experience and expertise;
- speed of delivery;
- industry, business process and general business expertise; and
- objectivity of advice provided.
PATENTS, TRADEMARKS AND OTHER INTELLECTUAL PROPERTY
In connection with the distribution, Lucent assigned to us its rights to a
number of patents, trademarks, copyrights, trade secrets and other intellectual
property directly related to and important to our business. In addition, Lucent
and its subsidiaries have also granted rights and licenses to those of their
patents, trademarks, copyrights, trade secrets and other intellectual property
which enable us to manufacture, market and sell all our products. Further,
Lucent has conveyed to us numerous sublicenses under patents of third parties.
We have entered into a cross license with Lucent in connection with these
patents.
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Lucent has assigned to us in excess of 1,500 U.S. patents and patent
applications and their respective corresponding foreign patents and patent
applications, as well as numerous trademarks, both in the United States and in
foreign countries. that the transferred trademarks are the primary trademarks
used in the sale of our products and services, except for the Lucent and Bell
Laboratories names.
We have commenced marketing our products under our new name, "Avaya."
However, until December 31, 2000, we have the limited ability to use Lucent's
corporate mark and logo on a royalty-free basis without other marks, and in
conjunction with the name "Avaya" and trademarks in a transition mark or logo.
With respect to the manufacture of certain products, this period will be nine
months. Beginning January 1, 2001, for an additional six months in the United
States and twelve months outside of the United States, we have the limited
ability to refer to Lucent's corporate name without use of Lucent's logo on a
royalty-free basis without other marks and in conjunction with our own trade
name and trademarks. The rights granted to use the Lucent name and logo are
applicable only to our products as of the distribution and not to any products
developed by us after the distribution.
Avaya's intellectual property policy will be to protect our products and
processes by asserting our intellectual property rights where appropriate and
prudent. We will also obtain patents, copyrights, and other intellectual
property rights used in connection with our business when practicable and
appropriate.
EMPLOYEES
As of September 30, 2000, we employed approximately 31,000 full-time
employees, including approximately 3,500 research and development employees,
3,500 account managers, 6,700 field service employees and 800 employees in
professional service. Of these 31,000 employees, approximately 20,000 are
management and non-union-represented employees and approximately 11,000 are U.S.
union-represented employees covered by collective bargaining agreements. On May
31, 1998 Lucent entered into a collective bargaining agreement with the
Communications Workers of America and the International Brotherhood of
Electrical Workers. In connection with the distribution, we assumed the
obligations under the agreement with respect to our union-represented employees.
The agreement is effective until May 31, 2003 unless the parties reach a mutual
agreement to amend its term. We believe that we generally have a good
relationship with our employees and the unions that represent them. We are
subject from time to time to unfair labor charges filed by the unions with the
National Labor Relations Board. If we are unsuccessful in resolving these
charges or the legal proceeding which Region 6 of the National Labor Relations
Board has brought against Lucent results in an adverse decision, our operations
may be disrupted, our initiative to outsource substantially all of our
manufacturing may be delayed or prohibited or we may incur additional costs that
may decrease our profitability. See "-- Legal Proceedings" for a description of
the legal proceeding that has been brought against Lucent and may affect us.
In October 2000, we entered into an agreement with the unions representing
our U.S. Services employees to offer eligible employees the ability to retire
from Lucent as of September 30, 2000 and continue working as on-call support
service technicians at Avaya. The agreement was intended to give us the
flexibility to match our workforce needs with our customers' cyclical service
demands for the design, installation and maintenance of their communications
systems.
BACKLOG
Our backlog, which represents the aggregate of the sales price of orders
received from customers, but not yet recognized as revenue, was approximately
$495 million and $788 million on September 30, 2000 and September 30, 1999,
respectively. The majority of these orders are fulfilled within two months.
However, all orders are subject to possible rescheduling by customers. Although
we believe that the orders included in the backlog are firm, some orders may be
cancelled by the customer without penalty, and we may elect to permit
cancellation of orders without penalty where management believes it is in our
best interests to do so.
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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 United States, governing
the cleanup of soil and groundwater contamination. Such provisions impose
liability for the costs of investigating and remediating releases of hazardous
materials at our 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 approximately
five 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
environmental liabilities will not exceed the amount of reserves for such
matters or will not have a material adverse effect on our consolidated financial
position, results of operations or cash flows.
RELATIONSHIP BETWEEN LUCENT AND OUR COMPANY AFTER THE DISTRIBUTION
In connection with the distribution, we entered into a Contribution and
Distribution Agreement and a number of ancillary agreements with Lucent for the
purpose of accomplishing the contribution to us of Lucent's enterprise
networking business and the distribution. These agreements govern the
relationship between Lucent and us subsequent to the distribution and provide
for the allocation of employee benefit, tax and other liabilities and
obligations attributable to periods prior to the distribution. The ancillary
agreements include:
- Interim Services and Systems Replication Agreement;
- Commercial Agreements;
- Employee Benefits Agreement;
- Intellectual Property Agreements;
- Development Project Agreement;
- Tax Sharing Agreement; and
- Real Estate Agreements.
In addition, the current Federal Tax Allocation Agreement and the current
State and Local Income Tax Allocation Agreement by and among Lucent and its
subsidiaries governing the allocation of income taxes among Lucent and its
subsidiaries continues to apply to us for taxable periods prior to and including
the distribution. Of the agreements summarized below, the material agreements
are incorporated by reference as exhibits to this Annual Report on Form 10-K and
the summaries of such agreements are qualified in their entirety by reference to
the full text of such agreements.
CONTRIBUTION AND DISTRIBUTION AGREEMENT
The Contribution and Distribution Agreement sets forth the agreements
between us and Lucent with respect to the principal corporate transactions
required to effect the contribution and the distribution, and other agreements
governing the relationship between Lucent and us.
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THE CONTRIBUTION AND THE DISTRIBUTION
To effect the contribution, Lucent transferred or agreed to transfer, or to
cause its subsidiaries to transfer, the assets of its enterprise networking
businesses. In general, we assumed, or agreed to assume, and perform and fulfill
all of the liabilities of the contributed businesses in accordance with their
respective terms. Pursuant to the Contribution and Distribution Agreement, the
distribution was effected as of 11:59 p.m. on September 30, 2000.
We are in discussions with Lucent regarding certain matters associated with
the contribution and distribution. The items in question relate primarily to the
settlement of certain obligations with respect to the employees transferred to
us by Lucent, receivables related to our businesses and other items related to
the transfer of certain assets and liabilities by Lucent to us upon the
distribution. While we do not believe that the resolution of these open items
will have a material adverse effect on our results of operations, there can be
no assurance that such resolution will not have a material adverse effect on our
financial position or cash flows.
RELEASES AND INDEMNIFICATION
The Contribution and Distribution Agreement provides for a full and
complete release and discharge of all liabilities existing or arising from all
acts and events occurring or failing to occur or alleged to have occurred or to
have failed to occur and all conditions existing or alleged to have existed on
or before the date of the agreement, between or among us or any of our
subsidiaries or affiliates, on the one hand, and Lucent or any of its
subsidiaries or affiliates other than us, on the other hand, except as expressly
set forth in the agreement. The liabilities released or discharged will include
liabilities arising under any contractual agreements or arrangements existing or
alleged to exist between or among any such members on or before the date of the
agreement.
We have agreed to indemnify, hold harmless and defend Lucent, each of its
affiliates and each of their respective directors, officers and employees, from
and against certain liabilities relating to, arising out of or resulting from
the contribution and the distribution or any material breach by us of the
agreement or any of the ancillary agreements. Lucent has agreed to indemnify,
hold harmless and defend us, each of our affiliates and each of our respective
directors, officers and employees from and against all liabilities related to
Lucent's businesses other than the contributed businesses and any material
breach by Lucent of the agreement or any of the ancillary agreements.
Also, Lucent has indemnified us and our affiliates, subject to limited
exceptions, against any claims of patent, copyright or trademark infringement or
trade secret misappropriation with respect to any product, software or other
material provided by or ordered from Lucent's retained businesses prior to the
distribution.
CONTINGENT LIABILITIES AND CONTINGENT GAINS
The Contribution and Distribution Agreement provides for indemnification by
us and Lucent with respect to contingent liabilities primarily relating to our
respective businesses or otherwise assigned to each of us, subject to the
sharing provisions described below. In the event the aggregate value of all
amounts paid by us or Lucent, in each case, together with any affiliates in
respect of any single contingent liability or any set or group of related
contingent liabilities is in excess of $50 million, we and Lucent will share
portions in excess of the threshold amount based on agreed upon percentages.
The Contribution and Distribution Agreement also provides for the sharing
of some contingent liabilities, which are defined as:
- any contingent liabilities that are not primarily contingent liabilities
of Lucent or contingent liabilities associated with the contributed
businesses;
- some specifically identified liabilities, including liabilities relating
to terminated, divested or discontinued businesses or operations; and
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- shared contingent liabilities within the meaning of the separation and
distribution agreement with AT&T Corp.
Lucent will assume the defense of, and may seek to settle or compromise,
any third party claim that is a shared contingent liability, and those costs and
expenses will be included in the amount to be shared by us and Lucent.
The Contribution and Distribution Agreement provides that we and Lucent
will have the exclusive right to any benefit received with respect to any
contingent gain that primarily relates to the business of, or that is expressly
assigned to, us or Lucent, respectively.
The Contribution and Distribution Agreement provides for the establishment
of a contingent claims committee comprised of one representative designated from
time to time by each of Lucent and us and sets forth procedures for the purpose
of resolving disagreements among the parties as to contingent gains and
contingent liabilities.
RESTRICTIONS ON BUSINESS TRANSACTIONS
Subject to Lucent's ability to terminate some of the rights, including
important intellectual property rights granted to us and our affiliates under
the ancillary agreements, the Contribution and Distribution Agreement provides
that none of Lucent, us, or our respective subsidiaries or affiliates will have
any duty to refrain from engaging in similar activities or lines of business, or
from doing business with any potential or actual supplier or customer of any
other person.
CHANGE OF CONTROL; RESTRICTIONS ON STRATEGIC ALLIANCES
In the event that, at any time prior to the third anniversary of the
distribution, there is a change of control of us as defined in the Contribution
and Distribution Agreement or, if prior to the second anniversary of the
distribution, we or any of our affiliates enters into a strategic alliance with
Nortel Networks Corporation or Cisco Systems, Inc. or any of their respective
affiliates, then Lucent could terminate or cause us to reconvey some of the
rights, including important intellectual property rights granted to us under the
Intellectual Property Agreements.
PROVISIONS RELATING TO THIRD-PARTY INTELLECTUAL PROPERTY LICENSE AGREEMENTS
The Contribution and Distribution Agreement provides, generally, for the
grant by Lucent to us of a sublicense under numerous third-party intellectual
property license agreements. The Patent and Technology License agreement
provides similar grants to us from Lucent's subsidiary, Lucent Technologies GRL
Corporation, with respect to third party patent license agreements executed by
that subsidiary.
INTERIM SERVICES AND SYSTEMS REPLICATION AGREEMENT
We and Lucent have entered into an Interim Services and Systems Replication
Agreement to provide each other, on an interim, transitional basis, with various
data processing services, telecommunications services and corporate support
services, including: accounting, financial management, information systems
management, tax, payroll, legal, human resources administration, procurement and
other general support. Furthermore, under the terms of this agreement Lucent
will provide us with technical support for our converged voice and data products
for an agreed upon period of time. The agreed upon charges for such services are
generally intended to allow the providing company to fully recover the allocated
direct costs of providing the services, plus all out-of-pocket costs and
expenses, without profit.
The Interim Services and Systems Replication Agreement also provides for
the replication and transfer of designated computer systems used for
administrative support or used in our businesses or Lucent's businesses. The
systems include hardware, software, data storage or maintenance and support
components. Costs and expenses of purchasing new hardware or obtaining new
software licenses will be borne by the party purchasing the new hardware or
licensing the new software.
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COMMERCIAL AGREEMENTS
We and Lucent entered into a Global Purchase and Service Agreement, a
General Sales Agreement, a Microelectronics Product Purchase Agreement, two
Reseller Agreements, a Master Subcontracting Agreement, a Master Services
Agreement and an Original Equipment Manufacturing and Value Added Reseller
Agreement. The pricing terms for the products and services covered by the Global
Purchase and Service Agreement and all other ancillary commercial agreements
reflect negotiated prices. Each of these agreements commenced October 1, 2000
and has a three year term, subject to extension.
Under the Global Purchase and Service Agreement we will provide to Lucent
communications and other related products for Lucent's internal operational use.
These products include some of our enterprise voice communications products and
our multi-service networking products. Under the agreement, we will also provide
warranty and post-warranty maintenance support services for products that are
already installed in Lucent offices as well as for new products installed
thereafter. The General Sales Agreement and the Microelectronics Product
Purchase Agreement govern transactions pursuant to which Lucent will provide
goods and services that are part of the businesses not transferred to us.
The Reseller Agreements govern transactions in which either we or Lucent
furnish items to the other for resale. Each agreement covers specified products
and licensed materials of both Lucent and ours, respectively. Either party may
add to or delete products upon ninety days notice.
The Master Subcontracting Agreement sets forth the terms by which we and
Lucent may subcontract for services and related deliverables from each other to
support our respective customers.
The Master Services Agreement covers any order for services not addressed
in any other commercial agreement between us and Lucent. Under this agreement
either we or Lucent or our affiliates or Lucent's affiliates may place orders
for services from the other party including maintenance service, professional
services, changes in services, and extension of services.
The Original Equipment Manufacturing and Value Added Reseller Agreement
governs transactions pursuant to which we and Lucent will buy, on an ordered
basis, products from each other for integration into finished products for sale
or resale or for resale in combination with enhancements added by the other
party.
EMPLOYEE BENEFITS AGREEMENT AND PLANS
EMPLOYEE BENEFITS AGREEMENT
We have entered into an Employee Benefits Agreement with Lucent, pursuant
to which we created independent pension and other employee benefit plans that
are substantially similar to Lucent's existing pension and other employee
benefit plans. This agreement provides for the transfer of assets and
liabilities of various existing Lucent pension and other employee benefit plans
related to Lucent employees who transferred to us. Generally, Lucent has no
liability or obligation to our current employees and their beneficiaries, and to
our employees who left our employ after September 30, 2000 under any of Lucent's
benefit plans, programs or practices. Our benefit plans assume and are
responsible for liabilities and obligations to those employees under all these
benefit plans, programs and practices which we may adopt. The employee benefits
agreement does not preclude us from discontinuing or changing such plans at any
time thereafter, subject to the exceptions noted below.
BENEFIT PLANS
We have established and administer defined benefit pension plans, defined
contribution savings/401(k) plans and welfare benefits plans for our employees
who, immediately prior to the distribution, participated in Lucent's benefit
plans. Lucent will transfer or transfer from the trusts for its benefit plans,
particular assets and liabilities related to such benefit plans to us or to
trusts we establish for our benefit plans. Each of our eligible employees will,
for all purposes under our benefit plans, be credited with the service and any
accrued benefit or account balance credited to him or her under the terms of the
corresponding Lucent plans as of the distribution.
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LUCENT STOCK OPTIONS AND RESTRICTED STOCK UNITS
Pursuant to the Employee Benefits Agreement, unvested Lucent stock options
and restricted stock units held by our employees were converted to our stock
options and restricted stock units at the time of the distribution. As part of
the conversion, we multiplied the number of shares purchaseable under each
converted stock option by a ratio determined at the time of the distribution and
divided the exercise price per share of each option by the same ratio. The
number of shares covered by each restricted stock unit were multiplied by the
same ratio. Fractional shares were rounded down to the nearest whole number of
shares. All other terms of the converted stock options and restricted stock
units remain the same as those in effect immediately prior to the distribution.
Vested Lucent stock options as of the distribution remain options to acquire
Lucent common stock, subject to adjustments based on the same ratio.
INTELLECTUAL PROPERTY AGREEMENTS
We entered into a series of agreements with Lucent pursuant to which Lucent
transferred to us the primary trademarks used in the sale of our products and
services, except for Lucent's name and logo and the Bell Laboratories name; we
and Lucent divided ownership of technology, patents, patent applications and
foreign counterparts between us and Lucent; and we and Lucent granted
cross-licenses to each other with respect to patents and technology. We have the
use of the Lucent name and logo, but not the Bell Laboratories name, on a
royalty-free basis, for a transitional period.
DEVELOPMENT PROJECT AGREEMENT
We and Lucent entered into a Development Project Agreement governing
Lucent's and our future commercial relationship under which Bell Laboratories
will perform some research and development activities for us. Under this
agreement, Bell Laboratories performs specific research and development projects
on a contract basis for us.
TAX SHARING AGREEMENT
We and Lucent entered into a Tax Sharing Agreement which governs Lucent's
and our respective rights, responsibilities and obligations after the
distribution with respect to taxes for the periods ending on or before the
distribution. Generally, pre-distribution taxes that are clearly attributable to
the business of one party will be borne solely by that party, and other
pre-distribution taxes will be shared by the parties based on a formula set
forth in the Tax Sharing Agreement. In addition, the Tax Sharing Agreement
addresses the allocation of liability for taxes that are incurred as a result of
restructuring activities undertaken to implement the distribution. If the
distribution fails to qualify as a tax-free distribution under Section 355 of
the Internal Revenue Code because of an acquisition of our stock or assets, or
some other actions of ours, then we will be solely liable for any resulting
corporate taxes.
REAL ESTATE AGREEMENTS
Lucent's real estate has been divided between Lucent and us. However, we
and Lucent continue to share some current work locations for our respective work
forces. As of September 30, 2000 the shared locations were approximately 100 of
Lucent's 1,300 real estate locations. Approximately 15% of these shared
locations will continue to be owned by either Lucent or us; the remaining 85%
will continue to be leased commercially. Generally, ownership of Lucent's
buildings and assignment of commercially leased buildings has been divided
between Lucent and us based on which company is the primary user of the
respective building.
OTHER AGREEMENTS
We and Lucent have continued the existing State and Local Income Tax
Allocation Agreement and the existing Federal Tax Allocation Agreement by and
among Lucent and its subsidiaries. These tax agreements govern the allocation of
state, local and federal income taxes for periods prior to and including the
distribution date. In addition, after the distribution, we became a party to
Lucent's two existing collective bargaining agreements. See "Employees" for a
description of these collective bargaining agreements.
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FORWARD LOOKING STATEMENTS
This Annual Report on Form 10-K contains forward-looking statements based
on current expectations, forecasts and assumptions that involve risks and
uncertainties that could cause actual outcomes and results to differ materially.
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. We undertake no obligation to update
publicly any forward looking statements, whether as a result of new information,
future events or otherwise.
The risks and uncertainties referred to above include, but are not limited
to, price and product competition, rapid technological development, dependence
on new product development, the mix of our products and services, customer
demand for our products and services, the ability to successfully integrate
acquired companies, control of costs and expenses, the ability to form and
implement alliances, international growth, U.S. and foreign government
regulation, general industry and market conditions and growth rates and general
domestic and international economic conditions including interest rate and
currency exchange rate fluctuations. For a more detailed discussion of the risks
and uncertainties we face, please see our other filings with the SEC, including
our Registration Statement on Form 10, which was declared effective by the SEC
on September 15, 2000.
ITEM 2. PROPERTIES.
As of September 30, 2000, we operated 11 manufacturing facilities, 68
warehouse locations and 3 repair sites in the United States and 21 other
countries. We also have 601 offices located in 50 countries and 24 research and
development facilities located in Australia, India, Israel, France, Singapore,
the United Kingdom and the United States. Our principal manufacturing facilities
are located in Australia, China, France, India, Ireland, Israel, the United
Kingdom, the United States and Venezuela. We also have a 25.5% interest in one
joint venture located in Gandhinagar, India which is predominantly used as a
manufacturing site and is mostly on owned property. These facilities have an
aggregate floor space of approximately 13 million square feet, of which
approximately 4 million square feet is owned and approximately 9 million square
feet is leased. Our lease terms range from monthly leases to 19 years. We
believe that all of our facilities and equipment are in good condition and are
well maintained and able to operate at present levels.
ITEM 3. 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 that should have, individually or in the aggregate, a
material adverse effect on our financial position, results of operations or cash
flows.
Three separate purported class action lawsuits are pending against Lucent
in state court in New York and West Virginia and in federal court in California.
The case in New York was filed in January 1999, and after being dismissed, was
re-filed in September 2000. The case in West Virginia was filed in April 1999
and the case in California was filed in June 1999. We may be named a party to
these actions and have assumed the obligations of Lucent for 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 not
been certified in any of the three cases, and to the extent a class is certified
in any of the cases, we expect that class to constitute those enterprises that
purchased the products in question. The complaints seek, among other remedies,
compensatory damages, punitive damages and counsel fees in amounts that have not
yet been specified. Although we believe that the outcome of these actions will
not adversely affect our financial position, results of operations or cash
flows, if these cases are not resolved in a timely manner, they will require
expenditure of significant legal costs related to their defense.
From time to time we are subject to unfair labor charges filed by the
unions representing our employees with the National Labor Relations Board, or
NLRB. For example, Region 6 of the National Labor Relations
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Board, which is located in Pittsburgh, Pennsylvania, has issued a complaint
alleging that Lucent has refused to bargain over the outsourcing of certain of
its manufacturing activities. In that proceeding, which will be held before an
administrative law judge in Region 6 of the National Labor Relations Board, the
General Counsel of the National Labor Relations Board will act as prosecutor and
the charging party, IBEW System Council EM-3, which is the union representing
the workers at the manufacturing facilities in question, will be an interested
party entitled to participate in the proceeding. Because the complaint relates
to some of the manufacturing facilities that were transferred to us as part of
the distribution, we may be named a party to this action.
The union alleges that Lucent did not provide relevant information relating
to the outsourcing of bargaining unit work, specifically the outsourcing of
circuit packs. The union also claims that Lucent bargained in bad faith during
1998 by withholding its intention to outsource the circuit pack production.
Moreover, the union alleges that Lucent has failed to bargain in good faith over
its decision to outsource certain of its manufacturing operations.
The complaint seeks as remedies for the alleged unlawful conduct, which
Lucent denies in its entirety, a possible return of the outsourced work to the
bargaining unit and/or back pay for affected employees. The amount of back pay
sought, if any, is not determinable at this time. The complaint also provides
that the NLRB may potentially seek injunctive relief if Lucent pursues its
current plans to outsource additional bargaining unit work. If we are
unsuccessful in resolving these charges, as they relate to us, our operations
may be disrupted, our initiative to outsource substantially all of our
manufacturing may be delayed or prohibited, or we may incur additional costs
that may decrease our profitability.
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 state court has
recently certified a class in this action. We cannot assure you that this case
will not have a material adverse effect on our financial position, results of
operations or cash flows.
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 its
financial results) through November 21, 2000. We understand that Lucent has not
yet been served with the complaints in these cases. Lucent has not yet answered
the complaints and a class has not yet been certified in the actions.
The above actions will most likely be consolidated with other purported
class actions filed against Lucent on behalf of shareholders in January 2000.
Those January 2000 actions have been consolidated and are pending in the Federal
District Court for the District of New Jersey. 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 shareholders of Lucent who bought Lucent
common stock between October 26, 1999 and January 6, 2000, but the consolidated
complaint has recently been 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 shareholder
class actions seek compensatory damages plus interest and attorneys' fees.
Any liability incurred by Lucent in connection with these shareholder class
action cases 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 in excess of $50 million. All of these cases 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.
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<PAGE> 29
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY-HOLDERS.
On September 13, 2000, Lucent, as sole shareowner of Avaya, approved the
following matters:
- the Restated Certificate of Incorporation and Amended and Restated Bylaws
of Avaya;
- effective upon the distribution, the resignations of Pamela F. Craven,
Jean F. Rankin and Richard J. Rawson as directors of Avaya;
- effective upon the distribution, the election of Franklin A. Thomas,
Jeffrey A. Harris, Henry B. Schacht, Daniel C. Stanzione and Donald K.
Peterson as directors of Avaya; and
- certain stock plans of Avaya.
Except as provided above, during the fourth quarter of the fiscal year
covered by this Annual Report on Form 10-K, no matter was submitted to a vote of
security-holders.
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.
The New York Stock Exchange is the principal market for shares of Avaya's
common stock. The high and low sales prices per share for shares of our common
stock during the period beginning September 18, 2000 (the date trading in our
common stock commenced) and ending September 30, 2000 was $26.00 and $18.8125,
respectively. Our common stock was traded on a "when issued" basis during this
period and began "regular way" trading on October 2, 2000.
As of November 30, 2000, there were approximately 1,406,847 holders of
record of our common stock.
We have paid no dividends to date on shares of our common stock. We have
established a policy to pay a dividend on shares of our common stock. The amount
and timing of the dividend payment will be determined by our board of directors
at a future date.
ITEM 6. SELECTED FINANCIAL DATA.
The following table sets forth our selected financial information derived
from our unaudited consolidated financial statements as of and for the nine
months ended September 30, 1996, and our audited consolidated financial
statements as of and for the fiscal years ended September 30, 1997, 1998, 1999
and 2000. In our opinion, all adjustments, which consist only of normal and
recurring accruals, considered necessary for a fair presentation have been
included in our unaudited consolidated financial statements. The selected
financial information may not be indicative of our future performance as an
independent company and should be read in conjunction with "Management's
Discussion and Analysis of Financial Condition and Results of Operations," and
the consolidated financial statements and the notes thereto included elsewhere
in this Annual Report on Form 10-K.
In reviewing the selected financial information, please note the following:
- In fiscal 1996, we changed our fiscal year end from December 31 to
September 30.
- The selected statement of operations information reflects the purchase of
Octel Communications Corporation in September 1997.
- The purchased in-process research and development is attributable to the
acquisitions of Lannet Ltd., SDX Business Systems PLC, Prominet
Corporation, Octel Communications Corporation and Agile Networks, Inc. in
1998 and 1997.
- Effective October 1, 1998, we changed our method for calculating the
market-related value of plan assets used in determining the expected
return-on-asset component of annual net pension and postretirement
benefit costs.
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<PAGE> 30
- On October 1, 1999, we adopted Statement of Position 98-1, "Accounting
for the Costs of Computer Software Developed or Obtained for Internal
Use."
- Total debt represents the amount of financing we assumed as a stand-alone
company after the distribution and debt attributable to our foreign
entities.
- On October 2, 2000, we sold to Warburg, Pincus Equity Partners, L.P. and
related investment funds 4,000,000 shares of our Series B convertible
participating preferred stock and warrants to purchase our common stock
for an aggregate purchase price of $400 million. The Series B convertible
participating preferred stock will be recorded in the mezzanine section
of the consolidated balance sheet because the investors may require us,
upon the occurrence of any change-of-control in us during the first five
years after the investment, to redeem the convertible participating
preferred stock.
<TABLE>
<CAPTION>
NINE MONTHS
YEAR ENDED SEPTEMBER 30, ENDED
--------------------------------- SEPTEMBER 30,
2000 1999 1998 1997 1996
------ ------ ------ ------ -------------
(DOLLARS IN MILLIONS)
<S> <C> <C> <C> <C> <C>
STATEMENT OF OPERATIONS INFORMATION:
Revenue........................................... $7,680 $8,268 $7,754 $6,413 $4,544
Business restructuring and related charges........ 684 -- -- -- --
Purchased in-process research and development..... -- -- 306 472 --
Income (loss) before cumulative effect of
accounting change............................... (375) 186 43 (148) 176
Cumulative effect of accounting change............ -- 96 -- -- --
Net income (loss)................................. (375) 282 43 (148) 176
Earnings (loss) per common share -- basic:
Income (loss) before cumulative effect of
accounting change............................ $(1.39) $ 0.72 $ 0.17 $(0.60) $ 0.77
Cumulative effect of accounting change.......... -- 0.37 -- -- --
------ ------ ------ ------ ------
Net income (loss) attributable to common
shareowners.................................. $(1.39) $ 1.09 $ 0.17 $(0.60) $ 0.77
====== ====== ====== ====== ======
Earnings (loss) per common share -- diluted:
Income (loss) before cumulative effect of
accounting change............................ $(1.39) $ 0.68 $ 0.17 $(0.60) $ 0.75
Cumulative effect of accounting change.......... -- 0.35 -- -- --
------ ------ ------ ------ ------
Net income (loss) attributable to common
shareowners.................................. $(1.39) $ 1.03 $ 0.17 $(0.60) $ 0.75
====== ====== ====== ====== ======
</TABLE>
<TABLE>
<CAPTION>
AS OF SEPTEMBER 30,
----------------------------------------------
2000 1999 1998 1997 1996
------ ------ ------ ------ ------
(DOLLARS IN MILLIONS)
<S> <C> <C> <C> <C> <C>
BALANCE SHEET INFORMATION:
Total assets.................................. $5,037 $4,239 $4,177 $3,340 $2,391
Total debt.................................... 793 10 14 25 7
</TABLE>
ITEM 7.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 Annual
Report on Form 10-K. The matters discussed in Management's Discussion and
Analysis of Financial Condition and Results of Operations contain certain
forward-looking statements within the meaning of the Private Securities
Litigation Reform Act of 1995. Statements made that are not historical facts are
forward-looking and, accordingly, involve estimates, forecasts,
30
<PAGE> 31
assumptions, risks and uncertainties that could cause actual results or outcomes
to differ materially from those expressed in the forward-looking statements. See
"Business -- Forward Looking Statements."
