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Exhibit 99.1
AVAYA INC.
TRANSCRIPT OF EARNINGS CONFERENCE CALL
OCTOBER 26, 2000
DEREK VIALIZ: On behalf of Avaya, I would like to welcome all to our
first earnings call as a public company. I'm Derek Vializ, Vice President of
Investor Relations. Today I'm joined by Avaya's President and CEO, Don Peterson,
and Avaya's Chief Financial Officer, Garry McGuire.
I would like to remind you that today's remarks may contain
forward-looking statements based on current expectations, forecasts, and
assumptions that involve risk and uncertainties that [could] cause actual
outcomes and results to differ materially.
Additional information regarding these and uncertainty may be found in
our filings with the Securities and Exchange Commission, and in particular our
registration statement [on] Form 10.
At this time, I'm delighted to introduce Don Peterson.
DON PETERSON: Thanks Derek and thanks to all of you for joining us. For
those of you that are new to Avaya, I'm going to start by giving you a quick
look at our long-term view of the market we serve, and the direction in which
we're driving our business for the future.
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First, we are in a large, and in fact, growing market. Overall our
existing markets are growing at about 11 percent, and our overall addressable
market is growing at about 16 percent.
In 1999 that market was sized at about $180 billion. However, within that
addressable market, some key segments are growing much faster. We're driving
toward those high growth segments, as we position Avaya for the future. Those
segments include IP telephony, virtual private networks, gigabit Ethernet,
unified communications, applications professional services and other kinds of
professional services, CRM solutions and network software. Most of these are
growing 20 to 30 percent, and some substantially faster. We plan to capitalize
on the opportunity presented by these high growth segments. We're shifting our
emphasis away from our current cash engines such as traditional voice PBXs and
voice messaging connectivity and voice maintenance.
Today about 80 percent of our business by revenue is in these cash
engines. Within a few years, we're targeting a 50/50 split between these cash
engines and the higher growing markets. Getting there requires a deliberate
discipline strategy. When we talked with many of you during our road show in
September, we described our strategy as a three part story.
First, aggressive and rapid restructuring action leading to a strong
improvement in the bottom line. We're seeing progress in that area already.
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Second, capturing the gains from restructuring and increased R&D
investment and focusing them on the faster growing part of the enterprise
market.
And the combined effect of those changes will move us towards our target
of growth at the overall market rate within three or four years.
Avaya is in the early stages of restructuring and repositioning. We've
been building capability in the areas we targeted as critical to our success.
Specifically, we've been restructuring aggressively to take costs out of the
business. Especially in some of the following areas.
We've taken steps to reduce or outsource a number of our corporate
functions.
We've streamlined sales support and marketing functions to position Avaya
for the future. That effort, including streamlining our distribution model by
unifying all sales channel accountability and driving towards a higher mix of
indirect to direct sales. I added that while we are experiencing some disruption
in the early months of those changes in the sales force, we are making good
progress. We're going to continue to fine-tune the changes, even as we
accelerate our growth starting in the year 2001.
Another boost to the bottom line is that we are consolidating and
reducing our real estate holdings by about 30 percent, and we struck a landmark
agreement with our unions that let 1500 services employees retire from the
business but remain on call to return as needed. In fact about 4,000 full time
people, including those 1500 service employees have left the business.
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With solid bottom line improvements underway, we're beginning to shift
our portfolio from our traditional core businesses to higher growth areas. Let
me just mention a few highlights of our progress. We have a five year agreement
for up to $200 million with Win First in the critical area of data
communications solutions. We'll provide equipment for a high speed fiber to the
home network that will support voice, data and video applications.
In IP telephony we introduced our Eclipse family of products, bringing
full, reliable PBX functionality to the world of pure IP.
In the global convergence market we announced a multi-million dollar sale
of Internet-based call centers to Atento. They'll be deployed in 13 countries,
in Latin America, Europe, and Africa.
In the fast growing xSP market, we introduced Avaya Hosted Solutions
that will let application service providers expand their offers across a broad
array of converged applications, included hosted IP telephony.
We're also continuing to forge and strengthen strategic alliances to
improve our technology, services and go-to-market capability. We were very
pleased in June to announce our alliance with Siebel Systems in the eBusiness
solutions space.
In short, we've made some solid progress in a relatively short time. But
as we expected the results for our spin-off year were mixed, as we executed our
plans to restructure for long term growth.
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As you know from our press release, we announced net income from ongoing
operations for fiscal 2000 of $156 million, or 55 cents a diluted share.
This represents an increase of over 200 percent from fiscal 1999, and is
inline with the picture that we have laid out for you on the road show. For the
year our earnings improved significantly. However our revenues are down
slightly. Again because of disruptions in the sales force as we organized our US
sales organization, the focus on higher growth segments, as well as because of
softness in the market for our traditional products, versus the period last year
when everyone was focused on year 2K.
Before Garry takes you through the details I would like to comment on one
recent news story. Earlier this week Lucent announced that Henry Schacht is
returning to his previous role there as chairman and CEO. As you know, Henry has
been Avaya's chairman for the last few months and has been very helpful in
guiding us through the transition to independence and to putting our strategy in
place.
Although Henry will not be able to devote the time needed to continue as
Avaya's chairman, I'm delighted that Henry will remain on our Board of Directors
and that he will continue to work with other members of the Board, to provide
guidance for Avaya's progress.
And now I'll invite Avaya's CFO, Garry McGuire, to discuss our results in
more detail.
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GARY MC GUIRE: Thanks Don. You all have the numbers in front of you, so I
don't want to eat up a lot of the Q&A time telling you what you already know. So
let me follow Don's lead and hit the highlights.
By way of definition, when we talk about ongoing operations, we're
excluding business restructuring reserves and one time charges associated with
our spin-off from Lucent. Those are included in as-reported operations.
Ongoing operations also exclude results from businesses sold or exited in
1999 or 2000, including the sale of our small and mid-sized sales organization
to Expanets, and a gain of $45 million on that sale, exiting the wire
installation business, as announced in November of '99, the sale of a lease
business in September of '99 and the cumulative effect of $158 million
accounting [change], related to pension and post-retirement benefit cost.
You'll find a detailed explanation of these in our release.
So first let me take a look covering the results. As Don mentioned, for
the fiscal year ended September 30th, net income from ongoing operations was
$156 million, or 55 cents a diluted share. This compares to net income from
ongoing operations of $50 million or 18