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 United States leader in sales of enterprise voice
communications and call center systems. We are not a leader in multi-service
networking products or in converged voice and data products. We have entered
these product areas relatively recently, and our multi-service networking
product portfolio is less complete than the portfolios of some of our
competitors. We are implementing a strategy focused on these products.
We report our operations in three segments: Communications Solutions,
Services and Connectivity Solutions. The Communications Solutions segment
represents our core businesses, comprised of our enterprise voice communications
systems and software, communications applications, professional services for
customer and enterprise relationship management, multi-service networking
products and product installation services. The purchase prices of our products
typically include installation. The Services segment represents our maintenance
and value-added services. The Connectivity Solutions segment represents our
structured cabling systems and our electronic cabinets. The results of our
corporate operations are recorded in corporate and other.
The following table sets forth the allocation of our revenue among our
operating segments, expressed as a percentage of total external revenue,
excluding corporate and other revenue:
<TABLE>
<CAPTION>
YEAR ENDED
SEPTEMBER 30,
-----------------------
2000 1999 1998
----- ----- -----
(PERCENTAGES)
<S> <C> <C> <C>
OPERATING SEGMENT:
Communications Solutions.................................... 56.3% 61.6% 59.2%
Services.................................................... 25.5 23.0 22.6
Connectivity Solutions...................................... 18.2 15.4 18.2
----- ----- -----
Total............................................. 100.0% 100.0% 100.0%
===== ===== =====
</TABLE>
SEPARATION FROM LUCENT
We were incorporated under the laws of the State of Delaware on February
16, 2000, as a wholly owned subsidiary of Lucent Technologies Inc. We had no
material assets or activities until the contribution to us by Lucent of its
enterprise networking businesses, which occurred immediately prior to the
distribution. Lucent conducted such businesses through various divisions and
subsidiaries. Following the distribution, we became an independent public
company, and Lucent no longer has a continuing stock ownership interest in us.
Prior to the distribution, we entered into several agreements with Lucent in
connection with, among other things, intellectual property, interim services and
a number of ongoing commercial relationships, including product supply
arrangements. The interim services agreement sets forth charges generally
intended to allow the providing company to fully recover the allocated direct
costs of providing the services, plus all out-of-pocket costs and expenses, but
without any profit. With limited exceptions, these interim services are not
expected to extend beyond March 31, 2001. The pricing terms for goods and
services covered by the commercial agreements reflect negotiated prices.
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<PAGE> 32
We are in discussions with Lucent regarding certain matters associated with
the contribution and distribution. The items in question relate primarily to the
settlement of certain obligations with respect to the employees transferred to
us by Lucent, receivables related to our businesses and other items related to
the transfer of certain assets and liabilities by Lucent to us upon the
distribution. While we do not believe that the resolution of these open items
will have a material adverse effect on our results of operations, there can be
no assurance that such resolution will not have a material adverse effect on our
financial position or cash flows.
Our consolidated financial statements, which are discussed below, reflect
the historical financial position, results of operations and cash flows of the
businesses transferred to us from Lucent as part of the distribution. Our
consolidated financial statements and the financial information included herein,
however, may not necessarily reflect our financial position, results of
operations and cash flows in the future or what our financial position, results
of operations and cash flows would have been had we been a stand-alone company
during the periods presented.
Cash, cash equivalents, debt and interest expense. During the periods
covered by our consolidated financial statements, Lucent used a centralized
approach to cash management and the financing of its operations. Prior to the
distribution, our cash deposits were transferred to Lucent on a regular basis.
As a result, none of Lucent's cash, cash equivalents or debt at the corporate
level were reflected in our consolidated financial statements. We have assumed
for purposes of calculating interest expense that we would have had average debt
balances of $962 million, $1,320 million and $1,439 million, for fiscal 2000,
1999 and 1998, respectively. The amount of debt incurred for purposes of
calculating interest expense reflects our estimates for the amount of debt we
would have needed during these periods to fund our operations, including those
required to fund our capital expenditures and acquisitions. For purposes of our
consolidated financial statements, we have assumed average interest rates of
7.9%, 6.8% and 6.5% per annum, for fiscal 2000, 1999 and 1998, respectively. The
interest rates used are estimates of what we believe we would have obtained with
a "BBB" rating, the current rating of our long term debt by Standard & Poor's.
Although we believe our estimates are reasonable, these amounts of debt and
interest rates are not necessarily indicative of the amount of debt and related
interest rates we actually would have had if we were a stand-alone company
during all periods presented.
Corporate overhead and basic research. The consolidated financial
statements include allocations of the assets, liabilities and expenses of
Lucent's corporate headquarters relating to our businesses. General corporate
overhead has been either allocated based on the ratio of our costs and expenses
to Lucent's costs and expenses or based on our revenue as a percentage of
Lucent's total revenue, as appropriate. General corporate overhead primarily
includes cash management, legal, accounting, tax, insurance, public relations,
advertising and data services and amounted to $398 million, $449 million and
$425 million for fiscal 2000, 1999 and 1998, respectively. We believe the costs
of these services charged to us are a reasonable representation of the costs
that would have been incurred if we had performed these functions as a
stand-alone company. We are currently performing these functions using our own
resources or purchased services.
Our consolidated financial statements also include an allocation from
Lucent to fund a portion of the costs of basic research conducted by Lucent's
Bell Laboratories. This allocation was based on our revenue as a percentage of
Lucent's total revenue. This allocation amounted to $75 million, $78 million and
$66 million for fiscal 2000, 1999 and 1998, respectively. We believe the costs
of this research charge to us are a reasonable representation of the costs that
would have been incurred if we had performed these functions as a stand-alone
company. We currently satisfy our corporate overhead and basic research
requirements using our own resources or through purchased services.
We intend to invest an amount equal to approximately 9% of our total
revenue in fiscal 2001 in research and development. These investments represent
a significant increase over our investments in research and development over the
previous three fiscal years, which was approximately 6% of total revenue for
each of those years. As a part of Lucent, we were allocated a portion of
Lucent's basic research, which did not necessarily directly benefit our
business. In the future, our investments in research and development will have a
greater focus on our products.
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<PAGE> 33
Benefit obligations. At the distribution, we assumed responsibility for
pension and postretirement benefits for our active employees. Obligations
related to retired and terminated vested employees as of September 30, 2000
remained the responsibility of Lucent. Following the distribution, our employees
became participants in the Avaya pension plans and, upon retirement, eligible
retirees will be participants in Avaya's postretirement benefit plans. Our share
of the Lucent plans' assets and liabilities was not included in our consolidated
financial statements until the distribution since Lucent had not yet separated
our portion of the employee benefit plans. For purposes of the financial
statements, the pension and postretirement costs were based on estimated plan
assets being equal to a proportional share of plan obligations incurred by
Lucent for employees who performed services for us.
Income taxes. Income taxes were calculated as if we filed separate tax
returns. However, Lucent was managing its tax position for the benefit of its
entire portfolio of businesses, and its tax strategies are not necessarily
reflective of the tax strategies that we would have followed or will follow as a
stand-alone company.
BUSINESS RESTRUCTURING AND RELATED CHARGES
In September 2000, we adopted a restructuring plan to improve profitability
and business performance as a stand-alone company and recorded a pretax charge
of $684 million as business restructuring and related charges in our
consolidated statement of operations. The components of the charge include $520
million of business restructuring costs, $75 million of asset impairment
charges, and $89 million of incremental period expenses associated with our
separation from Lucent.
We also recorded $73 million in selling, general and administrative expense
for start-up activities related to establishing independent operations including
fees for investment banking and other professional advisors, and marketing costs
associated with establishing our brand. The charges recorded in connection with
our restructuring and start-up activities totaled $757 million in fiscal 2000,
almost all of which will result in a usage of cash. During fiscal 2001, we
expect to incur additional period costs of approximately $200 million as a
result of our separation from Lucent and establishment as an independent
company. We expect to fund our restructuring and start-up activities through a
combination of debt and internally generated funds.
Components of the accrued business restructuring costs and amounts recorded
against the reserve as of September 30, 2000, were as follows:
<TABLE>
<CAPTION>
COSTS ACCRUED EXPENDITURES MADE RESERVE BALANCE AS OF
DURING FISCAL 2000 DURING FISCAL 2000 SEPTEMBER 30, 2000
------------------ ------------------ ---------------------
(DOLLARS IN MILLIONS)
<S> <C> <C> <C>
Employee separation costs....... $365 $(20) $345
Lease obligations............... 127 -- 127
Other related exit costs........ 28 (1) 27
---- ---- ----
Total................. $520 $(21) $499
==== ==== ====
</TABLE>
Accrued business restructuring costs for employee separations of $365
million related to approximately 4,900 occupational and management employees, of
which 1,470 employees worldwide have departed as of September 30, 2000,
predominately located in the United States. These costs include severance,
medical and other benefits. The employee separations are primarily attributed to
redesigning our services organization by reducing field technicians to a level
needed for non-peak work loads, consolidating and closing certain U.S. and
European manufacturing facilities and realigning the sales effort towards a
direct focus on strategic accounts and an indirect focus on smaller accounts.
Accrued costs for lease obligations of $127 million are comprised of $100
million to terminate real estate leases related to approximately two million
square feet of excess manufacturing, distribution and administrative space and
$27 million to cancel equipment leases related to our information systems
infrastructure. Real estate lease termination costs are being incurred primarily
in the United States, Europe and Asia, and have been reduced for sublease income
that management believes is probable. Other related exit costs of $28 million
primarily consist of decommissioning legacy computer systems in connection with
our separation from Lucent and terminating other contractual obligations.
33
<PAGE> 34
In connection with our restructuring initiatives, asset impairment charges
of $75 million were recorded. These charges were primarily comprised of $50
million related to an outsourcing contract with a major customer. During the
fourth quarter of fiscal 2000, we terminated our obligations under a leasing
arrangement and purchased the underlying equipment. The equipment is being used
to support a contract where we provide equipment outsourcing and related
services. Based on the terms of this contract, the estimated undiscounted cash
flows from the equipment's use and eventual disposition was determined to be
less than the equipment's carrying value, and resulted in the impairment charge
of $50 million to write such equipment down to its fair value.
Also during the fourth quarter of fiscal 2000, we recorded incremental
period costs of $89 million associated with our separation from Lucent related
primarily to computer system transition costs such as data conversion
activities, asset transfers, and training.
In addition to the actions already taken as part of the restructuring, we
are pursuing a contract manufacturing initiative, which is not included in the
charges above. If we are successful in this initiative, we may incur additional
charges in the future. We intend that our contract manufacturing initiative will
involve the outsourcing of substantially all of our manufacturing other than the
manufacturing of our structured cabling systems. We believe that outsourcing our
manufacturing will allow us to improve our cash flow over the next few years
through a reduction of inventory and reduced capital expenditures. We cannot
assure you that we will be able to implement this manufacturing initiative or
that, if implemented, we will achieve these anticipated benefits. Our
manufacturing initiative may be delayed or prohibited by a legal proceeding
described in "Legal Proceedings" brought by a governmental agency, which may
disrupt our operations or result in unanticipated costs.
ACQUISITIONS
As part of our continued efforts to broaden our portfolio of product
offerings, we completed the following key acquisitions during fiscal 1999 and
1998. There were no material acquisitions in fiscal 2000.
<TABLE>
<S> <C>
July 1999 Merger with Mosaix, Inc., a provider of software that
manages an enterprise's various office functions. Lucent
issued 2.6 million shares of Lucent common stock, with a
value of $145 million, for all of the outstanding stock of
Mosaix. The transaction was accounted for as a pooling of
interests.
August 1998 Acquisition of Lannet Ltd., an Israeli-based producer of
multi-service networking products. The purchase price was
$115 million in cash.
July 1998 Acquisition of SDX Business Systems PLC, a United
Kingdom-based provider of multi-service networking products.
The purchase price was $207 million in cash.
January 1998 Acquisition of Prominet Corporation, a producer of
multi-service networking products. The purchase price was
$199 million of Lucent common stock. In addition, under the
terms of the acquisition agreement, Lucent had a contingent
obligation to pay former Prominet shareowners $35 million in
Lucent stock. The $35 million of Lucent stock was paid in
July 1998 and was recorded primarily as goodwill.
</TABLE>
REVENUE
We derive revenue primarily from the sales of communication systems and
software. We sell our products both directly through our worldwide sales force
and indirectly through our global network of approximately 4,300 distributors,
dealers, value-added resellers, system integrators and contractors. The purchase
price of our systems and software typically includes installation and a one-year
warranty. We also derive revenue from:
- maintenance services, including services provided under maintenance
contracts and on a time and material basis;
- professional services for customer and enterprise relationship
management; and
- value-added services for outsourcing messaging and other parts of
communication systems.
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<PAGE> 35
Maintenance contracts typically have terms that range from one to five
years. Contracts for professional services typically have terms that range from
two to four weeks for standard solutions and from six months to one year for
customized solutions. Contracts for value-added services typically have terms
that range from one to seven years. Revenue from sales of communications systems
and software is recognized when contractual obligations have been satisfied,
title and risk of loss has been transferred to the customer and collection of
the resulting receivable is reasonably assured. Revenue from the direct sales of
products with installation services is recognized at the time the products are
installed, after satisfaction of all the terms and conditions of the underlying
customer contract. Our indirect sales to distribution partners are recognized at
the time of shipment if all contractual obligations have been satisfied. We
accrue a provision for estimated sales returns and other allowances as a
reduction of revenue at the time of revenue recognition, as required. For our
value-added services, professional services and services performed under
maintenance contracts, we recognize revenue ratably over the term of the
underlying customer contract or at the end of the contract, when obligations
have been satisfied. For services performed on a time and materials basis,
revenue is recognized upon performance.
COSTS AND OPERATING EXPENSES
Our costs of products consist primarily of materials and components, labor
and manufacturing overhead. Our costs of services consist primarily of labor,
parts and service overhead. Our selling, general and administrative expenses and
research and development expenses consist primarily of salaries, commissions,
benefits and other miscellaneous items. Please see "-- Purchased In-Process
Research and Development" for a discussion of this line item.
Total operating expenses in the fiscal years ended September 30, 1999, and
September 30, 1998, were reduced due to the reversal of $33 million and $23
million, respectively, of business restructuring reserves recorded in December
1995 primarily related to favorable experiences in employee separations for
those years.
OPERATING TRENDS
We have been increasing, and intend to continue to increase, the percentage
of our sales made through our distribution partners. To further this strategy,
in March 2000, we sold our primary distribution function for our voice
communications systems for small and mid-sized enterprises to Expanets, Inc. As
the percentage of our sales through distribution partners increases, if sales
volume remained the same, our revenue would decline.
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<PAGE> 36
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:
<TABLE>
<CAPTION>
YEAR ENDED SEPTEMBER 30,
--------------------------
2000 1999 1998
------ ------ ------
<S> <C> <C> <C>
Revenue..................................................... 100.0% 100.0% 100.0%
Costs....................................................... 56.6 55.2 53.0
----- ----- -----
Gross margin.............................................. 43.4 44.8 47.0
----- ----- -----
Operating expenses
Selling, general and administrative....................... 34.2 33.8 33.6
Business restructuring and related charges................ 8.9 -- --
Research and development.................................. 6.1 6.5 5.5
Purchased in-process research and development............. -- -- 3.9
----- ----- -----
Total operating expenses.................................... 49.2 40.3 43.0
----- ----- -----
Operating income (loss)................................... (5.8) 4.5 4.0
Other income, net........................................... 0.9 0.3 0.3
Interest expense............................................ (1.0) (1.1) (1.2)
Provision (benefit) for income taxes...................... (1.0) 1.5 2.5
Cumulative effect of accounting change...................... -- 1.2 --
----- ----- -----
Net income (loss)........................................... (4.9)% 3.4% 0.6%
===== ===== =====
</TABLE>
Included in operating income for the fiscal year ended September 30, 1999,
is $97 million received on the sale in 1999 of equipment, which was previously
rented to customers, net of the equipment's book value of approximately $2
million. This equipment consisted predominately of discontinued product lines.
This transaction represented 1.2% of fiscal 1999 revenue.
FISCAL YEAR ENDED SEPTEMBER 30, 2000 COMPARED TO FISCAL YEAR ENDED SEPTEMBER
30, 1999
The following table shows the change in external revenue, both in dollars
and in percentage terms:
<TABLE>
<CAPTION>
YEAR ENDED
SEPTEMBER 30, CHANGE
---------------------- --------------
2000 1999 $ %
--------- --------- ----- -----
(DOLLARS IN MILLIONS)
<S> <C> <C> <C> <C>
OPERATING SEGMENT:
Communications Solutions......................... $4,323 $5,088 $(765) (15.0)%
Services......................................... 1,958 1,900 58 3.1
Connectivity Solutions........................... 1,397 1,274 123 9.7
Corporate and other.............................. 2 6 (4) (66.7)
------ ------ -----
Total.................................. $7,680 $8,268 $(588) (7.1)%
====== ====== =====
</TABLE>
Revenue. Revenue decreased 7.1% or $588 million, from $8,268 million for
fiscal 1999, to $7,680 million for fiscal 2000, due to a decrease in the
Communications Solutions segment, partially offset by increases in the
Connectivity Solutions and Services segments. The decrease in the Communications
Solutions segment was partially attributable to a sales reduction of $188
million of our Merlin Magix and Partner and $127 million of our DEFINITY product
lines due largely to the shift from a direct retail market to an indirect
distribution channel resulting from our sale of this distribution function. The
sales reduction of our enterprise voice communications systems was also
attributed to attrition within our skilled sales force, which particularly
affected our most advanced DEFINITY product offering. In addition, sales of our
messaging products decreased by $204 million as customers purchased a higher
than usual number of
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<PAGE> 37
systems in 1999 to upgrade their systems in anticipation of year 2000 concerns.
In addition, the Communications Solutions segment experienced a $218 million
decrease in installation revenue as a result of the reduction in product sales.
These decreases were partially offset by increases in professional services as
well as in sales of our eBusiness Communications Solutions. The Connectivity
Solutions segment increase was driven by growth in ExchangeMax structured
cabling systems and electronic cabinets sales of $215 million, largely offset by
a decrease in SYSTIMAX structured cabling systems. The increase in the Services
segment was the result of strong growth in maintenance services internationally
and in existing value-added service accounts.
Revenue within the United States decreased 9.4% or $628 million, from
$6,683 million for fiscal 1999, to $6,055 million for fiscal 2000. Revenue
outside the United States increased 2.5% or $40 million, from $1,585 million for
fiscal 1999, to $1,625 million for the same period in fiscal 2000. Revenue
outside the United States in 2000 represented 21.2% of revenue compared with
19.2% in 1999. We continued to expand our business outside of the United States,
with growth led by the Asia/Pacific region.
Costs and gross margin. Total costs decreased 4.8% or $219 million, from
$4,564 million for fiscal 1999, to $4,345 million for fiscal 2000 primarily due
to the decrease in product sales. Gross margin percentage decreased 1.4% from
44.8% in fiscal 1999 as compared with 43.4% in fiscal 2000. The decrease in
gross margin percentage for the year was primarily due to aggressive pricing and
promotional actions.
Selling, general and administrative. Selling, general and administrative
expenses decreased 6.0% or $169 million, from $2,795 million for fiscal 1999, to
$2,626 million for fiscal 2000. The decrease is primarily due to reduced bonus
compensation expenses resulting from lower than anticipated financial
performance and lower staffing levels resulting from the realignment and
integration of our sales force and our information systems group. The headcount
reductions for our information systems group were associated with the ongoing
implementation of a new computer software platform. The majority of these
reductions were associated with the shutdown and elimination of support for
obsolete and redundant computer systems. The reduction in selling, general and
administrative expenses was partially offset by $73 million in charges for
start-up activities related to establishing independent operations including
fees for investment banking and other professional advisors, and marketing costs
associated with establishing our brand.
Business restructuring and related charges. Business restructuring and
related charges of $684 million for fiscal 2000 represent costs associated with
our restructuring plan to improve profitability and business performance as a
stand-alone company. The components of the charge include $520 million of
business restructuring costs principally for employee separations and lease
obligations, $75 million of asset impairment charges, and $89 million of
incremental period costs associated with our separation from Lucent.
Research and development. Research and development expenses decreased
13.3% or $72 million, from $540 million for fiscal 1999, to $468 million for
fiscal 2000. Increases in funding for call center and converged voice and data
products as well as spending associated with the acquisition of Mosaix, were
more than offset by reduced spending on more mature product lines such as
Partner, Merlin Magix and Wireless. In addition, spending decreased due to
synergies realized in consolidation of the data product line research and
development operations of Prominet and Lannet.
Other income, net. Other income, net increased 153.6% or $43 million, from
$28 million for fiscal 1999, to $71 million for fiscal 2000. This increase was
primarily due to a gain of $45 million realized in March 2000 on the sale of our
U.S. sales division serving small and mid-sized enterprises, which was
calculated based on the net cash proceeds received related to this sale.
Provision for income taxes. The effective tax rate (benefit) for fiscal
2000 and 1999 were (16.3%) and 39.4%, respectively. The tax benefit in fiscal
2000 is primarily due to our net loss that resulted from the business
restructuring and related charges, offset by non-deductible charges associated
with our reorganization, and taxes on foreign earnings in connection with our
separation from Lucent.
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FISCAL YEAR ENDED SEPTEMBER 30, 1999 COMPARED TO FISCAL YEAR ENDED SEPTEMBER
30, 1998
The following table shows the change in external revenue, both in dollars
and in percentage terms:
<TABLE>
<CAPTION>
YEAR ENDED
SEPTEMBER 30, CHANGE
---------------------- --------------
1999 1998 $ %
--------- --------- ----- -----
(DOLLARS IN MILLIONS)
<S> <C> <C> <C> <C>
OPERATING SEGMENT:
Communications Solutions......................... $5,088 $4,583 $ 505 11.0%
Services......................................... 1,900 1,750 150 8.6
Connectivity Solutions........................... 1,274 1,408 (134) (9.5)
Corporate and other.............................. 6 13 (7) (53.8)
------ ------ -----
Total.................................. $8,268 $7,754 $ 514 6.6%
====== ====== =====
</TABLE>
Revenue. Revenue increased 6.6% or $514 million, from $7,754 million in
fiscal 1998 to $8,268 million in fiscal 1999 due to increases in both the
Communications Solutions segment and the Services segment. These increases were
partially offset by a decrease in the Connectivity Solutions segment. The
increase in the Communications Solutions segment was led by approximately $130
million of higher sales of DEFINITY products, increases of approximately $300
million of applications associated with our customer relationship management
products and services, multi-service networking products and unified messaging
systems, which accommodate voice, facsimile and electronic mail messages, as
well as from the sale of equipment which was previously rented to customers. The
Services segment increase was the result of increases of approximately $80
million and $70 million in sales of maintenance and value-added services,
respectively. The decrease in the Connectivity Solutions segment was the result
of $48 million, $52 million and $34 million in decreases in sales of SYSTIMAX,
ExchangeMax structured cabling systems and electronic cabinets, respectively.
Revenue within the United States increased 4.8% or $307 million, from
$6,376 million in fiscal 1998 to $6,683 million in fiscal 1999. Revenue outside
the United States increased 15.0% or $207 million, from $1,378 million in fiscal
1998 to $1,585 million in fiscal 1999. Revenue outside the United States in
fiscal 1999 represented 19.2% of total revenue compared with 17.8% in fiscal
1998. We continued to expand our business outside of the United States, with
growth led by the Europe/Middle East/Africa region in fiscal 1999.
Costs and gross margin. Total costs increased 11.1% or $457 million, from
$4,107 million in fiscal 1998 to $4,564 million in fiscal 1999 primarily due to
the increase in sales. Gross margin percentage decreased 2.2 percentage points
from 47.0% to 44.8% in fiscal 1999 compared with fiscal 1998. The decrease in
gross margin percentage for the year was primarily due to price reductions,
partially offset by a more favorable product mix.
Selling, general and administrative. Selling, general and administrative
expenses increased 7.1% or $186 million, from $2,609 million in fiscal 1998 to
$2,795 million in fiscal 1999. The increase is attributable to approximately $80
million related to the full year impact associated with the 1998 acquisitions of
Lannet and SDX, and approximately $40 million of costs associated with the
implementation of a new computer software platform.
Research and development. Research and development expenses increased
27.7% or $117 million, from $423 million in fiscal 1998 to $540 million in
fiscal 1999. This was due to increases of approximately $60 million resulting
from the acquisitions of Lannet and SDX, as well as approximately $60 million of
increases in our voice and data communications over the internet products and
connectivity product lines.
Purchased in-process research and development. There was no charge in
fiscal 1999 for in-process research and development. In fiscal 1998, the charges
of $306 million were associated with the acquisitions of Lannet, Prominet and
SDX.
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<PAGE> 39
Other income, net. Other income, net increased 12.0% or $3 million, from
$25 million in fiscal 1998 to $28 million in fiscal 1999. This increase was
primarily due to gains recorded on the sale of an Octel product line, Computer
Telephony Products.
Provision for income taxes. The effective tax rates were 39.4% and 82.1%
for the fiscal years 1999 and 1998, respectively. Excluding the impact of the
purchased in-process research and development expenses associated with the
Prominet, SDX and Lannet acquisitions in 1998, the effective tax rate for the
year ended September 30, 1998 was 36.2%. The increase in the effective tax rate
is primarily due to the tax impact of non-deductible goodwill and increased
activity outside the United States.
HISTORICAL QUARTERLY PERFORMANCE
The following table sets forth our historical quarterly revenue, gross
margin and net income (loss) from the first quarter of fiscal 1998 through the
fourth quarter of fiscal 2000:
<TABLE>
<CAPTION>
FISCAL YEAR QUARTERS
---------------------------------
FIRST SECOND THIRD FOURTH
------ ------ ------ ------
(DOLLARS IN MILLIONS)
<S> <C> <C> <C> <C>
FISCAL YEAR ENDING SEPTEMBER 30, 2000
Revenue............................................. $1,845 $1,934 $1,885 $2,016
Gross margin........................................ 868 822 822 823
Net income (loss)................................... 69 66 33 (543)(1)
FISCAL YEAR ENDING SEPTEMBER 30, 1999
Revenue............................................. $1,894 $1,938 $2,038 $2,398(2)
Gross margin........................................ 840 841 939 1,084
Income (loss) before cumulative effect of accounting
change............................................ 4 (34) 87 129
Cumulative effect of accounting change(3)........... 96 -- -- --
Net income (loss)................................... 100 (34) 87 129
FISCAL YEAR ENDING SEPTEMBER 30, 1998
Revenue............................................. $1,865 $1,690 $1,918 $2,281
Gross margin........................................ 919 776 850 1,102
Net income (loss)................................... 105 (97) 59 (24)
</TABLE>
---------------
(1) In September 2000, we recorded a pre-tax charge of $684 million for business
restructuring and related charges.
(2) In fiscal 1999, we sold equipment, which was previously rented to customers
for $97 million. The equipment had a net book value of approximately $2
million and consisted predominantly of discontinued product lines.
(3) Effective October 1, 1998, we changed our method for calculating the
market-related value of plan assets used in determining the expected
return-on-asset component of annual net pension and postretirement benefit
costs.
Our quarterly financial results can vary from quarter to quarter based on
various factors including the compensation system for our sales force, which
focuses on achieving full year results and because many of our customers' buying
behaviors can fluctuate quarter to quarter. For example, our product revenue in
the first quarter of fiscal 1999 and in the fourth quarter of fiscal 1999 was
$1,448 million and $1,895 million, respectively.
LIQUIDITY AND CAPITAL RESOURCES
Avaya's cash and cash equivalents increased to $271 million at September
30, 2000, from $194 million at September 30, 1999. The increase primarily
resulted from $485 million of net cash provided by operating activities, offset
in part by $428 million of net cash used in investing activities.
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<PAGE> 40
In fiscal 2000, net cash provided by operating activities of $485 million
resulted primarily from the net effect of (i) a net loss of $375 million, (ii)
adjustments to net loss for non-cash charges of $736 million, and (iii) cash
generated by changes in operating assets and liabilities of $124 million. Our
net cash provided by operating activities increased from $431 million in fiscal
1999 to $485 million in fiscal 2000 primarily as a result of a reduction in
working capital. The reduction in working capital resulted from a decrease in
inventory and an increase in accounts payable due to business restructuring and
start-up activities related to establishing our independent operations. These
changes were partially offset by a decrease in payroll and benefit liabilities.
In fiscal 2000 and 1999, days sales outstanding in accounts receivable were 74
and 69, respectively, and days sales of inventory on-hand were 65 and 75,
respectively.
Our net cash provided by operating activities increased from $129 million
in fiscal 1998 to $431 million in fiscal 1999 as a result of a significant
reduction in working capital driven by improvement in accounts receivable
management and an increase in net income. Domestic customer support functions,
which include cash collection, were centralized into four regional customer care
centers in the second half of fiscal 1999, which resulted in accelerated cash
collections.
Our net cash used in investing activities was $428 million in fiscal 2000
compared with $86 million and $459 million for fiscal 1999 and 1998,
respectively. Capital expenditures, which account for the largest component of
investing activities in fiscal 2000, 1999, and 1998, with the exception of
acquisitions of businesses in 1998, generally relate to expenditures for
equipment and facilities used in manufacturing and research and development.
Capital expenditures increased to $499 million in fiscal 2000 from $202 million
in fiscal 1999 due mainly to Avaya establishing itself as a stand-alone entity,
including information technology upgrades and corporate infrastructure
expenditures. In fiscal 1998, acquisitions of businesses drove higher levels of
cash used in investing activities.
Net cash provided by financing activities was $42 million in fiscal 2000
compared with net cash used in financing activities of $257 million in fiscal
1999. Net cash provided by financing activities was $265 million for fiscal
1998. Prior to the distribution, we relied on Lucent to provide financing for
our operations. Cash flows from financing activities principally reflect changes
in Lucent's investment in us prior to the distribution. In addition, upon the
distribution, we assumed all of Lucent's obligations in connection with its
issuance of $780 million of commercial paper.
Our commercial paper program is comprised of short-term borrowings in the
commercial paper market at market interest rates. Through November 2000, we
repaid approximately $76 million of the commercial paper. Interest rates on our
commercial paper obligations are variable due to their short-term nature. A
variation of .125% in the interest rate charged under the commercial paper
program would result in an annual change of approximately $975,000 in interest
expense based on the outstanding commercial paper balance as of September 30,
2000.
In addition, we entered into two unsecured revolving credit facilities with
third party financial institutions consisting of an $850 million 364-day credit
facility and an $850 million five-year credit facility. Funds are available
under these revolving credit facilities for general corporate purposes, to
backstop commercial paper, and for acquisitions.
On October 2, 2000, we sold to Warburg, Pincus Equity Partners, L.P. and
related investment funds, collectively referred to herein as the investors,
4,000,000 shares of our Series B convertible participating preferred stock and
warrants to purchase our common stock for an aggregate purchase price of $400
million. Based on an agreed upon formula, the Series B convertible participating
preferred stock is expected to be initially convertible into approximately 5.0%
of our fully diluted common stock, calculated using a modified treasury stock
method as of the 90th day after issuance. The warrants have an exercise price
equal to 130% of the conversion price for the Series B convertible participating
preferred stock. The warrants are exercisable for 3.6% of a total number of
shares of common stock to be calculated pursuant to an agreed upon formula as of
the 90th day after issuance. Of these warrants, warrants exercisable for 2.0% of
such total number of shares of common stock will have a four-year term and
warrants exercisable for 1.6% of such total number of shares of common stock
will have a five-year term. During a period commencing no later than June 30,
2001, until the second anniversary of their issuance, if the market price of our
common stock exceeds 200%, in the case of the
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<PAGE> 41
four-year warrants, and 225%, in the case of the five-year warrants, of the
exercise price of the warrants for 20 consecutive trading days, we can force the
exercise of up to 50% of the four-year warrants and the five-year warrants,
respectively.
The shares of Series B convertible participating preferred stock have an
aggregate initial liquidation value of $400 million and will accrete for the
first ten years at an annual rate of 6.5%, compounded quarterly. After the third
anniversary of the issue date, 50% of the amount accreted for the year may be
paid in cash as a dividend on a quarterly basis, at our option. After the fifth
anniversary of the issue date through the tenth anniversary, we may elect to pay
100% of the amount accreted for the year as a cash dividend on a quarterly
basis. Following the tenth anniversary of the issue date, we will pay quarterly
cash dividends at an annual rate of 12% of the then accreted liquidation value
of the Series B convertible participating preferred stock, compounded quarterly.
The Series B convertible participating preferred shares also participate, on an
as-converted basis, in dividends paid on our common stock.
The Emerging Issues Task Force of the Financial Accounting Standards Board
recently issued EITF Issue No. 00-27, Application of EITF Issue No. 98-5,
"Accounting for Convertible Securities with Beneficial Conversion Features or
Contingently Adjustable Conversion Ratios," to Certain Convertible Instruments.
This EITF Issue will apply to the Warburg Pincus investment. Under the EITF
Issue, any amounts ascribed to a beneficial conversion feature of the Series B
convertible participating preferred stock will be recorded as a reduction to net
income attributable to common shareowners. A beneficial conversion feature will
exist if the conversion price (accounting basis) for the Series B convertible
participating preferred stock or warrants is less than the fair value of our
common stock at the commitment date. Based on our preliminary analysis, we do
not expect there to be a material impact, if any, on our future results of
operations for any beneficial conversion features associated with the Series B
convertible participating preferred stock or with the warrants to purchase
shares of our common stock. The beneficial conversion features, if any,
associated with dividends paid in kind, where it is our option to pay the
dividends in cash will be measured when the dividends are declared.
At any time after the fifth anniversary of their issuance, we may force
conversion of the shares of Series B convertible participating preferred stock.
If we give notice of a forced conversion, the investors will be able to require
us to redeem the Series B convertible participating preferred shares at 100% of
the then current liquidation value, plus accrued and unpaid dividends. Following
a change-in-control of us during the first five years after the investment,
other than a change of control transaction that is a business combination
involving solely the issuance of common stock, the accretion of some or all the
liquidation value of the Series B convertible participating preferred stock
through the fifth anniversary of the issue date will be accelerated, subject to
our ability to pay a portion of the accelerated accretion in cash in some
instances. In addition, for 60 days following the occurrence of any
change-of-control of us during the first five years after the investment, the
investors will be able to require us to redeem the Series B convertible
participating preferred stock at 101% of the liquidation value, including any
accelerated accretion of the liquidation value, plus accrued and unpaid
dividends.
Our cost of capital and 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 currently rated P-2 by Moody's and A-2 by
Standard & Poor's, and our long term debt rating is Baa1 by Moody's and BBB by
Standard & Poor's.
Our ability to issue additional equity is constrained because our issuance
of additional common stock may cause the distribution to be taxable to Lucent
under Section 355(e) of the Internal Revenue Code, and under the tax sharing
agreement we would be required to indemnify Lucent against that tax. See
"Business -- Relationship Between Lucent and Our Company After the
Distribution -- Tax Sharing Agreement" for a more detailed discussion of Section
355(e) and the tax sharing agreement between Lucent and us.
Our primary future cash needs on a recurring basis will be to fund working
capital, capital expenditures and debt service, and we believe that our cash
flows from operations will be sufficient to meet these needs. We expect to fund
our business restructuring and separation costs through a combination of debt
and internally generated funds. If we do not generate sufficient cash from
operations, we may need to incur additional debt.
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<PAGE> 42
We currently anticipate spending over the next year approximately $499 million
for business restructuring and approximately $200 million for additional
expenditures resulting from our continuing establishment as an independent
company. In order to meet our cash needs, we may from time to time issue
additional commercial paper, if the market permits such borrowings, or issue
long or short-term debt, if available. We may also refinance all or a portion of
the commercial paper program with long-term or other short-term debt
instruments, although it is our intention to reissue the commercial paper on a
long-term basis. We intend to file a debt registration statement to have the
flexibility to access the capital markets from time to time.
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 and strategic
acquisitions, 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 contain,
and any future debt agreements we may enter into may contain, 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.
PURCHASED IN-PROCESS RESEARCH AND DEVELOPMENT
In connection with the acquisitions of Lannet, SDX and Prominet in fiscal
1998, a portion of each purchase price was allocated to purchased in-process
research and development. As part of the process of analyzing these
acquisitions, we made a decision to buy technology that had not yet been
commercialized rather than develop the technology internally. We based this
decision on factors such as the amount of time it would take to bring the
technology to market. We also considered Bell Laboratories' resource allocation
and its progress on comparable technology, if any. Our management expects to use
a similar decision process in the future.
We estimated the fair value of in-process research and development for the
above acquisitions using an income approach. This involved estimating the fair
value of the in-process research and development using the present value of the
estimated after-tax cash flows expected to be generated by the purchased
in-process research and development, using risk-adjusted discount rates and
revenue forecasts as appropriate. The selection of the discount rate was based
on consideration of Lucent's weighted average cost of capital, as well as other
factors, including the useful life of each technology, profitability levels of
each technology, the uncertainty of technology advances that were known at the
time, and the stage of completion of each technology. We believe that the
estimated in-process research and development amounts so determined represent
fair value and do not exceed the amount a third party would have paid for the
projects.
Where appropriate, we deducted an amount reflecting the contribution of the
core technology from the anticipated cash flows from an in-process research and
development project. At the date of acquisition, the in-process research and
development projects had not yet reached technological feasibility and had no
alternative future uses. Accordingly, the value allocated to these projects was
capitalized and immediately expensed at acquisition. If the projects are not
successful or completed in a timely manner, management's product pricing and
growth rates may not be achieved and we may not realize the financial benefits
expected from the projects.
The development efforts related to the majority of the purchased in-process
technology projects are progressing in accordance with the assumptions
underlying the appraisals. As expected in the normal course of product
development, a number of projects have experienced delays and other projects are
being evaluated due to changes in strategic direction and market conditions.
These factors are not expected to have a material adverse effect on our results
of operations and financial position in future periods.
Set forth below are descriptions of the significant acquired in-process
research and development projects related to our acquisition of Prominet.
On January 23, 1998, Lucent completed the purchase of Prominet for $199
million. Prominet was a participant in the gigabit ethernet networking industry.
A gigabit ethernet network is a high performance local area network used by an
enterprise to connect computers, printers, workstations and the like within a
building or campus. We allocated $157 million to in-process research and
development using the income approach
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described above. The $157 million was allocated to the following projects: Phase
II for $12 million, Phase III for $92 million, and Phase IV for $53 million.
At the acquisition date, Prominet was working on a gigabit ethernet router
with improved technological and administrative functionality. A router is an
interface between two networks. The project was expected to be completed in
three phases, Phase II through Phase IV. Each phase represented an effort to
significantly enhance the technological and administrative capabilities of the
router.
Phase II. Revenue attributable to Phase II was estimated to be $8 million
in 1999 and $18 million in 2000. Revenue was expected to peak in 2004 and
decline thereafter through the end of the product's life in 2009 as new product
technologies were expected to be introduced by us. Revenue growth was expected
to decrease from 112% in 2000 to 8% in 2004, and be negative for the remainder
of the projection period. At the acquisition date, costs to complete the
research and development efforts related to the initial release of the project
were expected to be $2 million.
Phase III. Revenue attributable to Phase III was estimated to be $47
million in 1999 and $99 million in 2000. Revenue was expected to peak in 2004
and decline thereafter through the end of the product's life in 2009 as new
product technologies were expected to be introduced by us. Revenue growth was
expected to decrease from 112% in 2000 to 8% in 2004, and be negative for the
remainder of the projection period. At the acquisition date, costs to complete
the research and development efforts related to the initial release of the
project were expected to be $4 million.
Phase IV. Revenue attributable to Phase IV was estimated to be $38 million
in 1999 and $79 million in 2000. Revenue was expected to peak in 2004 and
decline thereafter through the end of the product's life in 2009 as new product
technologies were expected to be introduced by us. Revenue growth was expected
to decrease from 106% in 2000 to 7% in 2004, and be negative for the remainder
of the projection period. At the acquisition date, costs to complete the
research and development efforts related to the initial release of the project
were expected to be $3 million.
An average risk-adjusted discount rate of 25% was utilized to discount
projected cash flows.
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 United States, governing
the cleanup of soil and groundwater contamination. Such provisions impose
liability for the costs of investigating and remediating releases of hazardous
materials at our 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 approximately
five 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
environmental liabilities will not exceed the amount of reserves for such
matters or will not have a material adverse effect on our consolidated 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 that should have, individually or in the aggregate, a
material adverse effect on our financial position, results of operations or cash
flows.
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Three separate purported class action lawsuits are pending against Lucent
in state court in New York and West Virginia and in federal court in California.
The case in New York was filed in January 1999, and, after being dismissed, was
re-filed in September 2000. The case in West Virginia was filed in April 1999
and the case in California was filed in June 1999. We may be named a party to
these actions and have assumed the obligations of Lucent for 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 not
been certified in any of the three cases, and to the extent a class is certified
in any of the cases, we expect that class to constitute those enterprises that
purchased the products in question. The complaints seek, among other remedies,
compensatory damages, punitive damages and counsel fees in amounts that have not
yet been specified. Although we believe that the outcome of these actions will
not adversely affect our financial position, results of operations or cash
flows, if these cases are not resolved in a timely manner, they will require
expenditure of significant legal costs related to their defense.
From time to time we are subject to unfair labor charges filed by the
unions representing our employees with the National Labor Relations Board. For
example, Region 6 of the National Labor Relations Board, which is located in
Pittsburgh, Pennsylvania, has issued a complaint alleging that Lucent has
refused to bargain over the outsourcing of certain of its manufacturing
activities. In that proceeding, which will be held before an administrative law
judge in Region 6 of the National Labor Relations Board, the General Counsel of
the National Labor Relations Board will act as prosecutor and the charging
party, IBEW System Council EM-3, which is the union representing the workers at
the manufacturing facilities in question, will be an interested party entitled
to participate in the proceeding. Because the complaint relates to some of the
manufacturing facilities that were transferred to us as part of the
distribution, we may be named a party to this action.
The union alleges that Lucent did not provide relevant information relating
to the outsourcing of bargaining unit work, specifically the outsourcing of
circuit packs. The union also claims that Lucent bargained in bad faith during
1998 by withholding its intention to outsource the circuit pack production.
Moreover, the union alleges that Lucent has failed to bargain in good faith over
its decision to outsource certain of its manufacturing operations.
The complaint seeks as remedies for the alleged unlawful conduct, which
Lucent denies in its entirety, a possible return of the outsourced work to the
bargaining unit and/or back pay for affected employees. The amount of back pay
sought, if any, is not determinable at this time. The complaint also provides
that the National Labor Relations Board may potentially seek injunctive relief
if Lucent pursues its current plans to outsource additional bargaining unit
work. If we are unsuccessful in resolving these charges, as they relate to us,
our operations may be disrupted, our initiative to outsource substantially all
of our manufacturing may be delayed or prohibited, or we may incur additional
costs that may decrease our profitability.
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 state court has
recently certified a class in this action. We cannot assure you that this case
will not have a material adverse effect on our financial position, results of
operations or cash flows.
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
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Lucent common stock during the period from October 10, 2000 (the date Lucent
originally reported its financial results) through November 21, 2000. We
understand that Lucent has not yet been served with the complaints in these
cases. Lucent has not yet answered the complaints and a class has not yet been
certified in the actions.
The above actions will most likely be consolidated with other purported
class actions filed against Lucent on behalf of shareholders in January 2000.
Those January 2000 actions have been consolidated and are pending in the Federal
District Court for the District of New Jersey. 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 shareholders of Lucent who bought Lucent
common stock between October 26, 1999 and January 6, 2000, but the consolidated
complaint has recently been 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 shareholder
class actions seek compensatory damages plus interest and attorneys' fees.
Any liability incurred by Lucent in connection with these shareholder class
action cases 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 in excess of $50 million. All of these cases 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.
RISK MANAGEMENT
We are exposed to risk from changes in foreign currency exchange rates and
interest rates that could impact our results of operations and financial
position. We manage our exposure to these market risks through our regular
operating and financing activities and, when deemed appropriate, through the use
of derivative financial instruments. We use derivative financial instruments as
risk management tools and not for speculative or trading purposes. In addition,
derivative financial instruments are entered into with a diversified group of
major financial institutions in order to manage our exposure to nonperformance
on such instruments.
We use foreign currency forward contracts, and to a lesser extent, foreign
currency options, to reduce significant exposure to the risk that the eventual
net cash inflows and outflows resulting from the sale of products to non-United
States customers and purchases from non-United States suppliers will be
adversely affected by changes in exchange rates. Foreign currency exchange
contracts are used to hedge recorded, firmly committed or anticipated purchases
and sales. The use of these derivative financial instruments allows us to reduce
our overall exposure to exchange rate movements, since the gains and losses on
these contracts substantially offset losses and gains on the assets, liabilities
and transactions being hedged. As of September 30, 2000, our primary net foreign
currency market exposures included British pounds, European Monetary Union
dollars, Singapore dollars and Canadian dollars.
The fair value of foreign currency exchange contracts is sensitive to
changes in foreign currency exchange rates. As of September 30, 2000 and 1999, a
10% appreciation in foreign currency exchange rates from the prevailing market
rates would increase our related net unrealized gain for fiscal 2000 and 1999 by
approximately $20 million and $8 million, respectively. Conversely, a 10%
depreciation in these currencies from the prevailing market rates would decrease
our related net unrealized gain for fiscal 2000 and 1999 by approximately $18
million and $10 million, respectively. Consistent with the nature of the
economic hedge of such foreign currency exchange contracts, such unrealized
gains or losses would be offset by corresponding decreases or increases,
respectively, of the underlying asset, liability or transaction being hedged.
While we hedge many foreign currency transactions, the decline in value of
non-United States dollar currencies may, if not reversed, adversely affect our
ability to contract for product sales in United States dollars because our
products may become more expensive to purchase in United States dollars for
local customers doing business in the countries of the affected currencies.
We may enter into interest rate swap agreements to manage the risk between
fixed, floating and variable interest rates and long-term and short-term
maturity debt instruments. There were no interest rate swap agreements in effect
during fiscal 2000 and 1999.
45
<PAGE> 46
The Contribution and Distribution Agreement provides that, as between us
and Lucent, we have assumed all liabilities under or otherwise relating to
derivatives and similar obligations primarily related to our business.
By their nature all such instruments involve risk including the credit risk
of nonperformance by counterparties, and our maximum potential loss may exceed
the amount recognized in our financial statements. However, at both September
30, 2000 and 1999, in our opinion there was no significant risk of loss in the
event of nonperformance of the counterparties to these financial instruments. We
control our exposure to credit risk through credit approvals, credit limits and
monitoring procedures, and we believe that reserves for losses are adequate.
EUROPEAN MONETARY UNION (EURO)
On January 1, 1999, eleven member countries of the European Union
established fixed conversion rates between their existing sovereign currencies,
and adopted the EURO as their new common legal currency. The EURO is currently
trading on currency exchanges and the legacy currencies will remain legal tender
in the participating countries for a transition period between January 1, 1999
and January 1, 2002. During the transition period, cash-less payments can be
made in the EURO, and parties can elect to pay for goods and services and
transact business using either the EURO or a legacy currency. Between January 1,
2002 and July 1, 2002, the participating countries will introduce EURO notes and
coins and permanently withdraw all legacy currencies.
We will continue to evaluate the accounting, tax, legal and regulatory
requirements associated with the EURO introduction. Based on current information
and our current assessment, we do not expect that the EURO conversion will have
a material adverse effect on our consolidated financial position, results of
operations or cash flows.
RECENT ACCOUNTING PRONOUNCEMENTS
SFAS 133
In June 1998, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards ("SFAS") No. 133, "Accounting for
Derivative Instruments and Hedging Activities". SFAS 133 establishes new
accounting and reporting standards for derivative financial instruments and for
hedging activities. SFAS 133 requires us to measure all derivatives at fair
value and to recognize them in the balance sheet as an asset or liability,
depending on our rights or obligations under the applicable derivative contract.
Subsequent to the issuance of SFAS 133, the FASB received many requests to
clarify certain issues causing difficulties in implementation. In June 2000, the
FASB issued SFAS 138, "Accounting for Certain Derivative Instruments and Certain
Hedging Activities -- an Amendment of FASB Statement No. 133," which responds to
those requests by amending certain provisions of SFAS 133. These amendments
include allowing foreign-currency denominated assets and liabilities to qualify
for hedge accounting, permitting the offsetting of selected inter-entity foreign
currency exposures that reduce the need for third party derivatives and
redefining the nature of interest rate risk to avoid sources of ineffectiveness.
We adopted SFAS 133 and the corresponding amendments of SFAS 138 on October 1,
2000, and such adoption did not have a material impact on our consolidated
results of operations, financial position or cash flows.
SAB 101
In December 1999, the Securities and Exchange Commission issued Staff
Accounting Bulletin ("SAB") 101, "Revenue Recognition in Financial Statements".
SAB 101 provides guidance on the recognition, presentation and disclosure of
revenue in financial statements and requires adoption no later than the fourth
quarter of our fiscal year 2001. The adoption of this standard is not expected
to have a material impact on our consolidated results of operations, financial
position or cash flow.
46
<PAGE> 47
SFAS 140
In September 2000, the FASB issued SFAS No. 140, "Accounting for Transfers
and Servicing of Financial Assets and Extinguishments of Liabilities." This
Standard replaced SFAS No. 125, "Accounting for Transfers and Servicing of
Financial Assets and Extinguishments of Liabilities," and provides consistent
standards for distinguishing transfers of financial assets that are sales from
transfers that are secured borrowings. This Standard will be applied
prospectively, with certain exceptions, and is effective for transfers and
servicing of financial assets and extinguishments of liabilities occurring after
March 31, 2001. The adoption of this Standard is not expected to have a material
impact on our consolidated results of operations, financial position or cash
flows.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
See "Management's Discussion and Analysis of Financial Condition and
Results of Operations -- Risk Management."
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
<TABLE>
<S> <C>
Consolidated Financial Statements:
Report of Independent Accountants......................... 48
Consolidated Statements of Operations for the three fiscal
years ended September 30, 2000......................... 49
Consolidated Balance Sheets as of September 30, 2000 and
1999................................................... 50
Consolidated Statements of Changes in Stockholders' Equity
for the three fiscal years ended September 30, 2000.... 51
Consolidated Statements of Cash Flows for the three fiscal
years ended September 30, 2000......................... 52
Notes to Consolidated Financial Statements................ 53
Financial Statement Schedule:
Schedule II -- Valuation and Qualifying Accounts for
the three fiscal years ended September 30, 2000....... 100
</TABLE>
47
<PAGE> 48
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors and
Stockholders of Avaya Inc.:
In our opinion, the consolidated financial statements listed in the
accompanying index present fairly, in all material respects, the financial
position of Avaya Inc. and its subsidiaries (the "Company") at September 30,
2000 and 1999, and the results of their operations and their cash flows for each
of the three years in the period ended September 30, 2000, in conformity with
accounting principles generally accepted in the United States of America. In
addition, in our opinion, the financial statement schedule listed in the
accompanying index presents fairly, in all material respects, the information
set forth therein when read in conjunction with the related consolidated
financial statements. These financial statements and the financial statement
schedule are the responsibility of the Company's management; our responsibility
is to express an opinion on these financial statements and the financial
statement schedule based on our audits. We conducted our audits of these
statements in accordance with auditing standards generally accepted in the
United States of America, which require that we plan and perform the audit to
obtain reasonable assurance about whether the financial statements are free of
material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements, assessing
the accounting principles used and significant estimates made by management, and
evaluating the overall financial statement presentation. We believe that our
audits provide a reasonable basis for our opinion.
Until September 30, 2000, the Company was a fully integrated business of
Lucent Technologies Inc. ("Lucent"); consequently, as indicated in Note 1, these
consolidated financial statements have been derived from the consolidated
financial statements and accounting records of Lucent, and reflect significant
assumptions and allocations. Moreover, as indicated in Note 1, prior to
September 30, 2000, the Company relied on Lucent and its other businesses for
administrative, management and other services. Accordingly, these consolidated
financial statements do not necessarily reflect the financial position, results
of operations, changes in stockholders' equity and cash flows of the Company had
it been a separate stand-alone entity, independent of Lucent during such
periods.
As discussed in Notes 2 and 11 to the consolidated financial statements,
the Company adopted Statement of Position 98-1 "Accounting for the Costs of
Computer Software Developed or Obtained for Internal Use" in 2000 and changed
its method for calculating annual pension and postretirement benefit costs in
1999, respectively.
/s/ PRICEWATERHOUSECOOPERS LLP
PricewaterhouseCoopers LLP
New York, New York
October 25, 2000
48
<PAGE> 49
AVAYA INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(DOLLARS IN MILLIONS, EXCEPT PER SHARE AMOUNTS)
<TABLE>
<CAPTION>
YEAR ENDED SEPTEMBER 30,
--------------------------
2000 1999 1998
------ ------ ------
<S> <C> <C> <C>
REVENUE
Products.................................................. $5,722 $6,368 $6,004
Services.................................................. 1,958 1,900 1,750
------ ------ ------
7,680 8,268 7,754
------ ------ ------
COSTS
Products.................................................. 3,370 3,579 3,253
Services.................................................. 975 985 854
------ ------ ------
4,345 4,564 4,107
------ ------ ------
GROSS MARGIN................................................ 3,335 3,704 3,647
------ ------ ------
OPERATING EXPENSES
Selling, general and administrative....................... 2,626 2,795 2,609
Business restructuring and related charges................ 684 -- --
Research and development.................................. 468 540 423
Purchased in-process research and development............. -- -- 306
------ ------ ------
TOTAL OPERATING EXPENSES.................................... 3,778 3,335 3,338
------ ------ ------
OPERATING INCOME (LOSS)..................................... (443) 369 309
Other income, net......................................... 71 28 25
Interest expense.......................................... (76) (90) (94)
------ ------ ------
INCOME (LOSS) BEFORE INCOME TAXES........................... (448) 307 240
Provision (benefit) for income taxes...................... (73) 121 197
------ ------ ------
INCOME (LOSS) BEFORE CUMULATIVE EFFECT OF ACCOUNTING
CHANGE.................................................... (375) 186 43
Cumulative effect of accounting change (net of income taxes
of $62)................................................... -- 96 --
------ ------ ------
NET INCOME (LOSS)........................................... $ (375) $ 282 $ 43
====== ====== ======
Earnings (Loss) Per Share:
Basic..................................................... $(1.39) $ 1.09 $ 0.17
====== ====== ======
Diluted................................................... $(1.39) $ 1.03 $ 0.17
====== ====== ======
</TABLE>
See Notes to Consolidated Financial Statements.
49
<PAGE> 50
AVAYA INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(DOLLARS IN MILLIONS)
<TABLE>
<CAPTION>
SEPTEMBER 30,
----------------
2000 1999
------ ------
<S> <C> <C>
ASSETS
Current Assets:
Cash and cash equivalents................................... $ 271 $ 194
Receivables less allowances of $62 in 2000 and $58 in
1999...................................................... 1,758 1,765
Inventory................................................... 639 824
Deferred income taxes, net.................................. 450 137
Other current assets........................................ 244 123
------ ------
TOTAL CURRENT ASSETS........................................ 3,362 3,043
------ ------
Property, plant and equipment, net.......................... 966 676
Prepaid benefit costs....................................... 387 --
Deferred income taxes, net.................................. 44 171
Goodwill, net............................................... 204 261
Other assets................................................ 74 88
------ ------
TOTAL ASSETS................................................ $5,037 $4,239
====== ======
LIABILITIES AND STOCKHOLDERS' EQUITY
Current Liabilities:
Accounts payable............................................ $ 763 $ 364
Current portion of long term debt........................... 80 5
Business restructuring reserve.............................. 499 --
Payroll and benefit liabilities............................. 491 687
Advance billings and deposits............................... 253 198
Other current liabilities................................... 503 343
------ ------
TOTAL CURRENT LIABILITIES................................... 2,589 1,597
------ ------
Long term debt.............................................. 713 5
Benefit obligations......................................... 421 354
Deferred revenue............................................ 83 88
Other liabilities........................................... 467 378
------ ------
TOTAL NONCURRENT LIABILITIES................................ 1,684 825
------ ------
Commitments and contingencies
Series B convertible participating preferred stock, par
value $1.00 per share, 4 million shares authorized; none
issued and outstanding.................................... -- --
STOCKHOLDERS' EQUITY
Series A junior participating preferred stock, par value
$1.00 per share, 7.5 million shares authorized; none
issued and outstanding.................................... -- --
Owner's net investment...................................... -- 1,871
Common stock, par value $0.01 per share, 1.5 billion shares
authorized, 282,027,675 issued and outstanding as of
September 30, 2000........................................ 3 --
Additional paid-in capital.................................. 825 --
Accumulated other comprehensive loss........................ (64) (54)
------ ------
TOTAL STOCKHOLDERS' EQUITY.................................. 764 1,817
------ ------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY.................. $5,037 $4,239
====== ======
</TABLE>
See Notes to Consolidated Financial Statements.
50
<PAGE> 51
AVAYA INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF
CHANGES IN STOCKHOLDERS' EQUITY
(DOLLARS IN MILLIONS)
<TABLE>
<CAPTION>
YEAR ENDED SEPTEMBER 30,
-----------------------------
2000 1999 1998
------- ------- -------
<S> <C> <C> <C>
OWNER'S NET INVESTMENT:
Beginning balance........................................... $ 1,871 $ 1,854 $ 1,290
Net income (loss)........................................... (375) 282 43
Transfers to Lucent......................................... (7,783) (8,488) (7,313)
Transfers from Lucent....................................... 7,115 8,223 7,834
Recapitalization upon Distribution.......................... (828) -- --
------- ------- -------
Ending balance.............................................. $ -- $ 1,871 $ 1,854
------- ------- -------
COMMON STOCK:
Beginning balance........................................... $ -- $ -- $ --
Issuance of stock pursuant to the Distribution.............. 3 -- --
------- ------- -------
Ending balance.............................................. $ 3 $ -- $ --
------- ------- -------
ADDITIONAL PAID-IN CAPITAL:
Beginning balance........................................... $ -- $ -- $ --
Additional paid-in capital resulting from the
Distribution.............................................. 825 -- --
------- ------- -------
Ending balance.............................................. $ 825 $ -- $ --
------- ------- -------
ACCUMULATED OTHER COMPREHENSIVE LOSS:
Beginning balance........................................... $ (54) $ (59) $ (30)
Foreign currency translations............................... (10) 5 (29)
------- ------- -------
Ending balance.............................................. $ (64) $ (54) $ (59)
------- ------- -------
TOTAL STOCKHOLDERS' EQUITY.................................. $ 764 $ 1,817 $ 1,795
======= ======= =======
TOTAL COMPREHENSIVE INCOME (LOSS):
Net income (loss)........................................... $ (375) $ 282 $ 43
Other comprehensive income (loss)........................... (10) 5 (29)
------- ------- -------
Total comprehensive income (loss)........................... $ (385) $ 287 $ 14
======= ======= =======
</TABLE>
See Notes to Consolidated Financial Statements.
51
<PAGE> 52
AVAYA INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(DOLLARS IN MILLIONS)
<TABLE>
<CAPTION>
YEAR ENDED SEPTEMBER 30,
-------------------------
2000 1999 1998
------ ----- ------
<S> <C> <C> <C>
OPERATING ACTIVITIES:
Net income (loss)......................................... $(375) $282 $ 43
Adjustments to reconcile net income (loss) to net cash
provided by operating activities:
Cumulative effect of accounting change................. -- (96) --
Business restructuring and related charges
(reversals)........................................... 684 (33) (23)
Depreciation and amortization.......................... 220 212 193
Provision for uncollectible receivables................ 36 25 33
Deferred income taxes.................................. (179) (7) (84)
Purchased in-process research and development.......... -- -- 306
Other adjustments for non-cash items, net.............. (25) 2 (8)
Changes in operating assets and liabilities, net of
effects of acquired and divested businesses:
Receivables.......................................... (50) 5 (424)
Inventory............................................ 131 81 (204)
Accounts payable..................................... 298 (47) 142
Other assets and liabilities......................... (255) 7 155
----- ---- -----
NET CASH PROVIDED BY OPERATING ACTIVITIES................... 485 431 129
----- ---- -----
INVESTING ACTIVITIES:
Capital expenditures...................................... (499) (202) (197)
Proceeds from the sale or disposal of property, plant and
equipment.............................................. 14 17 13
Dispositions of businesses................................ 82 29 --
Acquisitions of businesses, net of cash acquired.......... -- -- (248)
Cash from merger.......................................... -- 60 --
Other investing activities, net........................... (25) 10 (27)
----- ---- -----
NET CASH USED IN INVESTING ACTIVITIES....................... (428) (86) (459)
----- ---- -----
FINANCING ACTIVITIES:
Transfers (to) from Lucent................................ (741) (253) 311
Increase in long term debt................................ 8 -- --
Assumption of commercial paper from Lucent................ 780 -- --
Other..................................................... (5) (4) (46)
----- ---- -----
NET CASH PROVIDED BY (USED IN) FINANCING ACTIVITIES......... 42 (257) 265
----- ---- -----
Effect of exchange rate changes on cash and cash
equivalents............................................... (22) (1) 6
Net increase (decrease) in cash and cash equivalents........ 77 87 (59)
Cash and cash equivalents at beginning of year.............. 194 107 166
----- ---- -----
Cash and cash equivalents at end of year.................... $ 271 $194 $ 107
===== ==== =====
</TABLE>
See Notes to Consolidated Financial Statements.
52
<PAGE> 53
AVAYA INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. BACKGROUND AND BASIS OF PRESENTATION
Background
On September 30, 2000, Lucent Technologies Inc. ("Lucent") spun off its
enterprise communications businesses to its shareowners, which became a separate
legal entity known as Avaya Inc. (the "Company"). The businesses owned by the
Company provide 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.
The consolidated financial statements include the Company and its
subsidiaries as well as certain assets, liabilities, and related operations
transferred to the Company (the "Contribution") from Lucent immediately prior to
the Distribution (as defined below). The consolidated financial statements
include the historical operations transferred to the Company by Lucent (the
"Company's Businesses"). Because prior to the Distribution no direct ownership
relationship existed among all the various units comprising the Company, Lucent
and its subsidiaries' net investment in the Company is shown in lieu of
stockholders' equity in the consolidated financial statements as of September
30, 1999.
On February 16, 2000, the Company was incorporated in Delaware as a wholly
owned subsidiary of Lucent. On that date, 1,000 shares of the Company's common
stock, par value $0.01 per share, were issued, authorized and outstanding.
On September 30, 2000, Lucent distributed to its shareowners all of its
interest in the Company. On that date, 282,027,675 shares of Avaya common stock,
which included the 1,000 shares previously issued to Lucent, were issued to
Lucent shareowners (the "Distribution") based on a distribution ratio of one
share of Avaya common stock for every twelve shares of Lucent common stock
owned. In lieu of receiving fractional shares of Avaya common stock, shareowners
received cash for their fractional interest. At the Distribution, the Company's
authorized capital stock consisted of 200 million shares of preferred stock, par
value $1.00 per share, of which the Company has presently designated 7.5 million
shares as Series A junior participating preferred stock and 4 million shares as
Series B convertible participating preferred stock, and 1.5 billion shares of
common stock, par value $0.01 per share.
Rights Agreement
The Company adopted a rights agreement prior to the Distribution date. The
issuance of a share of the Company's common stock also constitutes the issuance
of a preferred stock purchase right associated with such share. These rights are
intended to have anti-takeover effects in that the existence of the rights may
deter a potential acquirer from making a takeover proposal or a tender offer.
Basis of Presentation
The consolidated financial statements have been derived from the financial
statements and accounting records of Lucent using the historical results of
operations and historical basis of the assets and liabilities of the Company's
Businesses. Management believes the assumptions underlying the consolidated
financial statements are reasonable. However, the consolidated financial
statements included herein may not necessarily reflect the Company's results of
operations, financial position and cash flows in the future or what its results
of operations, financial position and cash flows would have been had the Company
been a stand-alone company during the periods presented.
The consolidated financial statements include allocations of certain Lucent
corporate headquarters' assets, liabilities, and expenses relating to the
Company's Businesses that were transferred to the Company from Lucent. General
corporate overhead has been allocated either based on the ratio of the Company's
costs
53
<PAGE> 54
AVAYA INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
and expenses to Lucent's costs and expenses or based on the Company's revenue as
a percentage of Lucent's total revenue. General corporate overhead primarily
includes cash management, legal, accounting, tax, insurance, public relations,
advertising and data services and amounted to $398 million, $449 million and
$425 million in 2000, 1999 and 1998, respectively. Management believes the costs
of these services charged to the Company are a reasonable representation of the
costs that would have been incurred if the Company had performed these functions
as a stand-alone company. The Company currently performs these functions using
its own resources or purchased services.
The consolidated financial statements also include an allocation from
Lucent to fund a portion of the costs of basic research conducted by Lucent's
Bell Laboratories. This allocation was based on the Company's revenue as a
percentage of Lucent's total revenue. This allocation amounted to $75 million,
$78 million and $66 million for fiscal 2000, 1999 and 1998, respectively.
Management believes the costs of this research charge to the Company are a
reasonable representation of the costs that would have been incurred if the
Company had performed these functions as a stand-alone company. The Company
currently satisfies its basic research requirements using its own resources or
through purchased services.
During the periods covered by these financial statements, Lucent used a
centralized approach to cash management and the financing of its operations.
Prior to the Distribution, cash deposits from the Company's Businesses were
transferred to Lucent on a regular basis and were netted against the owner's net
investment account. As a result, none of Lucent's cash, cash equivalents or debt
at the corporate level have been allocated to the Company in the consolidated
financial statements. Cash and cash equivalents in the consolidated financial
statements represent primarily amounts held by the Company's foreign operations.
Changes in stockholders' equity represent any funding required from Lucent for
working capital, acquisition or capital expenditure requirements after giving
effect to the Company's transfers to or from Lucent of its cash flows from
operations and other noncash transactions between the Company and Lucent.
Interest Expense
Although the Company's Consolidated Statements of Operations include
interest expense for each of the respective years, the accompanying balance
sheets prior to the Distribution do not include an allocation of Lucent debt at
the corporate level because Lucent used a centralized approach to finance its
operations. The interest rates used equate to an estimate of what the Company
believed it would have obtained with a "BBB" rating, the Company's current long
term debt rating by Standard & Poor's. The associated weighted average interest
rate for each of the respective years was 7.9%, 6.8% and 6.5%, respectively.
Average debt balances utilized for the interest expense calculation include an
estimate of the amount of financing thought to be needed to historically fund
the Company's operations and were $962 million, $1,320 million and $1,439
million in 2000, 1999 and 1998, respectively. These estimates were determined
based upon the cash flows for each of the periods and do not necessarily reflect
the level of financing the Company will incur as a stand-alone company.
The Company believes these are reasonable estimates of the cost of
financing the Company's assets and operations in the past. However, the Company
may not be able to obtain financing at interest rates similar to those used for
the interest expense calculation. Accordingly, the Company's interest expense as
a stand-alone company may be higher than that reflected in the Consolidated
Statements of Operations.
On September 30, 2000, the Company assumed $780 million of commercial paper
from Lucent, which largely represents the portion of Lucent liabilities that
Lucent had determined should be attributed to the Company's businesses. It is
anticipated that the Company will incur additional debt in the future to fund a
portion of its business restructuring. Long term debt in the Consolidated
Balance Sheet as of September 30, 2000 also includes debt attributed to the
Company's foreign entities.
54
<PAGE> 55
AVAYA INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Pension and Postretirement Costs
At the Distribution, the Company assumed responsibility for pension and
postretirement benefits for its active employees. Obligations related to retired
and terminated vested employees as of September 30, 2000 remained the
responsibility of Lucent. Prior to the Distribution, the Company's employees
participated in the Lucent pension plans and postretirement benefit plans. The
Company's share of the Lucent plans' asset and liabilities was not included in
the Company's consolidated financial statements until the Distribution since
Lucent had not yet separated Avaya's portion of the employee benefit plans. For
purposes of the financial statements, the pension and postretirement costs were
based on estimated plan assets being equal to a proportional share of plan
obligations incurred by Lucent for employees who performed services for the
Company.
Income Taxes
The Company's income taxes are calculated on a separate tax return basis.
However, Lucent was managing its tax position for the benefit of its entire
portfolio of businesses, and its tax strategies are not necessarily reflective
of the tax strategies that the Company would have followed or will follow as a
stand-alone entity.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Principles of Consolidation
The consolidated financial statements include all majority-owned
subsidiaries in which the Company exercises control. Investments in which the
Company exercises significant influence, but which it does not control
(generally a 20%-50% ownership interest), are accounted for under the equity
method of accounting. All material intercompany transactions and balances
between and among the Company's Businesses have been eliminated. Transactions
between any of the Company's Businesses and Lucent are included in these
financial statements.
Use of Estimates
The preparation of financial statements and related disclosures in
conformity with accounting principles generally accepted in the United States of
America requires management to make estimates and assumptions that affect the
reported amounts of assets and liabilities, the disclosure of contingent assets
and liabilities at the date of the financial statements and revenue and expenses
during the period reported. These estimates include an allocation of costs by
Lucent, assessing the collectability of accounts receivable, the use and
recoverability of inventory, the realization of deferred tax assets and useful
lives for amortization periods of tangible and intangible assets, among others.
The markets for the Company's products are characterized by intense competition,
rapid technological development and frequent new product introduction, all of
which could impact the future realizability of the Company's assets. Actual
results could differ from those estimates.
Foreign Currency Translation
Balance sheet accounts of the Company's foreign operations are translated
from foreign currencies into U.S. dollars at period-end exchange rates while
income and expenses are translated at average exchange rates during the period.
Translation gains or losses related to net assets located outside the United
States are shown as a component of accumulated other comprehensive loss in
stockholders' equity. Gains and losses resulting from foreign currency
transactions (transactions denominated in a currency other than the entity's
functional currency) are included in the Consolidated Statements of Operations.
55
<PAGE> 56
AVAYA INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Revenue Recognition
Revenue from sales of communications systems and software is recognized
when contractual obligations have been satisfied, title and risk of loss have
been transferred to the customer and collection of the resulting receivable is
reasonably assured. Revenue from the direct sales of products that include
installation services is recognized at the time the products are installed,
after satisfaction of all the terms and conditions of the underlying customer
contract. The Company's indirect sales to distribution partners are recognized
at the time of shipment if all contractual obligations have been satisfied. The
Company accrues a provision for estimated sales returns and other allowances as
a reduction of revenue at the time of revenue recognition, as required. For the
Company's value-added services, professional services and services performed
under maintenance contracts, the Company recognizes revenue ratably over the
term of the underlying customer contract or at the end of the contract, when
obligations have been satisfied. For services performed on a time and materials
basis, revenue is recognized upon performance.
Research and Development Costs and Software Development Costs
Research and development costs are charged to expense as incurred. This
line item includes an allocation from Lucent for the costs of basic research
conducted by Bell Laboratories. The costs incurred for the development of
computer software that will be sold, leased or otherwise marketed, however, are
capitalized when technological feasibility has been established. These
capitalized costs are subject to an ongoing assessment of recoverability based
on anticipated future revenues and changes in hardware and software
technologies. Costs that are capitalized include direct labor and related
overhead.
Amortization of capitalized software development costs begins when the
product is available for general release. Amortization is recognized on a
product-by-product basis on the greater of either the sales ratio method or the
straight-line method over the products' estimated useful lives. Unamortized
capitalized software development costs determined to be in excess of net
realizable value of the product are expensed immediately.
Cash and Cash Equivalents
Cash and cash equivalents represent primarily amounts held by the Company's
foreign operations. All highly liquid investments with original maturities of
three months or less are considered to be cash equivalents.
Inventory
Inventory is stated at the lower of cost, determined on a first-in,
first-out basis, or market.
Property, Plant and Equipment
Property, plant and equipment are stated at cost less accumulated
depreciation. Depreciation is determined using a straight-line method on either
the unit or group method over the estimated useful lives of the various asset
classes. The unit method is used for manufacturing and laboratory equipment and
large computer systems. The group method is used for other depreciable assets.
Estimated lives range from three to ten years for machinery, electronic and
other equipment, and thirty years for buildings.
Major renewals and improvements are capitalized and minor replacements,
maintenance and repairs are charged to current operations as incurred. Upon
retirement or disposal of assets, the cost and related accumulated depreciation
are removed from the Consolidated Balance Sheets and any gain or loss is
reflected in the Consolidated Statements of Operations.
The Company adopted Statement of Position 98-1, "Accounting for the Costs
of Computer Software Developed or Obtained for Internal Use" on October 1, 1999.
Certain costs of computer software developed or
56
<PAGE> 57
AVAYA INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
obtained for internal use, that were previously expensed as incurred, are
capitalized and amortized on a straight-line basis over three years. Costs for
general and administrative, overhead, maintenance and training, as well as the
cost of software that does not add functionality to the existing system, are
expensed as incurred. As of September 30, 2000, the Company had unamortized
internal use software costs of $46 million.
Goodwill and Long-Lived Assets
Goodwill is the excess of the purchase price over the fair value of
identifiable net assets acquired in business combinations accounted for as
purchases. Goodwill is amortized on a straight-line basis over the periods
benefited. Long-lived assets and goodwill are reviewed for impairment whenever
events such as asset impairments, product discontinuance, plant closures,
product dispositions or other changes in circumstances indicate that the
carrying amount may not be recoverable. In reviewing for impairment, the Company
compares the carrying value of such assets to the estimated undiscounted future
cash flows expected from the use of the assets and their eventual disposition.
An impairment loss, equal to the difference between the assets' fair value and
their carrying value, is recognized when the estimated future cash flows are
less than their carrying amount.
Financial Instruments
The Company uses various financial instruments, including foreign currency
forward contracts, to manage and reduce risk to the Company by generating cash
flows which offset the cash flows of certain transactions in foreign currencies
or underlying financial instruments in relation to their amount and timing. The
Company's derivative financial instruments are used as risk management tools and
not for speculative or trading purposes. The Company's non-derivative financial
instruments include letters of credit and commitments to extend credit.
Income Taxes
The Company's operations through September 30, 2000 will be included in
Lucent's consolidated income tax returns. Income tax expense in the Company's
consolidated financial statements has been calculated on a separate tax return
basis. Following the Distribution, the Company will file a consolidated Federal
income tax return for Avaya and its subsidiaries. The asset and liability
approach is used to recognize deferred tax assets and liabilities for the
expected future tax consequences of temporary differences between the carrying
amounts and the tax bases of assets and liabilities.
Other Comprehensive Income (Loss)
Comprehensive income (loss) includes, in addition to net income (loss),
unrealized gains and losses excluded from the Consolidated Statements of
Operations that are recorded directly to a separate section of stockholders'
equity on the Consolidated Balance Sheets. These unrealized gains and losses are
referred to as other comprehensive income and, for the Company prior to the
Distribution, primarily consist of foreign currency translation adjustments,
which are not adjusted for income taxes since they relate to indefinite
investments in non-U.S. subsidiaries.
Reclassifications
Certain prior year amounts have been reclassified to conform to the current
year presentation.
57
<PAGE> 58
AVAYA INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
3. ACQUISITIONS, DIVESTITURES AND OTHER TRANSACTIONS
Acquisitions
Purchase Method
The following table presents information about certain acquisitions by the
Company in the fiscal year ended September 30, 1998. These acquisitions were
accounted for under the purchase method of accounting, and the acquired
technology valuation included both existing technology and purchased in-process
research and development. The consolidated financial statements include the
results of operations and the estimated fair values of the assets and
liabilities assumed from the respective dates of acquisition. All charges
related to the write-off of purchased in-process research and development were
recorded in the quarter in which the transaction was completed. There were no
material acquisitions accounted for under the purchase method in fiscal 2000 and
1999.
<TABLE>
<CAPTION>
AMORTIZATION PERIOD
PURCHASED ---------------------------
ACQUISITION PURCHASE EXISTING IPR&D GOODWILL EXISTING TECH.
DATE PRICE GOODWILL TECHNOLOGY (NONDEDUCTIBLE) (IN YEARS) (IN YEARS)
----------- -------- -------- ---------- --------------- ---------- --------------
(DOLLARS IN MILLIONS)
<S> <C> <C> <C> <C> <C> <C> <C>
1998
Lannet(1)................. 8/98 $115 $ 2 $15 $ 67 7 5
SDX(2).................... 7/98 $207 $96 $16 $ 82 10 5
Prominet(3)............... 1/98 $199 $35 $23 $157 5 6
</TABLE>
---------------
(1) Acquisition of Lannet Ltd., an Israeli-based producer of multi-service
networking products. The purchase price of $115 million was in cash.
(2) Acquisition of SDX Business Systems PLC, a United Kingdom-based provider of
multi-service networking products. The purchase price of $207 million was in
cash.
(3) Acquisition of Prominet Corporation, a producer of multi-service networking
products. The purchase price was $199 million of Lucent common stock. In
addition, under the terms of the acquisition agreement, Lucent had a
contingent obligation to pay former Prominet shareowners $35 million in
Lucent stock. The $35 million of Lucent stock was paid in July 1998 and was
recorded primarily as goodwill.
Included in the purchase price for each of the above acquisitions was
purchased in-process research and development. As some of the technology had not
reached technological feasibility and had no future alternative use, it was
written off as a non-tax-deductible charge to earnings immediately upon
consummation of the respective acquisition. The remaining purchase price was
allocated to tangible assets and intangible assets, including goodwill and
existing technology, less liabilities assumed.
The value allocated to purchased in-process research and development was
determined utilizing an income approach that included an excess earnings
analysis reflecting the appropriate cost of capital for the investment.
Estimates of future cash flows related to the purchased in-process research and
development were made for each project based on the Company's estimates of
revenue, operating expenses and income taxes from the project. These estimates
were consistent with historical pricing, margins and expense levels for similar
products.
Revenue was estimated based on relevant market size and growth factors,
expected industry trends, individual product sales cycles and the estimated life
of each product's underlying technology. Estimated operating expenses, income
taxes, and charges for the use of contributory assets were deducted from
estimated revenue to determine estimated after-tax cash flows for each project.
Estimated operating expenses include cost of goods sold; selling, general and
administrative expenses; and research and development expenses. The research and
development expenses include estimated costs to maintain the products once they
have been
58
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AVAYA INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
introduced into the market and generate revenue and costs to complete the
purchased in-process research and development.
The rates utilized to discount the projected cash flows were based on
consideration of Lucent's weighted average cost of capital, as well as other
factors including the useful life of each project, the anticipated profitability
of each project, the uncertainty of technology advances that were known at the
time and the stage of completion of each project.
Lucent's management was primarily responsible for estimating the fair value
of the assets and liabilities acquired, and conducted due diligence in
determining the fair value. Lucent made estimates and assumptions that affect
the reported amounts of assets, liabilities and expenses resulting from such
acquisitions. The Company believes these estimates and allocations are
reasonable.
Pooling of Interests Merger
On July 15, 1999, the Company completed its merger with Mosaix, a provider
of software that manages an enterprise's various office functions and helps them
deliver more responsive and efficient customer service. Under the terms of the
agreement, the outstanding common stock of Mosaix was converted into
approximately 2.6 million shares of Lucent common stock with a value of $145
million. The financial position and results of operations of Mosaix were
immaterial to the Company and as such the consolidated financial statements
include the results of operations and the historical basis of the assets
acquired and liabilities assumed from the date of acquisition.
Divestitures
In September 2000, in conjunction with the Company's restructuring plans to
exit certain manufacturing businesses, the Company sold its manufacturing
facility located in San Jose, California, to Sanmina Corporation. This facility
produced electronic equipment used in structured cabling systems. In connection
with the sale, the Company received proceeds of approximately $18 million and
recorded a loss of approximately $1 million.
On March 31, 2000, the Company completed the sale of its U.S. sales
division that served small and mid-sized businesses to Expanets, Inc. Under the
agreement, approximately 1,800 of the Company's sales and sales support
employees were transferred to Expanets, which became a distributor of the
Company's products to this market and a significant customer of the Company. A
gain of $45 million was recognized to the extent of cash proceeds received
related to the sale of this business and is included in other income, net.
Other Transactions
In fiscal 1999, the Company sold equipment, which was previously rented to
customers, for $97 million. The equipment had a net book value of approximately
$2 million and consisted predominantly of discontinued product lines. Rental
income generated by this equipment for fiscal 1999 and 1998 was $79 million and
$91 million, respectively.
4. RECENT PRONOUNCEMENTS
SFAS 133
In June 1998, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards ("SFAS") No. 133, "Accounting for
Derivative Instruments and Hedging Activities." SFAS 133 establishes new
accounting and reporting standards for derivative financial instruments and for
hedging activities. SFAS 133 requires the Company to measure all derivatives at
fair value and to recognize them in the balance sheet as an asset or liability,
depending on the Company's rights or obligations under the
59
<PAGE> 60
AVAYA INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
applicable derivative contract. Subsequent to the issuance of SFAS 133, the FASB
received many requests to clarify certain issues causing difficulties in
implementation. In June 2000, the FASB issued SFAS 138, "Accounting for Certain
Derivative Instruments and Certain Hedging Activities -- an Amendment of FASB
Statement No. 133," which responds to those requests by amending certain
provisions of SFAS 133. These amendments include allowing foreign-currency
denominated assets and liabilities to qualify for hedge accounting, permitting
the offsetting of selected inter-entity foreign currency exposures that reduce
the need for third party derivatives and redefining the nature of interest rate
risk to avoid sources of ineffectiveness. The Company adopted SFAS 133 and the
corresponding amendments of SFAS 138 on October 1, 2000, and such adoption did
not have a material impact on the Company's consolidated results of operations,
financial position or cash flows.
SAB 101
In December 1999, the Securities and Exchange Commission issued Staff
Accounting Bulletin ("SAB") 101, "Revenue Recognition in Financial Statements."
SAB 101 provides guidance on the recognition, presentation and disclosure of
revenue in financial statements and requires adoption no later than the fourth
quarter of the Company's fiscal year 2001. The adoption of this Standard is not
expected to have a material impact on the Company's consolidated results of
operations, financial position or cash flows.
SFAS 140
In September 2000, the FASB issued SFAS No. 140, "Accounting for Transfers
and Servicing of Financial Assets and Extinguishments of Liabilities." This
Standard replaced SFAS No. 125, "Accounting for Transfers and Servicing of
Financial Assets and Extinguishments of Liabilities," and provides consistent
standards for distinguishing transfers of financial assets that are sales from
transfers that are secured borrowings. This Standard will be applied
prospectively, with certain exceptions, and is effective for transfers and
servicing of financial assets and extinguishments of liabilities occurring after
March 31, 2001. The adoption of this Standard is not expected to have a material
impact on the Company's consolidated results of operations, financial position
or cash flows.
5. SUPPLEMENTARY FINANCIAL INFORMATION
Statement of Operations Information
<TABLE>
<CAPTION>
YEAR ENDED SEPTEMBER 30,
--------------------------
2000 1999 1998
------ ------ ------
(DOLLARS IN MILLIONS)
<S> <C> <C> <C>
INCLUDED IN COSTS
Amortization of software development costs.................. $ 24 $ 14 $ 24
INCLUDED IN SELLING, GENERAL AND ADMINISTRATIVE EXPENSES
Amortization of goodwill and existing technology............ 55 59 45
INCLUDED IN COSTS AND OPERATING EXPENSES
Depreciation and amortization of property, plant and
equipment and internal use software....................... 141 139 124
---- ---- ----
Total depreciation and amortization............... $220 $212 $193
==== ==== ====
</TABLE>
60
<PAGE> 61
AVAYA INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
<TABLE>
<CAPTION>
YEAR ENDED SEPTEMBER 30,
--------------------------
2000 1999 1998
------ ------ ------
(DOLLARS IN MILLIONS)
<S> <C> <C> <C>
OTHER INCOME, NET
Gain (loss) on foreign currency transactions................ $(10) $ -- $ 7
Gain on businesses sold..................................... 44 24 --
Interest income............................................. 7 -- --
Miscellaneous, net.......................................... 30 4 18
---- ---- ----
Total other income, net........................... $ 71 $ 28 $ 25
==== ==== ====
</TABLE>
Balance Sheet Information
<TABLE>
<CAPTION>
SEPTEMBER 30,
----------------------
2000 1999
--------- ---------
(DOLLARS IN MILLIONS)
<S> <C> <C>
INVENTORY
Completed goods............................................. $ 472 $ 577
Work in process and raw materials........................... 167 247
------ ------
Total Inventory................................... $ 639 $ 824
====== ======
PROPERTY, PLANT AND EQUIPMENT, NET
Land and improvements....................................... $ 42 $ 32
Buildings and improvements.................................. 383 329
Machinery, electronic and other equipment................... 1,091 979
Assets under construction................................... 179 40
Internal use software....................................... 50 --
------ ------
Total property, plant and equipment......................... 1,745 1,380
Less: Accumulated depreciation and amortization............. (779) (704)
------ ------
Property, plant and equipment, net................ $ 966 $ 676
====== ======
</TABLE>
Cash Flow Information
Payments for interest and income taxes historically were paid by Lucent on
behalf of the Company and do not necessarily reflect what the Company would have
paid had it been a stand-alone company. The interest and income tax expense
amounts shown in the Consolidated Statements of Operations have been calculated
based on management's estimate of what the Company may have incurred had it been
a separate company.
Net transfers (to) from Lucent are comprised predominately of the following
noncash transactions: (1) a $528 million increase in owner's net investment due
to prepaid pension costs and other assets and a $439 million decrease from
benefit obligations and other accrued liabilities assumed by the Company from
Lucent on the Distribution date for the fiscal year ended September 30, 2000,
(2) a $96 million decrease in owner's net investment for a change in accounting
related to pension and postretirement benefit costs reflected in the fiscal year
ended September 30, 1999, (3) an $82 million increase in owner's net investment
attributed to the Mosaix pooling of interests merger in the fiscal year ended
September 30, 1999, and (4) a $199 million increase in owner's net investment to
reflect the Prominet acquisition that was purchased with Lucent common stock in
the fiscal year ended September 30, 1998.
61
<PAGE> 62
AVAYA INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Acquisitions and dispositions of businesses
Shown below is the impact on cash flows related to the acquisition and
disposition of businesses for the fiscal years ended September 30, 2000 and 1998
(excluding Prominet which was a non-cash transaction), respectively:
<TABLE>
<CAPTION>
FISCAL 1998
---------------------
(DOLLARS IN MILLIONS)
<S> <C>
Acquisition of Businesses:
Fair value of assets acquired, net of cash acquired....... $ 353
Less: Fair value of liabilities assumed................... (105)
-----
Acquisitions of businesses, net of cash acquired....... $ 248
=====
</TABLE>
<TABLE>
<CAPTION>
FISCAL 2000
---------------------
(DOLLARS IN MILLIONS)
<S> <C>
Disposition of Businesses:
Cash proceeds............................................. $ 82
Less: Basis in net assets sold............................ (38)
----
Gain on businesses sold................................ $ 44
====
</TABLE>
6. BUSINESS RESTRUCTURING AND RELATED CHARGES
In September 2000, the Company adopted a restructuring plan to improve
profitability and business performance as a stand-alone company and recorded a
pretax charge of $684 million as business restructuring and related charges in
the Consolidated Statement of Operations. The components of the charge include
$520 million of business restructuring costs, $75 million of asset impairment
charges, and $89 million of incremental period expenses associated with the
Company's separation from Lucent.
The Company also recorded $73 million in selling, general and
administrative expenses for start-up activities related to establishing
independent operations including fees for investment banking and other
professional advisors, and marketing costs associated with establishing the
Avaya brand. The charges recorded in connection with the Company's restructuring
and start-up activities totaled $757 million in fiscal 2000, almost all of which
will result in a usage of cash. During fiscal 2001, the Company expects to incur
additional period costs of approximately $200 million as a result of the
Company's separation from Lucent and establishment as an independent company.
The Company expects to fund its restructuring and start-up activities through a
combination of debt and internally generated funds.
Components of the business restructuring costs and amounts recorded against
the reserve as of September 30, 2000, were as follows:
<TABLE>
<CAPTION>
COSTS ACCRUED EXPENDITURES MADE RESERVE BALANCE AS OF
DURING FISCAL 2000 DURING FISCAL 2000 SEPTEMBER 30, 2000
------------------ ------------------ ---------------------
(DOLLARS IN MILLIONS)
<S> <C> <C> <C>
Employee separation costs....... $365 $(20) $345
Lease obligations............... 127 -- 127
Other related exit costs........ 28 (1) 27
---- ---- ----
Total................. $520 $(21) $499
==== ==== ====
</TABLE>
Accrued business restructuring costs for employee separations of $365
million related to approximately 4,900 occupational and management employees, of
which 1,470 employees worldwide have departed as of September 30, 2000,
predominately located in the United States. These costs include severance,
medical and
62
<PAGE> 63
AVAYA INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
other benefits. The employee separations are primarily attributed to redesigning
the services organization by reducing field technicians to a level needed for
non-peak work loads, consolidating and closing certain U.S. and European
manufacturing facilities and realigning the sales effort towards a direct focus
on strategic accounts and an indirect focus on smaller accounts.
Accrued costs for lease obligations of $127 million are comprised of $100
million to terminate real estate leases related to approximately two million
square feet of excess manufacturing, distribution and administrative space and
$27 million to cancel equipment leases related to the Company's information
systems infrastructure. Real estate lease termination costs are being incurred
primarily in the United States, Europe and Asia, and have been reduced for
sublease income that management believes is probable. Other related exit costs
of $28 million primarily consist of decommissioning legacy computer systems in
connection with the Company's separation from Lucent and terminating other
contractual obligations.
In connection with the Company's restructuring initiatives, asset
impairment charges of $75 million were recorded. These charges were primarily
comprised of $50 million related to an outsourcing contract with a major
customer. During the fourth quarter of fiscal 2000, the Company terminated its
obligations under a leasing arrangement and purchased the underlying equipment.
The equipment is being used to support a contract where the Company provides
equipment outsourcing and related services. Based on the terms of this contract,
the estimated undiscounted cash flows from the equipment's use and eventual
disposition was determined to be less than the equipment's carrying value, and
resulted in the impairment charge of $50 million to write such equipment down to
its fair value.
Also during the fourth quarter of fiscal 2000, the Company recorded
incremental period costs of $89 million 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 December 1995, a pre-tax charge of $146 million was recorded to cover
restructuring costs. The restructuring plans included the exit of certain
businesses as well as consolidating business unit operations. Total deductions
to the Company's business restructuring reserves were $49 million and $37
million for the years ended September 30, 1999 and 1998, respectively, and
related to employee separation costs. Included in these deductions were cash
payments of $16 million and $14 million for the years ended September 30, 1999
and 1998, respectively. In addition, the Company reversed $33 million and $23
million of business restructuring reserves primarily related to favorable
experience in employee separations for the years ended September 30, 1999 and
1998, respectively. As of September 30, 1999, all prior restructuring related
plans were complete and no such reserves remain.
7. EARNINGS PER SHARE OF COMMON STOCK
Basic earnings per common share are calculated by dividing net income
(loss) by the weighted average number of common shares outstanding during the
year. Since the Company's common stock was not issued until September 30, 2000,
the date of the Distribution, the weighted average number of common shares
outstanding during each of the years presented was calculated based on a twelve
to one ratio of Lucent's weighted average number of shares to Avaya's. Diluted
earnings per common share are calculated by adjusting weighted average
outstanding shares, assuming conversion of all potentially dilutive stock
options.
63
<PAGE> 64
AVAYA INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
<TABLE>
<CAPTION>
YEAR ENDED SEPTEMBER 30,
------------------------
2000 1999 1998
------ ----- -----
<S> <C> <C> <C>
Earnings per common share -- basic:
Income (loss) before cumulative effect of accounting
change................................................. $(1.39) $0.72 $0.17
Cumulative effect of accounting change.................... -- 0.37 --
------ ----- -----
Net income (loss) attributable to common shareowners...... $(1.39) $1.09 $0.17
Earnings per common share -- diluted:
Income (loss) before cumulative effect of accounting
change................................................. $(1.39) $0.68 $0.17
Cumulative effect of accounting change.................... -- 0.35 --
------ ----- -----
Net income (loss) attributable to common shareowners...... $(1.39) $1.03 $0.17
Number of shares (in millions):
Common shares -- basic.................................... 269 259 252
Effect of dilutive stock options(a)....................... -- 14 8
------ ----- -----
Common shares -- diluted.................................. 269 273 260
Options excluded from the computation of earnings per
share(b)............................................... 8.5 1.7 1.6
</TABLE>
---------------
(a) Diluted common shares for fiscal 2000 exclude 14 million equivalent shares
related to the conversion of in-the-money stock options due to their
anti-dilutive effect resulting from the loss recorded during the period.
(b) The diluted earnings per share calculation excluded these options in fiscal
2000, 1999 and 1998, respectively, since their inclusion would be
anti-dilutive due to the option exercise price being greater than the
average market value of the underlying stock.
8. LONG TERM DEBT
Commercial Paper Program
The Company has established a commercial paper program (the "CP Program")
pursuant to which the Company may issue up to $1.7 billion of commercial paper
at market interest rates with maturities not exceeding one year. Commercial
paper issued under the CP Program may bear interest at a fixed rate or at a
floating rate that may be reset periodically throughout the term. The floating
interest rate may be adjusted based on any one of a number of prevailing rates
for the relevant maturity period, as determined by the Company at the time of
issuance, including without limitation, certificate of deposit rates, commercial
paper rates for nonfinancial issuers, the federal funds rate, bank prime rates
and treasury bond rates.
Under the CP Program, the Company assumed, upon the Distribution, all of
Lucent's obligations in connection with its issuance of $780 million of
commercial paper. As of September 30, 2000, $700 million in commercial paper was
classified as long term debt in the Consolidated Balance Sheet since it is
supported by the five-year credit facility described below and management
intends to reissue the commercial paper on a long term basis. The weighted
average yield and maturity period for the commercial paper outstanding as of
September 30, 2000 was approximately 6.86% and 21 days, respectively.
Credit Facilities
The Company has also entered into two unsecured revolving credit facilities
(the "Credit Facilities") with third party financial institutions consisting of
an $850 million 364-day credit facility and an $850 million five-year credit
facility. Funds are available under the Credit Facilities for general corporate
purposes, to backstop commercial paper, and for acquisitions. The Credit
Facilities provide, at the Company's option, for fixed interest rate and
floating interest rate borrowings. Fixed rate borrowings under the Credit
Facilities bear
64
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AVAYA INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
interest at a rate equal to (i) the greater of (A) Citibank, N.A.'s base rate
and (B) the federal funds rate plus 0.5% plus (ii) a margin based on the
Company's long term debt rating (the "Applicable Margin"). Floating rate
borrowings bear interest at a rate equal to the LIBOR rate plus the Applicable
Margin and a utilization fee based on the Company's long term debt rating (the
"Applicable Utilization Fee"). Based on the Company's current long term debt
rating, the Applicable Margin for the 364-day credit facility and the five-year
credit facility is 0.42% and 0.40%, respectively, and the Applicable Utilization
Fee for both facilities is 0.125%.
Under the terms of the Credit Facilities, the Company is required to pay,
on a quarterly basis, a facility fee equal to a percentage of the outstanding
commitments for the most recently completed quarter. Such percentage is based on
the Company's long term debt rating. Based on the Company's current long term
debt rating, the applicable facility fee percentage for the 364-day credit
facility and the five-year credit facility is 0.08% and 0.10%, respectively.
The Credit Facilities contain certain customary covenants, including
limitations on the Company's ability to incur liens in certain circumstances or
enter into certain change of control transactions. In addition, for each of the
Company's first three fiscal quarters of 2001, the Company must maintain a ratio
of annualized consolidated earnings before interest and taxes to annualized
consolidated interest expense of at least 3 to 1. For each quarter thereafter,
the Company must maintain such ratio for the previous four consecutive fiscal
quarters.
No amounts were drawn under the Credit Facilities as of September 30, 2000.
In addition, the Company, through its foreign operations, entered into
several credit facilities totaling $95 million of which letters of credit of $27
million and $20 million were issued and outstanding as of September 30, 2000 and
1999, 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. Management does not believe it is practicable to estimate
the fair value of these financial instruments and does not expect any material
losses from their resolution since performance is not likely to be required.
As of September 30, 2000 and 1999, the Company also had debt attributable
to its foreign entities of $13 million and $10 million, respectively.
9. CONVERTIBLE PARTICIPATING PREFERRED STOCK
On October 2, 2000, the Company sold to Warburg, Pincus Equity Partners,
L.P. and related investment funds, collectively referred to herein as the
investors, 4,000,000 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. Based on an agreed upon formula, the
Series B convertible participating preferred stock is expected to be initially
convertible into approximately 5.0% of the Company's fully diluted common stock,
calculated using a modified treasury stock method as of the 90th day after
issuance. The warrants have an exercise price equal to 130% of the conversion
price for the Series B convertible participating preferred stock. The warrants
are exercisable for 3.6% of a total number of shares of common stock to be
calculated pursuant to an agreed upon formula as of the 90th day after issuance.
Of these warrants, warrants exercisable for 2.0% of such total number of shares
of common stock will have a four-year term and warrants exercisable for 1.6% of
such total number of shares of common stock will have a five-year term. During a
period commencing no later than June 30, 2001, until the second anniversary of
their issuance, if the market price of the Company's common stock exceeds agreed
upon trading price levels, the Company can force conversion of up to 50% of the
four-year warrants and the five-year warrants, respectively.
The shares of Series B convertible participating preferred stock have an
aggregate initial liquidation value of $400 million and will accrete for the
first ten years at an annual rate of 6.5%, compounded quarterly. After the third
anniversary of the issue date, 50% of the amount accreted for the year may be
paid in cash as a
65
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AVAYA INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
dividend on a quarterly basis, at the Company's option. After the fifth
anniversary of the issue date through the tenth anniversary, the Company may
elect to pay 100% of the amount accreted for the year as a cash dividend on a
quarterly basis. Following the tenth anniversary of the issue date, the Company
will pay quarterly cash dividends at an annual rate of 12% of the then accreted
liquidation value of the Series B convertible participating preferred stock,
compounded quarterly. The Series B convertible participating preferred shares
also participate, on an as-converted basis, in dividends paid on the Company's
common stock.
The $400 million proceeds from the Warburg Pincus investment will be
allocated between Series B convertible participating preferred stock and
warrants based upon the relative fair market value of each security and will be
initially classified on the Consolidated Balance Sheet in October 2000 at such
amounts. The Series B convertible participating preferred stock will be recorded
in the mezzanine section of the Consolidated Balance Sheet because the investors
may require the Company, upon the occurrence of any change-of-control in the
Company during the first five years from the investment, to redeem the
convertible participating preferred stock. The fair value allocated to the
warrants will be included in additional paid-in capital.
The Emerging Issues Task Force of the Financial Accounting Standards Board
recently issued EITF Issue No. 00-27, Application of EITF Issue No. 98-5,
"Accounting for Convertible Securities with Beneficial Conversion Features or
Contingently Adjustable Conversion Ratios," to Certain Convertible Instruments.
This EITF Issue will apply to the Warburg Pincus investment. Under the EITF
Issue, any amounts ascribed to a beneficial conversion feature of the Series B
convertible participating preferred stock will be recorded as a reduction to net
income attributable to common shareowners. A beneficial conversion feature will
exist if the conversion price (accounting basis) for the Series B convertible
participating preferred stock or warrants is less than the fair value of the
Company's common stock at the commitment date. Based on preliminary analysis,
the Company does not expect there to be a material impact, if any, on its future
results of operations for any beneficial conversion features associated with the
Series B convertible participating preferred stock or with the warrants to
purchase shares of the Company's common stock. The beneficial conversion
features, if any, associated with dividends paid in kind, where it is the
Company's option to pay the dividends in cash will be measured when the
dividends are declared.
10. INCOME TAXES
Income tax expense (benefit) in the Company's consolidated financial
statements has been calculated on a separate tax return basis. The following
table presents the principal reasons for the difference between the effective
tax rate and the U.S. federal statutory income tax rate:
<TABLE>
<CAPTION>
YEAR ENDED
SEPTEMBER 30,
---------------------
2000 1999 1998
----- ---- ----
<S> <C> <C> <C>
U.S. federal statutory income tax rate (benefit)............ (35.0)% 35.0% 35.0%
State and local income taxes, net of federal income tax
effect.................................................... (4.8) 4.2 3.5
Tax differentials on foreign earnings....................... 3.7 1.9 (2.7)
Research credits............................................ (2.2) (3.7) (2.1)
Purchased in-process research and development............... -- -- 45.9
Amortization of intangibles................................. 2.3 7.0 1.7
Non-deductible restructuring costs.......................... 18.2 -- --
Other differences -- net.................................... 1.5 (5.0) 0.8
----- ---- ----
Effective income tax rate (benefit)......................... (16.3)% 39.4% 82.1%
===== ==== ====
Effective income tax rate (benefit) excluding purchased
in-process research and development....................... (16.3)% 39.4% 36.2%
</TABLE>
66
<PAGE> 67
AVAYA INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The following table presents the U.S. and foreign components of income
(loss) before income taxes and the provision (benefit) for income taxes:
<TABLE>
<CAPTION>
YEAR ENDED SEPTEMBER 30,
------------------------
2000 1999 1998
------ ----- -----
(DOLLARS IN MILLIONS)
<S> <C> <C> <C>
INCOME (LOSS) BEFORE INCOME TAXES:
U.S. ....................................................... $(588) $173 $102
Foreign..................................................... 140 134 138
----- ---- ----
Income (loss) before income taxes........................... $(448) $307 $240
===== ==== ====
PROVISION (BENEFIT) FOR INCOME TAXES:
CURRENT
Federal..................................................... $ 130 $ 45 $117
State and local............................................. 11 19 31
Foreign..................................................... 74 59 30
----- ---- ----
Sub-total................................................... 215 123 178
----- ---- ----
DEFERRED
Federal..................................................... (244) (3) 20
State and local............................................. (44) 1 (1)
----- ---- ----
Sub-total................................................... (288) (2) 19
----- ---- ----
Provision (benefit) for income taxes........................ $ (73) $121 $197
===== ==== ====
</TABLE>
As of September 30, 2000, the Company had tax credit carryforwards of $18
million and federal, state and local, and foreign net operating loss
carryforwards (after-tax) of $17 million all of which expire primarily after the
year 2003. Federal and state net operating losses begin to expire in the year
2005 while the majority of foreign net operating losses can be carried forward
indefinitely.
The valuation allowance established for deferred tax assets primarily
relates to state tax credit carryforwards and foreign net operating loss
carryforwards for which management believes it is more likely than not such
deferred tax amounts will not be realized.
The asset and liability approach is used to recognize deferred tax assets
and liabilities for the expected future tax consequences of temporary
differences between the carrying amounts and the tax bases of assets and
liabilities. The components of deferred tax assets and liabilities at September
30, 2000 and 1999 are as follows:
<TABLE>
<CAPTION>
SEPTEMBER 30,
--------------
2000 1999
----- -----
(DOLLARS
IN MILLIONS)
<S> <C> <C>
DEFERRED INCOME TAX ASSETS
Benefit obligations......................................... $119 $214
Accrued liabilities......................................... 459 176
Net operating loss/credit carryforwards..................... 35 77
Valuation allowance......................................... (49) (73)
Other....................................................... 5 4
---- ----
Total deferred tax assets................................... $569 $398
==== ====
</TABLE>
67
<PAGE> 68
AVAYA INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
<TABLE>
<CAPTION>
SEPTEMBER 30,
--------------
2000 1999
----- -----
(DOLLARS
IN MILLIONS)
<S> <C> <C>
DEFERRED INCOME TAX LIABILITIES
Property, plant and equipment............................... $ 29 $ 41
Other....................................................... 46 49
---- ----
Total deferred tax liabilities.............................. $ 75 $ 90
==== ====
</TABLE>
The Company has not provided for U.S. deferred income taxes or foreign
withholding taxes on $415 million of undistributed earnings of its non-U.S.
subsidiaries as of September 30, 2000, since the Company intends to reinvest
these earnings indefinitely.
11. BENEFIT OBLIGATIONS
Pension and Postretirement Benefits
At the Distribution, the Company assumed responsibility for pension and
postretirement benefit obligations for its active employees. Obligations related
to retired and terminated vested employees as of September 30, 2000 remain the
responsibility of Lucent. Prior to the Distribution, the Company's employees
participated in the Lucent pension plans and postretirement benefit plans. The
Company's share of the Lucent plans' assets and liabilities was not included in
the Company's consolidated financial statements until the Distribution since
Lucent had not yet separated Avaya's portion of the employee benefit plans. In
connection with the Distribution, and subject to the completion of a review by
an independent actuarial consulting firm, the Company recorded as of September
30, 2000, an estimate of $387 million in prepaid benefit assets and $199 million
in accrued benefit obligations of various existing Lucent benefit plans related
to the employees for whom the Company assumed responsibility. The Company
believes the results from the independent review will not have a material effect
on the Consolidated Balance Sheet. The assets of the Lucent pension and other
employee benefit plans will be divided and transferred between Lucent and the
Company in accordance with the Employee Benefits Agreement (see Note 15).
The pension and postretirement costs incurred by Lucent for employees who
performed services for the Company were based on estimated plan assets being
equal to a proportional share of plan obligations incurred by Lucent for
employees who performed services for the Company. In relation to the Lucent
plans, the Company recorded pension expense of $79 million, $97 million and $70
million, and postretirement expense of $55 million, $62 million and $49 million
in fiscal 2000, 1999 and 1998, respectively.
Effective October 1, 1998, Lucent changed its method for calculating the
market-related value of plan assets used in determining the expected
return-on-asset component of annual net pension and postretirement benefit
costs. Under the previous accounting method, the calculation of the
market-related value of plan assets included only interest and dividends
immediately, while all other realized and unrealized gains and losses were
amortized on a straight-line basis over a five-year period. The new method used
to calculate market-related value includes recognizing immediately an amount
based on Lucent's historical asset returns and amortizes the difference between
that amount and the actual return on a straight-line basis over a five-year
period. The new method is preferable under SFAS No. 87, "Employers' Accounting
for Pensions", because it results in calculated plan asset values that are
closer to current fair value, thereby lessening the accumulation of unrecognized
gains and losses while still mitigating the effects of annual market value
fluctuations.
The cumulative effect of this accounting change for the Company related to
periods prior to fiscal 1999 of $158 million ($96 million after-tax) is a
one-time, non-cash credit to fiscal 1999 earnings. This accounting change also
resulted in a reduction in benefit costs in fiscal 1999 that increased income by
$30 million ($18 million after-tax) as compared with the previous accounting
method. The pro forma estimated effect if the
68
<PAGE> 69
AVAYA INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
accounting change were applied retroactively would be an increase to pre-tax
income of $28 million for fiscal 1998.
The information that follows relates to Lucent's employee benefit plans.
The following table shows the funded status of Lucent's defined benefit and
postretirement plans:
<TABLE>
<CAPTION>
PENSION POSTRETIREMENT
BENEFITS BENEFITS
SEPTEMBER 30, SEPTEMBER 30,
------------------- ------------------
2000 1999 2000 1999
-------- ------- ------- -------
(DOLLARS IN MILLIONS)
<S> <C> <C> <C> <C>
CHANGE IN BENEFIT OBLIGATION
Benefit obligation at October 1.................. $ 27,401 $27,846 $ 8,604 $ 9,193
Service cost..................................... 478 509 67 80
Interest cost.................................... 1,915 1,671 601 537
Actuarial losses (gains)......................... 370 (2,182) 33 (240)
Amendments....................................... (1) 1,534 -- (359)
Benefits paid.................................... (2,294) (1,977) (651) (607)
Benefit obligation assumed by Avaya.............. (1,756) -- (412) --
-------- ------- ------- -------
Benefit obligation at September 30............ $ 26,113 $27,401 $ 8,242 $ 8,604
-------- ------- ------- -------
CHANGE IN PLAN ASSETS
Fair value of plan assets at October 1........... $ 41,067 $36,191 $ 4,467 $ 3,959
Actual return on plan assets..................... 9,791 7,114 654 776
Lucent contributions............................. 19 14 8 29
Benefits paid.................................... (2,294) (1,977) (651) (607)
Assets transferred to Avaya...................... (2,984) -- (255) --
Other (including transfer of assets from pension
to postretirement plans)...................... (337) (275) 334 310
-------- ------- ------- -------
Fair value of plan assets at September 30..... $ 45,262 $41,067 $ 4,557 $ 4,467
-------- ------- ------- -------
FUNDED (UNFUNDED) STATUS OF THE PLAN............... $ 19,149 $13,666 $(3,685) $(4,137)
Unrecognized prior service cost.................. 2,086 2,583 49 121
Unrecognized transition asset.................... (322) (645) -- --
Unrecognized net gain............................ (14,499) (9,466) (1,208) (1,014)
-------- ------- ------- -------
Net amount recognized......................... $ 6,414 $ 6,138 $(4,844) $(5,030)
======== ======= ======= =======
Amounts recognized in the Lucent consolidated
balance sheets consist of:
Prepaid benefit costs............................ $ 6,440 $ 6,175 $ -- $ --
Accrued benefit obligations...................... (37) (63) (4,844) (5,030)
Intangible asset................................. 5 9 -- --
Accumulated other comprehensive income........... 6 17 -- --
-------- ------- ------- -------
Net amount recognized......................... $ 6,414 $ 6,138 $(4,844) $(5,030)
======== ======= ======= =======
</TABLE>
As of September 30, 2000, the pension and postretirement benefits related
to the employees for whom Avaya assumed responsibility, which are not included
in the table above, consist of a net amount recognized of $387 million and
$(198) million, respectively.
69
<PAGE> 70
AVAYA INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Pension plan assets include $102 million and $287 million of Avaya and
Lucent common stock at September 30, 2000 and 1999, respectively. Postretirement
plan assets include $3 million and $20 million of Avaya and Lucent common stock
at September 30, 2000 and 1999, respectively.
<TABLE>
<CAPTION>
AS OF SEPTEMBER 30,
--------------------
2000 1999 1998
---- ---- ----
<S> <C> <C> <C>
PENSION AND POSTRETIREMENT BENEFITS WEIGHTED-AVERAGE
ASSUMPTIONS
Discount rate............................................... 7.5% 7.25% 6.0%
Expected return on plan assets.............................. 9.0% 9.0% 9.0%
Rate of compensation increase............................... 4.5% 4.5% 4.5%
</TABLE>
The Company has several non-pension postretirement benefit plans. For
postretirement health care benefit plans, a 7.6% annual rate of increase in the
per capita cost of covered health care benefits was assumed for fiscal year
2001. The rate was assumed to gradually decline to 3.9% percent by the year
2005, and remain at that level thereafter. A one-percentage-point change in the
Company's health care cost trend rate would have the following effects:
<TABLE>
<CAPTION>
1 PERCENTAGE POINT
----------------------
INCREASE DECREASE
--------- ---------
(DOLLARS IN MILLIONS)
<S> <C> <C>
Effect on total of service and interest cost components..... $0.1 $0.1
Effect on postretirement benefit obligation................. $0.9 $1.5
</TABLE>
Savings Plans
The majority of the Company's employees were eligible to participate in
savings plans sponsored by Lucent. The plans allowed employees to contribute a
portion of their compensation on a pre-tax and/or after-tax basis in accordance
with specified guidelines. Lucent matched a percentage of employee contributions
up to certain limits. The Company's expense related to the Lucent savings plans
was $54 million, $68 million and $64 million in 2000, 1999 and 1998,
respectively. The Company established similar plans following the Distribution.
12. STOCK COMPENSATION PLANS
During 2000, 1999 and in prior years, certain employees of the Company were
granted stock options and other equity-based awards under Lucent's stock-based
compensation plans. At the time of the Distribution, unvested awards outstanding
under Lucent's stock plans that were held by Lucent employees who transferred to
the Company were converted to awards to acquire stock of the Company. Vested
Lucent stock options have remained options to acquire Lucent common stock,
subject to adjustments as described below. The Avaya stock options and other
awards as converted have the same vesting provisions, option periods, and other
terms and conditions as the Lucent options and awards they replaced. The number
of shares and exercise price of each stock option has been adjusted so that each
option, whether a Lucent option or a Company option, has the same ratio of the
exercise price per share to the market value per share, and the same aggregate
difference between market value and exercise price (intrinsic value), as the
Lucent stock options prior to the Distribution. Upon conversion, the stock
options retained the measurement date from the original issuance.
Stock options generally are granted with an exercise price equal to 100% of
the market value of a share of common stock on the date of grant, have a
ten-year term and vest within four years from the date of grant. As of September
30, 2000, there were authorized for grant approximately 60 million stock options
to purchase Avaya common stock under the Company's stock compensation plans,
excluding those stock options assumed by the Company from Lucent and converted
to Avaya stock options at the Distribution date.
70
<PAGE> 71
AVAYA INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
In connection with certain of the Company's acquisitions, outstanding stock
options held by employees of acquired companies became exercisable, according to
their terms, for Lucent's common stock effective at the acquisition date. For
acquisitions accounted for as purchases, the fair value of these options was
included as part of the purchase price.
During 2000, 1999, and 1998, the Company's employees were eligible to
participate in the Lucent Employee Stock Purchase Plan ("Lucent ESPP"). At the
time of the Distribution, Avaya initiated its own employee stock purchase plan.
Under the terms of Avaya's Employee Stock Purchase Plan ("Avaya ESPP"), eligible
employees may have up to 10% of eligible compensation deducted from their pay to
purchase common stock through March 31, 2002. Upon termination, it is the
Company's intention to propose and it is expected that the shareholders will
approve a similar plan. The per share purchase price is 85% of the average high
and low per share trading price of Avaya's common stock on the New York Stock
Exchange on the last trading day of each month. As of September 30, 2000, no
shares were purchased under the Avaya ESPP, which contains substantially the
same terms and conditions as the Lucent ESPP. In fiscal 2000, 1999 and 1998, 1.3
million, 1.2 million and 1.6 million Lucent shares, respectively, were purchased
under the Lucent ESPP by employees who were transferred to the Company upon the
Distribution, at a weighted average price of $45.50, $47.02 and $24.49,
respectively.
The Company has adopted the disclosure requirements of SFAS No. 123,
"Accounting for Stock-Based Compensation" and, as permitted under SFAS No. 123,
applies Accounting Principles Board Opinion ("APB") No. 25 and related
interpretations in accounting for its stock compensation plans. Compensation
expense recorded under APB No. 25, which uses the intrinsic value method, was $7
million, $14 million and $4 million for the years ended September 30, 2000, 1999
and 1998, respectively. If the Company had elected to adopt the optional
recognition provisions of SFAS No. 123, which uses the fair value-based method,
for its stock option plans and employee stock purchase plan, net income (loss)
would have been changed to the pro forma amounts indicated below:
<TABLE>
<CAPTION>
YEAR ENDED SEPTEMBER 30,
------------------------
2000 1999 1998
------ ----- -----
(DOLLARS IN MILLIONS)
<S> <C> <C> <C>
NET INCOME (LOSS)
As reported................................................. $(375) $282 $43
Pro forma................................................... $(469) $231 $16
</TABLE>
The fair value of stock options used to compute pro forma net income
disclosures is the estimated fair value at grant date using the Black-Scholes
option-pricing model with the following assumptions:
<TABLE>
<CAPTION>
YEAR ENDED SEPTEMBER 30,
--------------------------
2000 1999 1998
------ ------ ------
<S> <C> <C> <C>
WEIGHTED AVERAGE ASSUMPTIONS
Dividend yield.............................................. 0.20% 0.13% 0.23%
Expected volatility......................................... 38.4% 34.1% 29.3%
Risk free interest rate..................................... 6.3% 5.3% 5.2%
Expected holding period (in years).......................... 2.8 3.8 5.0
</TABLE>
Presented below is a summary of the status of the Lucent stock options held
by employees for whom the Company has assumed responsibility, and the related
transactions for the years ended September 30, 2000, 1999 and 1998. The stock
option activity is not necessarily indicative of what the activity would have
been had the Company been a separate stand-alone entity during the periods
presented or what the activity may be in the future.
71
<PAGE> 72
AVAYA INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
<TABLE>
<CAPTION>
SHARES WEIGHTED AVERAGE
(000'S) EXERCISE PRICE
------- ----------------
<S> <C> <C>
OPTIONS OUTSTANDING AT SEPTEMBER 30, 1997................... 15,774 $11.27
Granted/Assumed*(1)......................................... 12,665 31.65
Exercised................................................... (1,278) 7.73
Forfeited/Expired........................................... (95) 6.10
------
OPTIONS OUTSTANDING AT SEPTEMBER 30, 1998................... 27,066 20.99
Granted/Assumed............................................. 6,814 49.81
Exercised................................................... (2,246) 11.44
Forfeited/Expired........................................... (33) 36.86
------
OPTIONS OUTSTANDING AT SEPTEMBER 30, 1999................... 31,601 27.87
Granted/Assumed............................................. 18,431 52.66
Exercised................................................... (5,124) 12.26
Forfeited/Expired/Transferred(2)............................ (7,176) 28.37
------
OPTIONS OUTSTANDING AT SEPTEMBER 30, 2000 (IMMEDIATELY PRIOR
TO DISTRIBUTION).......................................... 37,732 41.90
Less: Lucent vested options................................. (7,147) 17.50
------
Lucent unvested options to be converted..................... 30,585 47.61
======
AVAYA OPTIONS CONVERTED AT DISTRIBUTION DATE................ 44,971 $31.63
======
</TABLE>
---------------
* Includes options converted in acquisitions.
(1) Includes options covering 5,843 shares of common stock granted under a
broad-based employee plan at a weighted average exercise price of $37.34.
(2) Includes 7,133 options attributable to the movement of employees between the
Company and Lucent during the year.
The weighted average fair value of Lucent's stock options, calculated using
the Black-Scholes option-pricing model, granted during the years ended September
30, 2000, 1999 and 1998 is $15.75, $19.21 and $12.35 per share, respectively.
The following table summarizes the status of the Company's stock options
outstanding at September 30, 2000:
<TABLE>
<CAPTION>
STOCK OPTIONS OUTSTANDING
-----------------------------------
WEIGHTED
AVERAGE WEIGHTED
REMAINING AVERAGE
SHARES CONTRACTUAL EXERCISE
RANGE OF EXERCISE PRICES (000'S) LIFE (YEARS) PRICE
------------------------ ------- ------------ --------
<S> <C> <C> <C>
$0.01 to $16.89...................................... 1,314 6.71 $13.39
$16.90 to $34.98..................................... 28,031 6.15 27.68
$34.99 to $44.11..................................... 14,551 9.21 39.77
$44.12 to $61.98..................................... 1,075 9.30 46.72
------
Total................................................ 44,971 $31.63
======
</TABLE>
There were no stock options exercisable as of September 30, 2000.
Subsequent to September 30, 2000, the Company granted approximately 26
million stock options through October 25, 2000, at the fair market value of the
Company's common stock on the date of grant.
72
<PAGE> 73
AVAYA INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Other stock unit awards are granted under certain award plans. The
following table presents the total number of shares of common stock represented
by awards granted to Company employees:
<TABLE>
<CAPTION>
YEAR ENDED SEPTEMBER 30,
--------------------------
2000 1999 1998
------ ------ ------
<S> <C> <C> <C>
Other stock unit awards granted (000's).................. 496 10 164
Weighted average market value of shares granted during
the period............................................. $57.83 $47.73 $24.98
</TABLE>
13. OPERATING SEGMENTS
The Company reports its operations in three segments: Communications
Solutions, Services and Connectivity Solutions. The Communications Solutions
segment represents the Company's core business, comprised of enterprise voice
communications systems and software, communications applications, professional
services for customer and enterprise relationship management, multi-service
networking products and product installation services. The purchase prices of
the Company's products typically include installation costs. The Connectivity
Solutions segment represents structured cabling systems and electronic cabinets.
The Services segment represents maintenance and value-added services.
Each segment is managed separately as each operation requires different
technologies and marketing strategies. Intersegment transactions that occur are
based on current market prices and all intersegment profit is eliminated in
consolidation. Disclosure of segment information is on the same basis used
internally for evaluating segment performance and for deciding how to allocate
resources.
The Company has centralized corporate functions and uses shared service
arrangements to realize economies of scale and efficient use of resources. The
costs of shared services, and other corporate center operations managed on a
common basis, are allocated to the segments based on usage, where possible, or
other factors based on the nature of the activity. The accounting policies of
the reportable operating segments are the same as those described in the Summary
of Significant Accounting Policies.
Performance measurement and resource allocation for the reportable
operating segments are based on many factors. The primary financial measure used
is operating income, exclusive of corporate operations including business
restructuring and related charges, goodwill and existing technology
amortization, charges related to purchased in-process research and development
and other costs from business acquisitions (acquisition or integration-related
costs).
Reportable Segments
<TABLE>
<CAPTION>
YEAR ENDED
SEPTEMBER 30,
--------------------------
2000 1999 1998
------ ------ ------
(DOLLARS IN MILLIONS)
<S> <C> <C> <C>
Communications Solutions:
External revenue.......................................... $4,323 $5,088 $4,583
Intersegment revenue...................................... 9 24 --
Total Revenue..................................... 4,332 5,112 4,583
Operating income (loss)................................... (83) 81 115
Assets.................................................... 1,795 2,204 2,274
Capital expenditures...................................... 137 64 86
Depreciation and amortization............................. 59 85 88
</TABLE>
73
<PAGE> 74
AVAYA INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
<TABLE>
<CAPTION>
YEAR ENDED
SEPTEMBER 30,
--------------------------
2000 1999 1998
------ ------ ------
(DOLLARS IN MILLIONS)
<S> <C> <C> <C>
Services:
External revenue.......................................... $1,958 $1,900 $1,750
Intersegment revenue...................................... -- -- --
Total Revenue..................................... 1,958 1,900 1,750
Operating income.......................................... 271 199 300
Assets.................................................... 680 599 695
Capital expenditures...................................... 63 20 21
Depreciation and amortization............................. 19 23 19
Connectivity Solutions:
External revenue.......................................... $1,397 $1,274 $1,408
Intersegment revenue...................................... 1 8 --
Total Revenue..................................... 1,398 1,282 1,408
Operating income.......................................... 181 111 224
Assets.................................................... 804 707 677
Capital expenditures...................................... 22 51 70
Depreciation and amortization............................. 30 37 30
</TABLE>
Reconciling Items
A reconciliation of the totals reported for the operating segments to the
significant line items in the consolidated financial statements is as follows:
<TABLE>
<CAPTION>
YEAR ENDED
SEPTEMBER 30,
--------------------------
2000 1999 1998
------ ------ ------
(DOLLARS IN MILLIONS)
<S> <C> <C> <C>
EXTERNAL REVENUE
Total reportable segments.............................. $7,678 $8,262 $7,741
Corporate and other.................................... 2 6 13
------ ------ ------
Total External Revenue......................... $7,680 $8,268 $7,754
====== ====== ======
OPERATING INCOME (LOSS)
Total reportable segments.............................. $ 369 $ 391 $ 639
Goodwill and existing technology amortization.......... (55) (59) (45)
Purchased in-process research and development.......... -- -- (306)
Corporate and other.................................... (757) 37 21
------ ------ ------
Total Operating Income (Loss).................. $ (443) $ 369 $ 309
====== ====== ======
</TABLE>
The business restructuring and related charges of $684 million and costs
associated with start-up activities of $73 million were recorded in September
2000, as well as the results of other smaller units and corporate operations,
are included in Corporate and other. In addition, assets not specifically
identifiable to the operating segments principally include cash, deferred taxes
and property, plant and equipment.
74
<PAGE> 75
AVAYA INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Geographic Information
<TABLE>
<CAPTION>
EXTERNAL REVENUE(1) LONG-LIVED ASSETS(2)
YEAR ENDED SEPTEMBER 30, AT SEPTEMBER 30,
-------------------------- --------------------
2000 1999 1998 2000 1999 1998
------ ------ ------ ---- ---- ----
(DOLLARS IN MILLIONS)
<S> <C> <C> <C> <C> <C> <C>
U.S. .................................... $6,055 $6,683 $6,376 $850 $583 $532
Foreign countries........................ 1,625 1,585 1,378 116 93 81
------ ------ ------ ---- ---- ----
Totals................................... $7,680 $8,268 $7,754 $966 $676 $613
====== ====== ====== ==== ==== ====
</TABLE>
---------------
(1) Revenue is attributed to geographic areas based on the location of
customers.
(2) Represents property, plant and equipment (net).
Concentrations
For any period presented, no single customer accounted for more than 10% of
the Company's consolidated revenue. The Company is not aware of any significant
concentration of business transacted with a particular supplier that could, if
suddenly eliminated have a material adverse affect on the Company's financial
position, results of operations or cash flows. The Company intends to outsource
the majority of its manufacturing operations and if successful, this initiative
could result in a concentration that, if suddenly eliminated, could have an
adverse affect on the Company's operations. While the Company believes that
alternative sources would be available, disruption of its primary source could
create a temporary, adverse effect on product shipments.
14. FINANCIAL INSTRUMENTS
Fair Value
The net carrying amounts and estimated fair values of the Company's foreign
currency forward exchange contracts and options were assets of $5 million and $7
million, respectively in fiscal 2000 and were immaterial in fiscal 1999. Market
quotes were used to estimate the fair value of foreign currency forward exchange
contracts/options. The carrying amounts of cash and cash equivalents,
investments, receivables, and long term debt reflected in the Consolidated
Balance Sheets approximate fair value.
Derivative Financial Instruments
The Company conducts its business on a multinational basis in a wide
variety of foreign currencies. Consequently, the Company enters into various
foreign exchange forward and option contracts to manage its exposure against
adverse changes in those foreign exchange rates. The notional amounts for
foreign exchange forward and option contracts represent the U.S. dollar
equivalent of an amount exchanged. Generally, foreign currency exchange
contracts are designated for firmly committed or forecasted sales and purchases
that are expected to occur in less than one year. Gains and losses on all hedged
contracts for firmly committed transactions and option contracts for anticipated
transactions are deferred in Other current assets and liabilities and are
recognized in income when the transactions occur. The gains and losses on all
hedged contracts were not material to the consolidated financial statements at
September 30, 2000 and 1999. All other gains and losses on foreign currency
exchange contracts are recognized in other income, net as the exchange rates
change.
The Company engages in foreign currency hedging activities to reduce the
risk that changes in exchange rates will adversely affect the eventual net cash
flows resulting from the sale of products to foreign customers and purchases
from foreign suppliers. The Company believes that it has achieved risk reduction
and hedge effectiveness because the gains and losses on its derivative
instruments substantially offset the losses and gains
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AVAYA INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
on the assets, liabilities and transactions being hedged. Hedge effectiveness is
periodically measured by comparing the change in fair value of each hedged
foreign currency exposure at the applicable market rate with the change in
market value of the corresponding derivative instrument.
The notional amounts at September 30, 2000 and 1999 of the Company's
foreign exchange forward contracts were $339 million and $93 million,
respectively, and foreign exchange option contracts were $24 million and $52
million, respectively. In fiscal 2000, these notional amounts principally
represent contracts in British pounds, European Monetary Union dollars,
Singapore dollars and Canadian dollars. Notional amounts represent the face
amount of the contractual arrangements and the basis on which U.S. dollars are
to be exchanged and are not a measure of market or credit exposure.
Non-Derivative and Off-Balance-Sheet Instruments
Requests for providing commitments to extend credit and financial
guarantees are reviewed and approved by senior management. Management regularly
reviews all outstanding commitments, letters of credit and financial guarantees,
and the results of these reviews are considered in assessing the adequacy of the
Company's reserve for possible credit and guarantee losses.
At September 30, 2000 and 1999, in management's opinion, there was no
significant risk of loss in the event of non-performance of the counterparties
to these financial instruments.
15. TRANSACTIONS WITH LUCENT AND OTHER RELATED PARTY TRANSACTIONS
For the fiscal years 2000, 1999 and 1998, the Company had $98 million, $108
million and $90 million, respectively, of revenue for products sold to Lucent.
For the fiscal years 2000, 1999 and 1998, the Company had $261 million, $189
million and $244 million, respectively, of products purchased from Lucent.
In connection with the Contribution and Distribution, the Company and
Lucent executed and delivered the Contribution and Distribution Agreement, and
certain related agreements which are summarized below. This summary is qualified
in all respects by the terms of the Contribution and Distribution Agreement and
such related agreements.
Contribution and Distribution Agreement
Pursuant to the Contribution and Distribution Agreement, Lucent transferred
to the Company substantially all of the assets, liabilities and operations
associated with the Company's Businesses. The Contribution and Distribution
Agreement, among other things, provides that, in general, the Company will
indemnify Lucent for all liabilities relating to the Company's Businesses and
for 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
allocated to one of the parties will be shared by Lucent and the Company in
prescribed percentages. The Contribution and Distribution Agreement also
provides that each party will share specified portions of contingent liabilities
based upon agreed percentages related to the business of the other party that
exceed $50 million.
The Company and Lucent are in discussions regarding certain matters
associated with the Contribution and Distribution. The items in question relate
primarily to the settlement of certain obligations with respect to the employees
transferred to the Company by Lucent, receivables related to the Company's
Businesses and other items related to the transfer of certain assets and
liabilities by Lucent to the Company upon the Distribution. While the Company
does not believe that the resolution of these open items will have a material
adverse effect on the Company's results of operations, there can be no assurance
that such resolution will not have a material adverse effect on the Company's
financial position or cash flows.
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AVAYA INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Employee Benefits Agreement and Plans
The Company and Lucent have entered into an Employee Benefits Agreement,
pursuant to which the Company has created independent pension and other employee
benefit plans that are substantially similar to Lucent's existing pension and
other employee benefit plans. This agreement provides for the transfer of assets
and liabilities of various existing Lucent pension and other employee benefit
plans related to Lucent employees who transferred to the Company. Generally,
Lucent has no liability or obligation to the Company's current employees and
their beneficiaries under any of Lucent's benefit plans, programs or practices.
Under the agreement, the Company will receive assets and liabilities of various
existing Lucent pension and other employee benefit plans related to the
employees for which the Company assumed responsibility.
Federal, State and Local Tax Allocation Agreements
The Company and Lucent have continued the existing State and Local Income
Tax Allocation Agreement and the existing Federal Tax Allocation Agreement by
and among Lucent and its subsidiaries. These tax agreements govern the
allocation of state, local and federal income taxes for periods prior to and
including the date of the Distribution.
Tax Sharing Agreement
The Company and Lucent have entered into a Tax Sharing Agreement, which
governs the Company's and Lucent's respective rights, responsibilities and
obligations after the Distribution with respect to taxes for the periods ending
on or before the Distribution. Generally, pre-Distribution taxes that are
clearly attributable to the business of one party will be borne solely by that
party, and other pre-Distribution taxes will be shared by the parties based on a
formula set forth in the Tax Sharing Agreement. In addition, the Tax Sharing
Agreement addresses the allocation of liability for taxes that are incurred as a
result of restructuring activities undertaken to implement the Distribution. 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.
Global Purchase and Service Agreement
The Company and Lucent have entered into a Global Purchase and Service
Agreement under which the Company provides to Lucent products for internal use.
These products include the Company's enterprise voice communications products as
well as multi-service networking products. The agreement neither grants to the
Company an exclusive right to provide Lucent any or all of these products or
services, nor does it require the procurement of products or services from the
Company by Lucent. The pricing terms of goods and services covered by the Global
Purchase and Service Agreement reflect negotiated prices.
General Sales Agreement and Microelectronics Product Purchase Agreement
The Company and Lucent have entered into a General Sales Agreement and a
Microelectronic Product Purchase Agreement, which govern transactions pursuant
to which Lucent will provide its products and services that are not part of the
businesses transferred to the Company pursuant to the Distribution. These
agreements neither grant to Lucent an exclusive right to provide the Company
with any or all products or services, nor require the procurement of products or
services from Lucent by the Company. The pricing terms of goods and services
covered by the General Sales Agreement and Microelectronics Product Purchase
Agreement reflect negotiated prices.
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AVAYA INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Other Commercial Agreements
In addition to the above listed agreements, the Company and Lucent have
entered into a number of other commercial agreements to govern resale,
subcontracting and original equipment manufacturing arrangements between Lucent
and the Company. The pricing terms of the products, and services covered by the
other commercial agreements reflect negotiated prices.
Interim Services and Systems Replication Agreement
The Company and Lucent have entered into an Interim Services and Systems
Replication Agreement to provide each other, on an interim, transitional basis,
with various data processing services, telecommunications services and corporate
support services, including: accounting, financial management, information
systems management, tax, payroll, legal, human resources administration,
procurement and other general support. Furthermore, under the terms of this
agreement, Lucent provides the Company with technical support for the Company's
converged voice and data products for a specified period of time. Specific
charges for such services are generally intended to allow the company providing
services to recover direct costs plus expenses, without profit.
The Interim Services and Systems Replication Agreement also provides for
the replication and transfer of specified computer systems used for
administrative support or used in the Company's Businesses or Lucent's retained
businesses. The systems include specified hardware, software, data storage or
maintenance and support components. Costs and expenses of purchasing hardware or
obtaining software will be borne by the party purchasing the hardware or
licensing the software.
Real Estate Agreements
Lucent and the Company have entered into various leases and sublease
arrangements for the sharing of certain facilities for a transitional period on
commercial terms. In the case of owned real estate to be leased, the lease terms
are either two or three years, except that a limited number of leases may be
terminated on 90 days' notice by the tenant. In the case of subleases or
sub-subleases of property, the lease term generally coincides with the remaining
term of the primary lease or sublease, respectively.
Trademark License Agreement
The Company and Lucent have entered into a Trademark License Agreement,
pursuant to which the Company has rights, on a royalty-free basis, to continue
to use the Lucent brand for specified transition periods following the
Distribution.
Patent Assignment
Pursuant to the Patent Assignment, Lucent and its subsidiary, Lucent
Technologies Guardian Corp., transferred to a subsidiary of the Company certain
patents and patent applications held by Lucent and Lucent Technologies Guardian
Corp. that relate principally to the Company's Businesses. Lucent retained
ownership of all other patents and patent applications currently owned by
Lucent.
Technology Assignment and Joint Ownership Agreement
The Company and Lucent executed and delivered assignments and other
agreements, including the technology assignment, related to technology owned or
controlled by Lucent and its subsidiaries prior to the Distribution. Technology
includes copyrights, mask works and other intellectual property other than
trademarks, trade names, service marks and patent rights. The technology
assignment divides ownership of technology between the Company and Lucent, with
each owning technology that was developed by or for, or
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AVAYA INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
purchased by, each company for their respective businesses. Certain specified
technology is owned jointly by the Company and Lucent.
Patent and Technology License Agreement
The Company and Lucent have entered into a Patent and Technology License
Agreement under which Lucent and the Company granted to each other under certain
patents and technology, a nonexclusive, personal, nontransferable license to
make, have made, use, lease, import, offer to sell, and sell any and all
products and services of the businesses in which the licensed company, including
specified related companies, is now or hereafter engaged. The cross-licenses
also permit each company, subject to specified limitations, to have third
parties make items under the other company's patents, as well as to pass through
to customers certain rights under the other company's patents with respect to
products and services furnished to customers by the licensed company.
Development Project Agreement
Lucent and the Company have entered into a Development Project Agreement
governing their future commercial relationship under which Lucent's Bell Labs
will perform certain development activities for the Company, and the Company
will perform certain development activities for Lucent. Under this agreement,
Bell Labs will perform specific research and development projects on a contract
basis for the Company.
Other Related Party Transactions
Henry Schacht, who is a member of the Company's Board of Directors, is a
managing director and senior advisor of an affiliate of an investor in the
Company.
During fiscal 2000, a privately held business, of which Mr. Schacht holds
an 80% equity interest and of which his son is the controlling shareholder,
purchased and paid for call center equipment and consulting services from the
Company for a total of approximately $1.2 million. This business continues to
purchase routine services from the Company on a time and materials basis.
16. COMMITMENTS AND CONTINGENCIES
Risks and Uncertainties
The Company has no history operating as an independent company, and it may
be unable to make the changes necessary to operate as a stand-alone business, or
it may incur greater costs as a stand-alone company that may cause its
profitability to decline. Prior to the Distribution, the Company's business was
operated by Lucent as a segment of its broader corporate organization rather
than as a separate stand-alone company. Lucent assisted the Company by providing
financing, particularly of acquisitions, as well as providing corporate
functions such as identifying and negotiating acquisitions, and legal and tax
functions. Following the Distribution, Lucent has no obligation to provide
assistance to the Company other than the interim and transitional services.
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 that should have, individually or in the
aggregate, a material adverse effect on its financial position, results of
operations or cash flows.
Three separate purported class action lawsuits are pending against Lucent
in state court in New York and West Virginia and in federal court in California.
The case in New York was filed in January 1999, and after
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AVAYA INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
being dismissed, was re-filed in September 2000. The case in West Virginia was
filed in April 1999 and the case in California was filed in June 1999. The
Company may be named a party to these actions and has assumed the obligations of
Lucent for 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 not been certified in any of the three cases, and to the
extent a class is certified in any of the cases, the Company expects that class
to constitute those enterprises that purchased the products in question. The
complaints seek, among other remedies, compensatory damages, punitive damages
and counsel fees in amounts that have not yet been specified. Although the
Company believes that the outcome of these actions will not adversely affect its
financial position, results of operations or cash flows, if these cases are not
resolved in a timely manner, they will require expenditure of significant legal
costs related to their defense.
From time to time the Company is subject to unfair labor charges filed by
the unions representing its employees with the National Labor Relations Board.
For example, Region 6 of the National Labor Relations Board, which is located in
Pittsburgh, Pennsylvania, has issued a complaint alleging that Lucent has
refused to bargain over the outsourcing of certain of its manufacturing
activities. In that proceeding, which will be held before an administrative law
judge in Region 6 of the National Labor Relations Board, the General Counsel of
the National Labor Relations Board will act as prosecutor and the charging
party, the International Brotherhood of Electrical Workers System Council EM-3,
which is the union representing the workers at the manufacturing facilities in
question, will be an interested party entitled to participate in the proceeding.
Because the complaint relates to some of the manufacturing facilities that were
transferred to the Company as part of the Distribution, the Company may be named
a party to this action.
The union alleges that Lucent did not provide relevant information relating
to the outsourcing of bargaining unit work, specifically the outsourcing of
circuit packs. The union also claims that Lucent bargained in bad faith during
1998 by withholding its intention to outsource the circuit pack production.
Moreover, the union alleges that Lucent has failed to bargain in good faith over
its decision to outsource certain of its manufacturing operations.
The complaint seeks as remedies for the alleged unlawful conduct, which
Lucent denies in its entirety, a possible return of the outsourced work to the
bargaining unit and/or back pay for affected employees. The amounts of back pay
sought, if any, is not determinable at this time. The complaint also provides
that the National Labor Relations Board may potentially seek injunctive relief
if Lucent pursues its current plans to outsource additional bargaining unit
work. If the Company is unsuccessful in resolving these charges, as they relate
to the Company, the Company's operations may be disrupted, the initiative to
outsource substantially all manufacturing may be delayed or prohibited, or the
Company may incur additional costs that may decrease profitability.
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 state
court has recently certified a class in this action. 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.
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
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AVAYA INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
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 its financial results) through November 21, 2000. The Company
understands that Lucent has not yet been served with the complaints in these
cases. Lucent has not yet answered the complaints and a class has not yet been
certified in the actions.
The above actions will most likely be consolidated with other purported
class actions filed against Lucent on behalf of shareholders in January 2000.
Those January 2000 actions have been consolidated and are pending in the Federal
District Court for the District of New Jersey. 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 shareholders of Lucent who bought Lucent
common stock between October 26, 1999 and January 6, 2000, but the consolidated
complaint has recently been 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 shareholder
class actions seek compensatory damages plus interest and attorneys' fees.
Any liability incurred by Lucent in connection with these shareholder class
action cases 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 in excess of $50 million. All of these cases 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.
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 United States,
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 of the
Company. 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 approximately five of the Company's 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
consolidated financial position, results of operations or cash flows.
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AVAYA INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Leases
The Company leases land, buildings and equipment under agreements that
expire in various years through 2019. Rental expense under operating leases was
$176 million, $146 million and $94 million for the years ended September 30,
2000, 1999 and 1998, respectively. The table below shows the future minimum
lease payments due under non-cancelable operating leases at September 30, 2000.
<TABLE>
<CAPTION>
YEAR ENDED SEPTEMBER 30,
------------------------------------------------
(DOLLARS IN MILLIONS)
LATER
2001 2002 2003 2004 2005 YEARS TOTAL
---- ---- ---- ---- ---- ----- -----
<S> <C> <C> <C> <C> <C> <C>
$139 $105 $72 $52 $36 $265 $669
</TABLE>
The Company also has sales-type and direct financing leases for certain
products. Lease payment receivables under such agreements were $35 million and
$43 million as of September 30, 2000 and 1999, respectively. The table below
shows the future minimum lease payments to be received under sales-type and
direct financing leases at September 30, 2000.
<TABLE>
<CAPTION>
YEAR ENDED SEPTEMBER 30,
------------------------------------------------
(DOLLARS IN MILLIONS)
LATER
2001 2002 2003 2004 2005 YEARS TOTAL
---- ---- ---- ---- ---- ----- -----
<S> <C> <C> <C> <C> <C> <C>
$11 $9 $7 $4 $3 $1 $35
</TABLE>
17. QUARTERLY INFORMATION (UNAUDITED)
<TABLE>
<CAPTION>
FISCAL YEAR QUARTERS
------------------------------------------------
FIRST SECOND THIRD FOURTH TOTAL
------ ------ ------ ------ ------
(DOLLARS IN MILLIONS, EXCEPT PER SHARE AMOUNTS)
<S> <C> <C> <C> <C> <C>
YEAR ENDED SEPTEMBER 30, 2000
Revenue..................................... $1,845 $1,934 $1,885 $2,016 $7,680
Gross margin................................ 868 822 822 823 3,335
Net income (loss)........................... 69 66 33 (543)(1) (375)
Earnings (loss) per share -- Basic.......... $ 0.26 $ 0.25 $ 0.12 $(1.95) $(1.39)
Earnings (loss) per share -- Diluted........ $ 0.25 $ 0.24 $ 0.12 $(1.95) $(1.39)
YEAR ENDED SEPTEMBER 30, 1999
Revenue..................................... $1,894 $1,938 $2,038 $2,398(2) $8,268
Gross margin................................ 840 841 939 1,084 3,704
Net income (loss) before cumulative effect
of accounting change...................... 4 (34) 87 129 186
Cumulative effect of accounting change(3)... 96 -- -- -- 96
Net income (loss)........................... 100 (34) 87 129 282
Earnings (loss) per share -- Basic:
Income (loss) before cumulative effect of
accounting change...................... $ 0.02 $(0.13) $ 0.34 $ 0.49 $ 0.72
Cumulative effect of accounting change.... 0.37 -- -- -- 0.37
------ ------ ------ ------ ------
Net income (loss) attributable to common
shareowners............................ $ 0.39 $(0.13) $ 0.34 $ 0.49 $ 1.09
</TABLE>
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AVAYA INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
<TABLE>
<CAPTION>
FISCAL YEAR QUARTERS
------------------------------------------------
FIRST SECOND THIRD FOURTH TOTAL
------ ------ ------ ------ ------
(DOLLARS IN MILLIONS, EXCEPT PER SHARE AMOUNTS)
<S> <C> <C> <C> <C> <C>
Earnings (loss) per share -- Diluted:
Income (loss) before cumulative effect of
accounting change...................... $ 0.01 $(0.13) $ 0.32 $ 0.46 $ 0.68
Cumulative effect of accounting change.... 0.36 -- -- -- 0.35
------ ------ ------ ------ ------
Net income (loss) attributable to common
shareowners............................ $ 0.37 $(0.13) $ 0.32 $ 0.46 $ 1.03
</TABLE>
---------------
(1) In September 2000, the Company recorded a pre-tax charge of $684 million for
business restructuring and related charges.
(2) In 1999, the Company sold equipment, which was previously rented to
customers for $97 million. The equipment had a net book value of
approximately $2 million and consisted predominantly of discontinued product
lines.
(3) Effective October 1, 1998, the Company changed its method for calculating
the market-related value of plan assets used in determining the expected
return-on-asset component of annual net pension and postretirement benefit
costs.
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<PAGE> 84
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE.
None.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.
Our board of directors is divided into three classes. Jeffrey A. Harris and
Franklin A. Thomas are Class 1 directors, with terms expiring at the annual
meeting of shareowners to be held after the end of fiscal 2001, Henry B. Schacht
and Daniel C. Stanzione are Class 2 directors with terms expiring at the annual
meeting of shareowners to be held after the end of fiscal 2002 and Patricia F.
Russo and Donald K. Peterson are the Class 3 directors, with terms expiring at
the annual meeting of shareowners to be held after the end of fiscal 2003.
Commencing with the annual meeting of shareowners to be held after the end of
fiscal 2001, directors for each class will be elected at the annual meeting of
shareowners held in the year in which the term for such class expires and
thereafter will serve for a term of three years.
As a result of the equity investment in us by Warburg, Pincus Equity
Partners, L.P. and related investment funds, these investors are entitled to
designate for election one individual to our board of directors and to have one
observer attend meetings of our board of directors as long as the investors and
their permitted transferees maintain ownership of a combination of shares of our
Series B convertible participating preferred stock and common stock that, in the
aggregate, on an as-converted basis, represent at least 50% of the shares of our
common stock initially issuable on conversion of all the shares of Series B
convertible participating preferred stock purchased by them.
The following table sets forth information as to persons who serve as our
directors or executive officers.
<TABLE>
<CAPTION>
NAME AGE POSITION
---- --- --------
<S> <C> <C>
Patricia F. Russo.................... 48 Chairman
Donald K. Peterson................... 51 Vice Chairman, President and Chief Executive Officer
Pamela F. Craven..................... 47 Vice President, General Counsel and Secretary
Michael A. Dennis.................... 41 Vice President of Worldwide Operations and Services
David P. Johnson..................... 40 Vice President of Worldwide Sales
Karyn Mashima........................ 47 Vice President of Global Strategy and Technology
Garry K. McGuire Sr.................. 54 Chief Financial Officer
Jeffrey A. Harris.................... 45 Director
Henry B. Schacht..................... 66 Director
Daniel C. Stanzione.................. 55 Director
Franklin A. Thomas................... 66 Director
</TABLE>
Patricia F. Russo has been the Chairman of our board of directors since
December 2000. From October 1999 until August 2000, Ms. Russo was the Executive
Vice President and Chief Executive Officer of Lucent's Service Provider Networks
Group and was the Executive Vice President, Corporate Operations of Lucent from
December 1996 until October 1999. From 1992 until December 1996, she was the
President of Lucent's Business Communications Group, whose businesses comprised
many of the businesses contributed to us in connection with the distribution.
Ms. Russo is a director of Schering Plough Corporation, Xerox Corporation, New
Jersey Manufacturers and Georgetown University.
Donald K. Peterson has been the Vice Chairman of our board of directors
since November 2000 and our President and Chief Executive Officer and a director
since the distribution. Mr. Peterson was the Executive Vice President and Chief
Executive Officer of Lucent's Enterprise Networks Group from March 1, 2000 until
the distribution. He was Executive Vice President and Chief Financial Officer
for Lucent from February 1996 until March 1, 2000. He joined AT&T in 1995 and
moved to Lucent following its spin-off in 1996. While at AT&T, Mr. Peterson held
the positions of Vice President and Chief Financial Officer of the AT&T
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<PAGE> 85
Communications Services Group from September 1995 until January 1996. Prior to
that time, Mr. Peterson held various senior executive positions at Northern
Telecom Inc., where he worked from 1976 through September 1995. His
responsibilities included President of Nortel Communications Systems, Inc., from
January 1993 to September 1995, Vice President of Finance of Northern Telecom
Inc., from January 1991 to January 1993, and Group Vice President of Northern
Telecom Inc., from September 1987 to January 1991.
Pamela F. Craven has been our Vice President, General Counsel and Secretary
since the distribution. Mrs. Craven was a director of Avaya from its inception
until the distribution and was Vice President, General Counsel and Secretary of
Lucent's Enterprise Networks Group from March 2000 until the distribution. Mrs.
Craven served as Vice President, Law and Secretary for Lucent from February 1,
1999 to April 2000. She joined AT&T in 1992 and moved to Lucent following its
spin-off in 1996. Mrs. Craven held the position of Vice President, Law and
Assistant Secretary for Lucent until January 1999. At AT&T, Mrs. Craven served
as a General Attorney responsible for mergers and acquisitions.
Michael A. Dennis has been our Vice President of Worldwide Operations and
Services since the distribution. Mr. Dennis was Vice President of U.S. Services
for Lucent's Enterprise Networks Group from April 2000 until the distribution.
He joined AT&T in July 1981 and moved to Lucent following its spin-off in 1996.
Mr. Dennis has held various positions at Lucent including Sales Vice President
and Field Services Vice President. At AT&T, Mr. Dennis held various positions
including General Manager of Global Business Communications Systems.
David P. Johnson has been our Vice President of Worldwide Sales since the
distribution. Mr. Johnson was Vice President of Worldwide Sales for Lucent's
Enterprise Networks Group from April 2000 until the distribution. He joined AT&T
in 1982 and moved to Lucent following its spin-off in 1996. Mr. Johnson has held
various positions at Lucent, including International President of Enterprise
Networks and Regional President of Asia/Pacific Region. At AT&T, Mr. Johnson
served as Regional President of the Asia/Pacific Region and as Strategic
Marketing Director.
Karyn Mashima has been our Vice President of Global Strategy and Technology
since the distribution. Ms. Mashima was Vice President of Strategy and
Technology for Lucent's Enterprise Networks Group from March 2000 until the
distribution. She joined AT&T in 1994 and moved to Lucent following its spin-off
in 1996. Ms. Mashima has held various positions at Lucent, including Vice
President of Advanced Multi-Media Communications Systems, Vice President of the
Enterprise Systems Group and Vice President and Chief Technical Officer.
Garry K. McGuire Sr., has been our Chief Financial Officer since the
distribution. Mr. McGuire was Chief Financial Officer for Lucent's Enterprise
Networks Group from May 2000 until the distribution. Mr. McGuire was a
consultant to Kleiner, Perkins, Caufield and Byers/Broadband Office from August
1999 to December 1999. He was President and Chief Executive Officer of Williams
Communications Solutions, LLC, from April 1997 to July 1999, and was President
of Nortel Communications Systems, LLC, from September 1995 until April 1997.
Prior to that, Mr. McGuire served as President of Bell Atlantic Meridian Systems
from January 1995 to September 1995.
Jeffrey A. Harris has been a director since October 2000. Mr. Harris has
been a Member and Managing Director of Warburg, Pincus & Company, LLC and a
general partner of Warburg, Pincus & Co. since 1988, where he has been employed
since 1983. Mr. Harris is a director of ECsoft Group PLC, Industri-Matematik
International Corp., Knoll Inc. and Spinnaker Exploration Inc., as well as
several privately held companies. Mr. Harris was designated for election to our
board by Warburg, Pincus Equity Partners, L.P. and related investment funds
pursuant to the terms of those investors' equity investment in us.
Henry B. Schacht has been a director since the distribution. From October
1, 2000 until October 23, 2000, Mr. Schacht served as the Chairman of our board
of directors. Mr. Schacht has been Chairman and Chief Executive Officer of
Lucent since October 23, 2000. Mr. Schacht has been a director for Lucent since
February 1996. He was Chairman of the Lucent board of directors from February
1996 to February 1998 and Chief Executive Officer of Lucent from February 1996
until October 1997. Mr. Schacht also served as Senior Advisor to Lucent from
February 1998 to February 1999. Mr. Schacht was a director of Cummins Engine
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Company, Inc. from 1977 to April 2000, and was Chief Executive Officer of
Cummins from 1973 to 1994 and Chairman of the Board for Cummins from 1977 to
1995. Mr. Schacht was a member of the AT&T Corp. board of directors from 1981
until taking office with Lucent in 1996 prior to its spin-off from AT&T. Mr.
Schacht is a managing director and senior advisor of Warburg, Pincus and
Company, LLC., and a director of The Chase Manhattan Corporation and the Chase
Manhattan Bank, N.A., Alcoa, Inc., Johnson and Johnson Corporation, Knoll Inc.
and the New York Times Company.
Daniel C. Stanzione has been a director since the distribution. Dr.
Stanzione has served as Special Advisor to the Chairman of Lucent since October
1999. He served as Chief Operating Officer of Lucent from November 1997 to
October 1999 and as the President of Bell Laboratories at Lucent from March 1996
to October 1999. Dr. Stanzione previously served as President of Network Systems
at Lucent from March 1996 to October 1997, as President of Network Systems at
AT&T from January 1996 to March 1996, and as President of AT&T Bell Laboratories
from January 1995 to March 1996. Dr. Stanzione is currently a director of Quest
Diagnostics, Inc.
Franklin A. Thomas has been a director since the distribution. Mr. Thomas
has been a director of Lucent since January 1996. Mr. Thomas also currently
serves as a consultant to the TFF Study Group, a position he has held since
1996. Mr. Thomas was President of the Ford Foundation between 1979 and 1996. Mr.
Thomas is currently a director of Alcoa Inc., Citigroup, N.A., Conoco Inc.,
Cummins Engine Company Inc., Lucent and PepsiCo Inc.
ANNUAL MEETING
Our first annual meeting of shareowners after the distribution is expected
to be held after the end of fiscal 2001. The annual meeting will be held at our
principal office or at such other place or by electronic means as permitted by
Delaware law and on such date as may be fixed from time to time by resolution of
our board of directors.
COMMITTEES OF THE BOARD OF DIRECTORS
We are managed under the direction of our board of directors. Our board of
directors has established an audit and finance committee and a corporate
governance and compensation committee.
Audit and Finance Committee
Messrs. Harris and Thomas and Dr. Stanzione comprise our audit and finance
committee. Mr. Harris serves as chairman of the audit and finance committee.
This committee meets with our management periodically to consider the adequacy
of our internal controls and the objectivity of our financial reporting. This
committee also meets with the independent auditors and with our own appropriate
financial personnel and internal auditors regarding these matters. Both the
independent auditors and the internal auditors regularly meet privately with
this committee and have unrestricted access to this committee. The audit and
finance committee recommends to our board of directors the appointment of the
independent auditors. The audit and finance committee reviews our financing
plans and reports recommendations to our full board for approval and to
authorize action.
Corporate Governance and Compensation Committee
Messrs. Harris and Thomas and Dr. Stanzione comprise our corporate
governance and compensation committee. Mr. Thomas serves as chairman of the
corporate governance and compensation committee. The functions of this committee
include recommending to our full board of directors nominees for election as
directors, making recommendations to our board of directors from time to time as
to matters of corporate governance, administering management incentive
compensation plans, establishing the compensation of officers and reviewing the
compensation of directors.
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This committee will consider qualified candidates for director suggested by
shareowners in written submissions to our corporate secretary.
DIRECTOR COMPENSATION
Commencing on or about March 1, 2001, the chairman of our board of
directors will receive an annual retainer of $200,000 and all non-employee
directors will receive an annual retainer of $100,000, except Mr. Schacht will
receive the retainer described below. On October 2, 2000, each non-employee
director except Mr. Schacht received an inaugural grant of an option to purchase
7,111 shares of our common stock at a price per share of $21.0938.
For his service in helping to establish Avaya as an independent public
company during the period from our inception in March 2000 through the
distribution and his service as our chairman during the period from the
distribution until October 23, 2000, Mr. Schacht received, on October 2, 2000,
an inaugural grant of an option to purchase 14,222 shares of our common stock,
at a price per share of $21.0938, on October 4, 2000, a grant of an option to
purchase 300,000 shares of our common stock at a price per share of $14.8438 and
will receive a retainer of $200,000 on or about March 1, 2001.
Upon her election as chairman of our board of directors, Ms. Russo received
a grant of an option to purchase 23,645 shares of our common stock at a price
per share of $12.6875.
The chair of each committee will receive an additional annual retainer of
$10,000. Directors will not receive separate meeting fees. Directors must elect
to receive between 50% and 100% of their retainers in our common stock or an
option to purchase our common stock or a combination of common stock and an
option. Any remaining amount may be paid in cash, but shall not exceed 50% of
the retainer. If a director elects to receive an option, the number of shares
purchaseable under the option will be determined pursuant to the following
formula:
<TABLE>
<S> <C> <C>
Number of shares = 3 x Dollar value of retainer taken as an option
-----------------------------------------------------
fair market value of our common stock on date of
grant
</TABLE>
The exercise price per share under the option will be the fair market value
of a share on the date of grant. Options will generally become exercisable on
the six-month anniversary of the date of grant and have a 10-year term.
Directors may defer all or a portion of their retainers under our deferred
compensation plan.
We also provide non-employee directors with travel accident insurance when
traveling on our business.
ITEM 11. EXECUTIVE COMPENSATION
The compensation of our executive officers is approved by our corporate
governance and compensation committee of our board of directors. The
compensation of the executive and other officers consists principally of base
salary, semi-annual cash bonus and long-term equity-based incentive
compensation.
Salaries of executive officers are based, among other factors, on our
corporate governance and compensation committee's assessment of the executive's
responsibilities, experience and performance and the competitive environment for
attracting and retaining executives.
Cash bonuses for executive officers will be assessed and awarded twice
during each fiscal year and will be based on individual and corporate
performance for two six-month periods. The assessment of an executive officer's
individual performance will be based on factors including their contribution
toward financial performance (including revenue and expense), people management
and process improvement. The assessment of corporate performance will be based
on our return on sales and revenue growth.
Our equity-based awards consist principally of stock options and restricted
stock unit awards which are granted from time to time under our 2000 Long Term
Incentive Plan. Our corporate governance and compensation committee bases grants
of stock-based awards on various factors, including competitive practice, the
executive officer's ability to contribute to our future services and the other
elements of the executive's compensation.
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Although certain of the individuals who serve as our executive officers
were performing services in connection with our businesses during fiscal 2000,
those individuals were employed by Lucent during such period, were not dedicated
exclusively to our businesses, and, in fact, devoted substantial time and effort
to other Lucent businesses or to the Lucent organization in general.
Accordingly, no information on the compensation of executive officers for
periods prior to September 30, 2000 is reported. Our Annual Report on Form 10-K
for fiscal year 2001 will contain information on compensation paid to our
executive officers in fiscal year 2001.
We describe below the current compensation arrangements for our chief
executive officer and our four other most highly compensated executive officers,
as measured by their base salaries, calculated on an annualized basis, and
target bonus amounts. In connection with the current compensation arrangements
for our executive officers described below:
- base salary represents the executive officer's current base salary on an
annualized basis.
- target bonus percentage represents the targeted percentage of annual base
salary payable in the form of a bonus for the fiscal year ending
September 30, 2001. Such percentage may be adjusted upward or downward
based on the factors described above.
The current compensation for our chief executive officer and our four other
most highly compensated officers is as follows:
- Donald K. Peterson, our Vice Chairman, President and Chief Executive
Officer, currently receives a base salary equal to $900,000 on an
annualized basis. Mr. Peterson's targeted bonus percentage is 125%.
- Garry K. McGuire Sr., our Chief Financial Officer, currently receives a
base salary equal to $425,000 on an annualized basis. Mr. McGuire's
targeted bonus percentage is 85%.
- David P. Johnson, our Vice President of Worldwide Sales, currently
receives a base salary equal to $350,000 on an annualized basis. Mr.
Johnson's targeted bonus percentage is 75%.
- Karyn Mashima, our Vice President of Global Strategy and Technology,
currently receives a base salary equal to $350,000 on an annualized
basis. Ms. Mashima's targeted bonus percentage is 75%.
- Michael A. Dennis, our Vice President of Worldwide Operations and
Services, currently receives a base salary of $350,000 on an annualized
basis. Mr. Dennis' targeted bonus percentage is 75%.
STOCK OPTIONS AND RESTRICTED STOCK UNITS
During the fiscal year ended September 30, 2000, none of the officers
listed above were granted options to purchase our common stock or restricted
stock units. Pursuant to the Employee Benefits Agreement, all Lucent stock
options and restricted stock units held by such officers which were unvested and
outstanding as of the distribution were converted, immediately after the
distribution, into options to purchase Avaya common stock or Avaya restricted
stock units.
PENSION PLANS
Prior to the distribution, most of our U.S. salaried employees, including
executive officers, were participants in Lucent's retirement income plan.
Effective at the time of the distribution, we adopted a retirement income plan
that replicates, in all material respects, the Lucent retirement income plan,
and that is a non-contributory pension plan which covers salaried employees,
including the executive officers. We have also adopted a non-contributory
supplemental pension plan that replicates in all material respects Lucent's
supplemental pension plans. The following is a summary description of the terms
of our retirement income plan and our supplemental pension plan.
Participants were given full credit under our retirement income plan for
service and compensation accrued under the Lucent retirement income plan. Under
our retirement income plan, annual pensions are
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computed on an modified career average pay basis. A participant's modified
career average pay will be equal to 1.4% of the sum of the individual's:
- average annual pay for the five years ending December 31, 1998, excluding
the annual bonus award paid in December 1997, times the number of years
of service prior to January 1, 1999;
- pay subsequent to December 31, 1998; and
- annual bonus award paid in December 1997.
The normal retirement age under our retirement income plan is 65. However,
employees who are at least age 50 with at least 15 years of service can retire
with reduced benefits. If an employee's age is at least 50 and, when added to
service, is equal to or greater than 75, the employee may retire with unreduced
pension benefits. A reduction equal to 3% is made for each year age plus service
is less than 75. Pension amounts under our retirement income plan are not
subject to reductions for social security benefits or other offset amounts.
Average annual pay includes base salary and annual bonus awards. However,
federal laws place limitations on compensation amounts that may be included
under this plan. In 2000, up to $170,000 in eligible base salary and annual
bonus could be included in the calculation under this plan.
Pension amounts based on our retirement income plan formula which exceed
the applicable limitations are paid under our supplemental pension plan.
Compensation and benefit amounts which exceed the applicable federal limitations
are taken into account, and pension amounts related to annual bonus awards
payable to executive officers are paid, under our supplemental pension plan.
This plan is a non-contributory plan, and will use the same modified career
average pay formula and eligibility rules as our retirement income plan to
provide supplemental pension benefits to our salaried employees, including our
executive officers.
Our supplemental pension plan will provide executive officers and other of
our eligible employees with minimum pensions. Eligible retired executive
officers and surviving spouses may receive an annual minimum pension equal to
15% of the sum of final base salary plus annual bonus awards. This minimum
pension is offset by amounts received by plan participants as pensions under all
our pension plans.
Pursuant to the terms of an arrangement provided by AT&T and assumed by
Lucent and, at the time of the distribution, by us, Mr. Peterson is also
entitled to a supplemental pension benefit under our supplemental pension plan.
This benefit is available to certain salaried employees who were hired generally
at or over age 35 and who terminate with at least five years service at an
employment level defined in the supplemental plan. This plan provides additional
pension credits equal to the difference between age 35 and the maximum possible
years of service attainable at age 65, but not to exceed actual net credited
service, at one-half the rate in our retirement income plan.
It is anticipated that some of our non-qualified executive benefit plans
will be supported by a benefits protection trust, the assets of which will be
subject to the claims of our creditors. In the event of a change in control or a
potential change in control of our company, certain additional funds might be
required to be contributed to such trust to support benefits under such plans.
AVAYA INC. 2000 LONG TERM INCENTIVE PLAN
We have adopted the Avaya Inc. 2000 Long Term Incentive Plan, for the
benefit of our executive officers and some of our other employees. The plan is
distinct from any other broad-based plan that we have adopted or may adopt for
the grant of stock options to our employees more generally. In order to ensure
that compensation paid pursuant to the 2000 Long Term Incentive Plan can qualify
as "performance-based compensation" not subject to the limitation on
deductibility of executive compensation in excess of $1 million, we intend to
seek shareowner approval of the 2000 Long Term Incentive Plan at our annual
meeting of shareowners to be held after the end of fiscal 2001.
The following description of the 2000 Long Term Incentive Plan is qualified
by reference to the full text thereof, a copy of which is incorporated by
reference as an exhibit to this Annual Report on Form 10-K.
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Awards
The 2000 Long Term Incentive Plan provides for the grant of incentive stock
options that qualify under Section 422 of the Code and non-statutory stock
options, stock appreciation rights, restricted stock awards, performance awards,
dividend equivalents and other stock unit awards, as such terms are defined in
the 2000 Long Term Incentive Plan. To date, 94 participants have received awards
under the 2000 Long Term Incentive Plan.
Shares Available
The total number of shares of our common stock available for awards granted
under the 2000 Long Term Incentive Plan is 25 million shares. During the
five-year term of the plan, no more than 2 million shares of our common stock
will be available for the grant of incentive stock options. No individual may be
granted awards with respect to more than 5 million shares of our common stock
over the five-year term of the plan.
Any shares issued by us through the assumption or substitution of
outstanding grants from Lucent or an acquired company do not reduce the number
of shares of our common stock available for grants under the 2000 Long Term
Incentive Plan. Any shares of our common stock issued under the 2000 Long Term
Incentive Plan, including in connection with substitute awards may consist, in
whole or in part, of authorized and unissued shares of our common stock or
treasury shares of our common stock or shares of our common stock purchased in
the open market. If any shares of our common stock subject to any award are
forfeited or such award otherwise terminates without the issuance of such shares
of our common stock or of other consideration in lieu of such shares, the shares
of our common stock subject to such award, to the extent of any such forfeiture
or termination, will again be available for grant under the 2000 Long Term
Incentive Plan. In the event of any merger, reorganization, consolidation,
recapitalization, stock dividend, or other change in corporate structure
affecting the shares of our common stock, such adjustment will be made in the
aggregate number and class of shares of our common stock which may be delivered
under the 2000 Long Term Incentive Plan, in the individual limit described
above, in the number, class and option price of shares of our common stock
subject to outstanding options thereunder, and in the value of, or number or
class of shares of our common stock subject to, awards as may be determined to
be appropriate by the corporate governance and compensation committee, in its
sole discretion; provided that the number of shares of our common stock subject
to any award will always be a whole number.
Plan Administration
The members of our corporate governance and compensation committee
administer the 2000 Long Term Incentive Plan.
Options; Stock Appreciation Rights
Options to purchase shares of our common stock may be granted under the
2000 Long Term Incentive Plan, either alone or in addition to other awards.
Except in the case of substitute awards, the purchase price per share of our
common stock purchasable under an option will be determined by our corporate
governance and compensation committee, in its sole discretion; provided that
such purchase price will not be less than the fair market value, as defined in
the 2000 Long Term Incentive Plan, of a share of our common stock on the date of
the grant of the option. The term of each option will be fixed by our corporate
governance and compensation committee in its sole discretion; provided that no
incentive stock option will be exercisable after the expiration of 10 years from
the date the option is granted. Options will be exercisable at such time or
times as determined by our corporate governance and compensation committee at or
subsequent to grant. Subject to the other provisions of the 2000 Long Term
Incentive Plan and any applicable award agreement, any option may be exercised
by the participant in such form or forms, including, without limitation, payment
by delivery of cash, shares of our common stock or other consideration
including, where permitted by law and our corporate governance and compensation
committee, awards having a fair market value on the exercise date equal to the
total option price, or by any combination of cash, shares of our common stock
and other
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consideration as our corporate governance and compensation committee may specify
in the applicable award agreement.
As of the time of the grant, the aggregate fair market value of the shares
of our common stock with respect to which incentive stock options held by any
participant become exercisable for the first time by such participant during any
calendar year under the 2000 Long Term Incentive Plan, including under any of
our other benefit plans or of any of our parent or subsidiary corporations, will
not exceed $100,000 or, if different, the maximum limitation in effect at the
time of grant under Section 422 of the Internal Revenue Code, or any successor
provision, and any regulations promulgated thereunder. In its sole discretion,
our corporate governance and compensation committee may provide, at the time of
grant, that the shares of common stock to be issued upon an option's exercise
will be in the form of restricted stock or other similar securities, or may
reserve the right so to provide after the time of grant. Upon termination of
employment, other than for death, disability or retirement, a participant
forfeits all unexercisable options and may exercise all exercisable options
within 90 days following such termination, except that, if such termination is
the result of some actions initiated by us, the participant may exercise a
portion of the previously unexercisable options within such 90 day period.
Stock appreciation rights may be granted to participants either alone or in
addition to other awards and may, but need not, relate to a specific option. Any
stock appreciation rights related to an option other than an incentive stock
option may be granted at the same time such option is granted or at any time
thereafter before exercise or expiration of such option. Any stock appreciation
right related to an incentive stock option must be granted at the same time such
option is granted. In the case of any stock appreciation right related to any
option, the stock appreciation right or applicable portion thereof will
terminate and no longer be exercisable upon the termination or exercise of the
related option, except that any stock appreciation right granted with respect to
less than the full number of shares of our common stock covered by a related
option will not be reduced except to the extent that the number of shares of our
common stock affected by the exercise or termination of the related option
exceeds the number of shares of our common stock not covered by the stock
appreciation right. Any option related to any stock appreciation right will no
longer be exercisable to the extent the related stock appreciation right has
been exercised. Our corporate governance and compensation committee may impose
such conditions or restrictions on the exercise of any stock appreciation right
as it may deem appropriate.
Performance Shares of Common Stock
Performance-based equity awards may be issued to participants, for no cash
consideration or for such minimum consideration as may be required by applicable
law, either alone or in addition to other awards granted under the 2000 Long
Term Incentive Plan. The performance criteria to be achieved during any
performance period under the 2000 Long Term Incentive Plan and the length of the
performance period will be determined by our corporate governance and
compensation committee upon the grant of each performance award. Performance
awards will generally be distributed only after the end of the relevant
performance period. Performance awards may be paid in cash, shares of our common
stock, other property or any combination thereof, in the sole discretion of our
corporate governance and compensation committee at the time of payment.
Performance awards may be paid in a lump sum or in installments following the
close of the performance period.
Other Stock Unit Awards
Other awards of shares of common stock and other awards that are valued in
whole or in part by reference to, or are otherwise based on, shares of our
common stock or other property may be granted to participants, either alone or
in addition to other awards. Other stock unit awards may be paid in shares of
our common stock, other securities, cash or any other form of property as the
corporate governance and compensation committee may determine. Our corporate
governance and compensation committee may impose these conditions or
restrictions on the exercise of any other stock award as the committee may deem
appropriate.
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Shares of our common stock, including securities convertible into shares of
our common stock, subject to other stock unit awards may be issued for no cash
consideration or for such minimum consideration as may be required by applicable
law; shares of our common stock, including securities convertible into such
shares of our common stock purchased pursuant to such a purchase right will be
purchased for such consideration as our corporate governance and compensation
committee may, in its sole discretion, determine, which except in the case of
substitute awards will not be less than the fair market value of such shares of
our common stock or other securities as of the date such purchase right is
awarded.
Restricted Shares of Common Stock
Restricted stock awards may be issued to participants, for no cash
consideration or for such minimum consideration as may be required by applicable
law, either alone or in addition to other awards granted under the 2000 Long
Term Incentive Plan. Except as otherwise determined by our corporate governance
and compensation committee at the time of grant, upon termination of employment
for any reason during the restriction period, all restricted stock awards still
subject to restriction will be forfeited by the participant and reacquired by
us.
Change in Control
The 2000 Long Term Incentive Plan generally provides that, unless our
corporate governance and compensation committee determines otherwise at the time
of grant with respect to a particular award, in the event of a change in
control,
- any options and stock appreciation rights outstanding as of the date the
change in control is determined to have occurred will become fully
exercisable and vested;
- the restrictions and deferral limitations applicable to any restricted
stock awards will lapse;
- all performance awards will be considered to be earned and payable in
full, and any deferral or other restriction will lapse and such
performance awards will be immediately settled or distributed; and
- the restrictions and deferral limitations and other conditions applicable
to any other stock unit awards or any other awards will lapse, and such
other stock unit awards or other awards will become free of all
restrictions, limitations or conditions and become fully vested and
transferable.
The 2000 Long Term Incentive Plan defines change in control to mean,
generally:
- an acquisition by any individual, entity or group of beneficial ownership
of 20% or more of either the then outstanding shares of our common stock
or the combined voting power of our then outstanding voting securities
entitled to vote generally in the election of directors;
- a change in the composition of a majority of our board of directors which
is not supported by our current board of directors;
- the approval by the shareholders of a merger, reorganization or
consolidation or sale or other disposition of all or substantially all of
our assets of or, if consummation of such corporate transaction is
subject, at the time of such approval by shareholders, to the consent of
any government or governmental agency, the obtaining of such consent
either explicitly or implicitly by consummation; or
- the approval of the shareholders of our complete liquidation or
dissolution.
Other Provisions
Our board of directors may amend, alter or discontinue the 2000 Long Term
Incentive Plan, but no amendment, alteration, or discontinuation may be made
that would impair rights under an award theretofore granted without the
participant's consent.
Our corporate governance and compensation committee will be authorized to
make adjustments in performance award criteria or in the terms and conditions of
other awards in recognition of limitations
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pursuant to Section 162(m) of the Internal Revenue Code, unusual or nonrecurring
events affecting us or our financial statements or changes in applicable laws,
regulations or accounting principles.
Subject to the provisions of the 2000 Long Term Incentive Plan and any
award agreement, the recipient of an award, including, without limitation, any
deferred award may, if so determined by our corporate governance and
compensation committee, be entitled to receive, currently or on a deferred
basis, interest or dividends, or interest or dividend equivalents, with respect
to the number of shares of our common stock covered by the award, and our
corporate governance and compensation committee may provide that such amounts,
if any, will be deemed to have been reinvested in additional shares of our
common stock or otherwise reinvested.
EMPLOYMENT AGREEMENTS
The employment agreement entered into by Mr. Peterson and AT&T,
subsequently assumed by Lucent, in 1995 required Lucent to establish a special
deferred compensation account in the amount of $190,000. In connection with the
distribution, we assumed Lucent's obligations under Mr. Peterson's employment
agreement. Interest is compounded as of the end of each calendar quarter for as
long as any sums remain in the account, and the quarterly rate of interest
applied at the end of any calendar quarter is one-quarter of the average 30-year
Treasury note rate for the previous quarter. The amounts credited to the account
vested in October 1999, and will be paid out following Mr. Peterson's
termination of employment with us.
SECTION 16(a) BENEFICIAL OWNERSHIP REPORTING COMPLIANCE
Section 16(a) of the Securities Exchange Act of 1934 requires our directors
and executive officers to file reports of holdings and transactions in our
common stock with the Securities and Exchange Commission and the New York Stock
Exchange. Based on our records and other information, we believe that all
Section 16 filing requirements applicable to our directors and executive
officers with respect to fiscal 2000 were met.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.
The following table sets forth information concerning shares of our common
stock beneficially owned as of October 2, 2000 by our directors and executive
officers and each person or entity known by us to beneficially own more than
five percent of the outstanding shares of our common stock.
Unless otherwise indicated in the footnotes below, each person or entity
has sole voting and investment power with respect to the shares of common stock
set forth opposite such person's or entity's name. Beneficial ownership is
determined in accordance with the rules of the Securities and Exchange
Commission and generally includes voting or investment power with respect to
securities. Shares of common stock and options, warrants and convertible
securities that are exercisable or convertible as of October 2, 2000 or within
60 days thereof into shares of our common stock are deemed to be outstanding and
to be beneficially owned by the person holding the options or warrants for the
purpose of computing the percentage ownership of the person, but are not treated
as outstanding for the purpose of computing the percentage ownership of any
other person. As of October 2, 2000, none of the parties set forth below held
options to purchase our common stock that were exercisable as of that date or
within 60 days thereof.
<TABLE>
<CAPTION>
OUR COMMON STOCK PERCENT OF SHARES
NAME BENEFICIALLY OWNED BENEFICIALLY OWNED
---- ------------------ ------------------
<S> <C> <C>
Warburg, Pincus Equity Partners, L.P.
466 Lexington Ave., 10th Fl.
New York, NY 10017-3147.................................. 28,309,894(1) 9.1%(1)
Patricia F. Russo.......................................... 9,934 *
Donald K. Peterson......................................... 8,960(2) *
Garry K. McGuire Sr. ...................................... -- --
David P. Johnson........................................... 328 *
Karyn Mashima.............................................. 213 *
</TABLE>
93
<PAGE> 94
<TABLE>
<CAPTION>
OUR COMMON STOCK PERCENT OF SHARES
NAME BENEFICIALLY OWNED BENEFICIALLY OWNED
---- ------------------ ------------------
<S> <C> <C>
Michael A. Dennis.......................................... 289 *
Henry B. Schacht(3)........................................ 309 *
Jeffrey A. Harris(4)....................................... -- --
Daniel C. Stanzione........................................ 11,157 *
Franklin A. Thomas......................................... -- --
Directors and executive officers as a group, including
those named above (11 persons)........................... 32,410 *
</TABLE>
---------------
* Indicates less than 1%.
(1) According to the Schedule 13D filed by Warburg, Pincus Equity Partners, L.P.
and other related parties on October 12, 2000, these are estimates based
upon the conversion of the Series B convertible participating preferred
stock and the exercise of the warrants purchased by Warburg, Pincus Equity
Partners, L.P. and related investment funds on October 2, 2000. The actual
amount of shares of our common stock will not be known until 90 days after
the issuance of the preferred stock and warrants. The formula for
determining the actual number of shares of our common stock into which the
Series B convertible participating preferred stock may be converted and the
formula for determining the actual number of shares of our common stock
issuable on exercise of the warrants is set forth under "Certain
Relationships and Related Transactions -- Equity Investment."
(2) All such shares are held in a deferred share account under our deferred
compensation plan.
(3) Mr. Schacht is a managing director and a senior advisor of Warburg, Pincus
and Company, LLC, an affiliate of Warburg, Pincus Equity Partners, L.P. The
table excludes the shares of our common stock in which Mr. Schacht has an
indirect interest through Warburg, Pincus Equity Partners, L.P.'s beneficial
ownership of our common stock. Mr. Schacht disclaims beneficial ownership of
such shares, except to the extent of his pecuniary interest therein.
(4) Mr. Harris is Warburg, Pincus Equity Partners, L.P.'s designee to our board
of directors. Mr. Harris is a partner of Warburg, Pincus & Co., the general
partner of Warburg, Pincus Equity Partners, L.P. The table excludes the
shares of our common stock in which Mr. Harris has an indirect interest
through Warburg, Pincus Equity Partners, L.P.'s beneficial ownership of our
common stock. Mr. Harris disclaims beneficial ownership of such shares,
except to the extent of his pecuniary interest therein.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.
Equity Investment
On October 2, 2000, Warburg, Pincus Equity Partners, L.P. and related
investment funds, which we refer to collectively as the investors, purchased
4,000,000 shares of our Series B convertible participating preferred stock and
warrants to purchase our common stock for an aggregate purchase price of $400
million. Based on the formula set forth below, the Series B convertible
participating preferred stock is expected to be initially convertible into
approximately 5.0% of our fully diluted common stock, calculated using a
modified treasury stock method as of the 90th day after issuance. The warrants
have an exercise price equal to 130% of the conversion price for the Series B
convertible participating preferred stock. The warrants are exercisable for 3.6%
of a total number of shares of common stock to be calculated pursuant to the
formula set forth below as of the 90th day after issuance. Of these warrants,
warrants exercisable for 2.0% of such total number of shares of common stock
will have a four-year term and warrants exercisable for 1.6% of such total
number of shares of common stock will have a five-year term. During a period
commencing no later than June 30, 2001, until the second anniversary of their
issuance, if the market price of our common stock exceeds 200%, in the case of
the four-year warrants, and 225%, in the case of the five-year warrants, of the
exercise price of the warrants for 20 consecutive trading days, we can force the
exercise of up to 50% of the warrants. The warrants are exercisable immediately
upon issuance.
94
<PAGE> 95
The shares of Series B convertible participating preferred stock have an
aggregate initial liquidation value of $400 million and will accrete for the
first ten years at an annual rate of 6.5%, compounded quarterly. After the third
anniversary of the issue date, 50% of the amount accreted for the year may be
paid in cash as a dividend, on a quarterly basis at our option. After the fifth
anniversary of the issue date through the tenth anniversary, we may elect to pay
100% of the amount accreted for the year as a cash dividend on a quarterly
basis. Following the tenth anniversary of the issue date, we will pay quarterly
cash dividends at an annual rate of 12% of the then applicable liquidation value
of the Series B convertible participating preferred stock, compounded quarterly.
The Series B convertible participating preferred shares also participate, on an
as-converted basis, in dividends paid on our common stock.
The initial conversion price of the Series B convertible participating
preferred stock is calculated as of 90 days after the issuance by dividing $7.6
billion by the number of fully diluted shares outstanding, calculated on a
modified treasury stock basis. The number of fully diluted shares outstanding
calculated on a modified treasury stock basis is equal to the sum of:
- the number of shares of our common stock outstanding immediately after
the distribution; and
- all shares of common stock issuable upon exercise or conversion of all
options and convertible securities issued and outstanding immediately
following the distribution that are held by our employees, officers and
directors and with respect to which the exercise price is less than or
equal to the average trading price of our common stock over the last 20
trading days during the period ending on the 90th day after the issue
date; and
- all shares and restricted shares of common stock and all shares of common
stock issuable upon exercise or conversion of all options and convertible
securities issued, sold or granted during the 90 days following the
distribution to our employees, officers and directors and with respect to
which the exercise price, or in the case of shares or restricted shares,
the purchase price, is less than or equal to the average trading price of
our common stock over the last 20 trading days during the period ending
on the 90th day after the issue date.
The number of shares of our common stock in respect of the options and other
securities described in the previous two bullet points is adjusted to reflect
the assumed application by us of the aggregate exercise, conversion or purchase
price of all such options and securities to repurchase shares of our common
stock at a price equal to the average trading price of our common stock over the
last 20 trading days during the period ending on the 90th day after the issue
date.
The warrants will be exercisable for 3.6% of a total number of shares of
our common stock determined as of the 90th day after the issuance of the
warrants and equal to the sum, adjusted to reflect the expected dilution
resulting from the issuance of shares of our common stock upon exercise of the
warrants, of:
- our outstanding common stock on the day the warrants were issued; and
- the lesser of:
- 17.65% of our outstanding common stock on the day the warrants were
issued; and
- the sum of:
- all shares of common stock issuable upon exercise or conversion of
all options and convertible securities issued or granted to our
directors, officers or employees as of the day the warrants were
issued which at such date had exercise or conversion prices at or
below the exercise price of the warrants; and
- all shares of restricted common stock and shares of common stock
issuable upon exercise or conversion of all options and convertible
securities issued, granted or sold to our directors, officers or
employees during the 90 days following the issuance of the warrants
with exercise or purchase prices at or below the exercise price of
the warrants.
95
<PAGE> 96
The Series B convertible participating preferred stock and the warrants
have customary antidilution rights.
Redemption. At any time after the fifth anniversary of their issuance, we
may force conversion of the shares of Series B convertible participating
preferred stock. If we give notice of a forced conversion, the investors will be
able to require us to redeem the Series B convertible participating preferred
shares at 100% of the then current liquidation value, plus accrued and unpaid
dividends. Following a change-in-control of us during the first five years after
the investment, other than a change-in-control transaction that is a business
combination involving solely the issuance of common stock, the accretion of some
or all of the liquidation value of the Series B convertible participating
preferred stock that would otherwise accrete through the fifth anniversary of
the issue date will be accelerated, subject to our ability to pay a portion of
the accelerated accretion in cash in some instances. In addition, for 60 days
following the occurrence of any change-in-control of us during the first five
years after the investment, the investors will be able to require us to redeem
the Series B convertible participating preferred stock at 101% of the
liquidation value, including any accelerated accretion of the liquidation value,
plus accrued and unpaid dividends.
Voting Rights and Board Seat. The shares of Series B convertible
participating preferred stock are entitled to vote, on an as-converted basis,
with our common stock on any matters submitted to holders of our common stock.
The shares of Series B convertible participating preferred stock also have
limited rights to vote as a separate class. So long as the investors and their
permitted transferees maintain ownership of a combination of shares of Series B
convertible participating preferred stock and common stock that, in the
aggregate, on an as-converted basis, represents at least 50% of the shares of
our common stock initially issuable on conversion of all the shares of Series B
convertible participating preferred stock purchased, they are permitted to
designate for election one individual to our board of directors, and our board
of directors will use reasonable efforts to cause such person to be elected.
Permitted transferees are defined as investment funds affiliated with Warburg,
Pincus Equity Partners, L.P. While this ownership level is maintained, the
investors and their permitted transferees also are permitted to designate one
observer to attend meetings of our board of directors.
Preemptive Rights. As long as the investors maintain the minimum ownership
interest necessary to designate a director for election to our board of
directors, they are entitled to preemptive rights to purchase a percentage of
any new shares of common stock and common stock equivalents sold by us for cash
in capital-raising transactions.
Other Matters. The investors also have agreed to limited transfer
restrictions for the securities acquired and a set of restrictions for a period
of five years that prohibits them from acquiring additional shares of our common
stock that, together with shares already owned by them, would exceed 9.9% of our
then outstanding common stock. The number of shares owned by the investors is
equal to the sum of:
- the number of shares of our common stock beneficially owned by the
investors and their controlled affiliates, excluding any shares issuable
with respect to any then unexercised warrants; and
- the number of shares of our common stock issuable upon conversion of the
shares of Series B convertible participating preferred stock beneficially
owned by the investors and their controlled affiliates, assuming the
liquidation value of such shares of Series B convertible participating
preferred stock had accreted until the fifth anniversary of their date of
issuance.
The investors have also agreed to restrictions that are intended to
prohibit them from taking actions that could result in a change-in-control of
our company.
We have agreed to file a shelf registration statement for the registered
sale of the Series B convertible participating preferred shares, the warrants
and the shares of our common stock issuable in respect of the Series B
convertible participating preferred shares and the warrants.
96
<PAGE> 97
Other Relationships and Related Party Transactions
Henry Schacht, who is a member of our board of directors, is a managing
director and senior advisor of Warburg, Pincus and Company, LLC. Warburg, Pincus
and Company, LLC is an affiliate of Warburg, Pincus Equity Partners, L.P., the
party who has made the equity investment in us, as described above.
During fiscal 2000, a privately held business, of which Mr. Schacht holds
an 80% equity interest and of which his son is the controlling shareholder,
purchased and paid for call center equipment and consulting services from us for
a total of approximately $1.2 million. This business continues to purchase
routine services from us on a time and materials basis.
Some of our directors and executive officers own substantial amounts of
Lucent common stock and vested Lucent options. Ownership of Lucent common stock
and Lucent options by our directors and officers could create, or appear to
create, potential conflicts of interest when faced with decisions that could
have disparate implications for Lucent and us.
97
<PAGE> 98
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K.
(a) Documents filed as a part of this Annual Report on Form 10-K:
(1) Financial Statements:
<TABLE>
<CAPTION>
PAGES
-----
<S> <C> <C>
(i) Consolidated Statements of Operations....................... 49
(ii) Consolidated Balance Sheets................................. 50
(iii) Consolidated Statements of Changes in Stockholders' 51
Equity......................................................
(iv) Consolidated Statements of Cash Flows....................... 52
(v) Notes to Consolidated Financial Statements.................. 53
</TABLE>
(2) Financial Statement Schedules:
<TABLE>
<S> <C> <C>
(i) Schedule II -- Valuation and Qualifying Accounts............ 100
</TABLE>
Separate financial statements of subsidiaries not consolidated and 50
percent or less owned persons are omitted since no such entity constitutes a
"significant subsidiary" pursuant to the provisions of Regulation S-X, Article
3-09.
(3) Exhibits:
The following documents are filed as Exhibits to this Annual Report on Form
10-K or incorporated by reference herein:
<TABLE>
<CAPTION>
EXHIBIT
NUMBER
-------
<C> <S>
2 Contribution and Distribution Agreement+
3.1 Restated Certificate of Incorporation of Avaya Inc.+
3.2 Amended and Restated By-laws of Avaya Inc.*
4.1 Specimen Common Stock certificate+
4.2 Restated Certificate of Incorporation of Avaya Inc.
(incorporated by reference as Exhibit 3.1 hereto)+
4.3 Amended and Restated By-laws of Avaya Inc. (filed as Exhibit
3.2 hereto)*
4.4 Rights Agreement between Avaya Inc. and The Bank of New
York, as Rights Agent+
4.5 Form of Certificate of Designations of Series A Junior
Participating Preferred Stock (attached as Exhibit A to the
Rights Agreement filed as Exhibit 4.4 hereto)+
4.6 Form of Right Certificate (attached as Exhibit B to the
Rights Agreement incorporated by reference as Exhibit 4.4
hereto)+
10.1 Contribution and Distribution Agreement (incorporated by
reference as Exhibit 2 hereto)+
10.2 Interim Services and Systems Replication Agreement+
10.3 Employee Benefits Agreement+
10.4 Tax Sharing Agreement+
10.5 Avaya Inc. Short Term Incentive Plan+
10.6 Avaya Inc. 2000 Long Term Incentive Plan+
10.7 Avaya Inc. 2000 Long Term Incentive Plan Restricted Stock
Unit Award Agreement+
10.8 Avaya Inc. 2000 Long Term Incentive Plan Nonstatutory Stock
Option Agreement+
10.9 Avaya Inc. Deferred Compensation Plan+
10.10 Employment Agreement of Mr. Peterson, dated August 8, 1995+
</TABLE>
98
<PAGE> 99
<TABLE>
<CAPTION>
EXHIBIT
NUMBER
-------
<C> <S>
10.11 Avaya Inc. Supplemental Pension Plan+
10.12 Avaya Inc. 2000 Stock Compensation Plan for Non-Employee
Directors+
10.13 Trademark License Agreement+
10.14 Patent and Technology License Agreement+
10.15 Technology Assignment and Joint Ownership Agreement+
10.16 Development Project Agreement+
10.17 Preferred Stock and Warrant Purchase Agreement+
10.18 Certificate of Designations, Preferences and Rights of
Series B Convertible Participating Preferred Stock of Avaya
Inc. (attached as Exhibit A to the Preferred Stock and
Warrant Purchase Agreement incorporated by reference as
Exhibit 10.17 hereto)+
10.19 Form of Warrant (attached as Exhibit B to the Preferred
Stock and Warrant Purchase Agreement incorporated by
reference as Exhibit 10.17 hereto)+
10.20 364-Day Competitive Advance and Revolving Credit Facility
Agreement, dated as of September 25, 2000 among Lucent
Technologies Inc., Avaya Inc., Citibank, N.A., as Agent,
Salomon Smith Barney, As Lead Arranger, Bank One, NA, The
Chase Manhattan Bank and Deutsche Bank AG New York and/or
Cayman Islands Branches, as Co-Syndication Agents and
Co-Arrangers, Commerzbank AG, as Co-Arranger and the Lenders
party thereto*
10.21 Five Year Competitive Advance and Revolving Credit Facility
Agreement, dated as of September 25, 2000 among Lucent
Technologies Inc., Avaya Inc., Citibank, N.A., as Agent,
Salomon Smith Barney, As Lead Arranger, Bank One, NA, The
Chase Manhattan Bank and Deutsche Bank AG New York and/or
Cayman Islands Branches, as Co-Syndication Agents and
Co-Arrangers, Commerzbank AG, as Co-Arranger and the Lenders
party thereto*
21 List of Subsidiaries of Avaya Inc.+
23 Consent of PricewaterhouseCoopers LLP*
24 Power of Attorney*
27 Financial Data Schedule*
</TABLE>
---------------
* Filed herewith.
+ Incorporated by reference to Avaya's Registration Statement on Form 10 (Reg.
No. 1-15951), declared effective by the Securities and Exchange Commission on
September 15, 2000.
(b) Reports on Form 8-K during the last quarter of the fiscal year covered
by this Report: None.
99
<PAGE> 100
AVAYA INC. AND SUBSIDIARIES
SCHEDULE II -- VALUATION AND QUALIFYING ACCOUNTS
(DOLLARS IN MILLIONS)
<TABLE>
<CAPTION>
COLUMN A COLUMN B COLUMN C COLUMN D COLUMN E
-------- ------------ ---------- -------- ----------
ADDITIONS
BALANCE AT CHARGED CHARGED
BEGINNING OF TO COSTS & TO OTHER BALANCE AT
PERIOD EXPENSES ACCOUNTS DEDUCTIONS END OF PERIOD
------------ ---------- -------- ---------- -------------
<S> <C> <C> <C> <C> <C>
YEAR 2000
Allowance for doubtful accounts.......... $58 $36 $-- $32 $62
YEAR 1999
Allowance for doubtful accounts.......... 82 25 1 50 58
YEAR 1998
Allowance for doubtful accounts.......... 57 33 17 25 82
</TABLE>
100
<PAGE> 101
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) 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
December 28, 2000
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons in the capacities and on
the date indicated.
<TABLE>
<CAPTION>
SIGNATURE TITLE DATE
--------- ----- ----
<S> <C> <C>
Principal Executive Officer:
* Vice Chairman, President and Chief December 28, 2000
--------------------------------------- Executive Officer
Donald K. Peterson
Principal Financial Officer:
/s/ GARRY K. MCGUIRE SR. Chief Financial Officer December 28, 2000
---------------------------------------
Garry K. McGuire Sr.
Principal Accounting Officer:
/s/ CHARLES D. PEIFFER Controller December 28, 2000
---------------------------------------
Charles D. Peiffer
Directors:
Chairman of the Board of Directors December 28, 2000
---------------------------------------
Patricia F. Russo
* Director December 28, 2000
---------------------------------------
Jeffrey A. Harris
</TABLE>
101
<PAGE> 102
<TABLE>
<CAPTION>
SIGNATURE TITLE DATE
--------- ----- ----
<S> <C> <C>
* Director December 28, 2000
---------------------------------------
Henry B. Schacht
* Director December 28, 2000
---------------------------------------
Daniel C. Stanzione
* Director December 28, 2000
---------------------------------------
Franklin A. Thomas
</TABLE>
* by Charles D. Peiffer, Attorney-In-Fact
102
<PAGE> 103
EXHIBIT INDEX
<TABLE>
<CAPTION>
EXHIBIT PAGE
NUMBER NUMBER
------- ------
<C> <S> <C>
2 Contribution and Distribution Agreement+
3.1 Restated Certificate of Incorporation of Avaya Inc.+
3.2 Amended and Restated By-laws of Avaya Inc.*
4.1 Specimen Common Stock certificate+
4.2 Restated Certificate of Incorporation of Avaya Inc.
(incorporated by reference as Exhibit 3.1 hereto)+
4.3 Amended and Restated By-laws of Avaya Inc. (filed as Exhibit
3.2 hereto)*
4.4 Rights Agreement between Avaya Inc. and The Bank of New
York, as Rights Agent+
4.5 Form of Certificate of Designations of Series A Junior
Participating Preferred Stock (attached as Exhibit A to the
Rights Agreement filed as Exhibit 4.4 hereto)+
4.6 Form of Right Certificate (attached as Exhibit B to the
Rights Agreement incorporated by reference as Exhibit 4.4
hereto)+
10.1 Contribution and Distribution Agreement (incorporated by
reference as Exhibit 2 hereto)+
10.2 Interim Services and Systems Replication Agreement+
10.3 Employee Benefits Agreement+
10.4 Tax Sharing Agreement+
10.5 Avaya Inc. Short Term Incentive Plan+
10.6 Avaya Inc. 2000 Long Term Incentive Plan+
10.7 Avaya Inc. 2000 Long Term Incentive Plan Restricted Stock
Unit Award Agreement+
10.8 Avaya Inc. 2000 Long Term Incentive Plan Nonstatutory Stock
Option Agreement+
10.9 Avaya Inc. Deferred Compensation Plan+
10.10 Employment Agreement of Mr. Peterson, dated August 8, 1995+
10.11 Avaya Inc. Supplemental Pension Plan+
10.12 Avaya Inc. 2000 Stock Compensation Plan for Non-Employee
Directors+
10.13 Trademark License Agreement+
10.14 Patent and Technology License Agreement+
10.15 Technology Assignment and Joint Ownership Agreement+
10.16 Development Project Agreement+
10.17 Preferred Stock and Warrant Purchase Agreement+
10.18 Certificate of Designations, Preferences and Rights of
Series B Convertible Participating Preferred Stock of Avaya
Inc. (attached as Exhibit A to the Preferred Stock and
Warrant Purchase Agreement incorporated by reference as
Exhibit 10.17 hereto)+
10.22 Form of Warrant (attached as Exhibit B to the Preferred
Stock and Warrant Purchase Agreement incorporated by
reference as Exhibit 10.17 hereto)+
10.23 364-Day Competitive Advance and Revolving Credit Facility
Agreement, dated as of September 25, 2000 among Lucent
Technologies Inc., Avaya Inc., Citibank, N.A., as Agent,
Salomon Smith Barney, As Lead Arranger, Bank One, NA, The
Chase Manhattan Bank and Deutsche Bank AG New York and/or
Cayman Islands Branches, as Co-Syndication Agents and
Co-Arrangers, Commerzbank AG, as Co-Arranger and the Lenders
party thereto*
</TABLE>
103
<PAGE> 104
<TABLE>
<CAPTION>
EXHIBIT PAGE
NUMBER NUMBER
------- ------
<C> <S> <C>
10.24 Five Year Competitive Advance and Revolving Credit Facility
Agreement, dated as of September 25, 2000 among Lucent
Technologies Inc., Avaya Inc., Citibank, N.A., as Agent,
Salomon Smith Barney, As Lead Arranger, Bank One, NA, The
Chase Manhattan Bank and Deutsche Bank AG New York and/or
Cayman Islands Branches, as Co-Syndication Agents and
Co-Arrangers, Commerzbank AG, as Co-Arranger and the Lenders
party thereto*
22 List of Subsidiaries of Avaya Inc.+
23 Consent of PricewaterhouseCoopers LLP*
24 Power of Attorney*
27 Financial Data Schedule*
</TABLE>
---------------
* Filed herewith.
+ Incorporated by reference to Avaya's Registration Statement on Form 10 (Reg.
No. 1-15951), declared effective by the Securities and Exchange Commission on
September 15, 2000.
104
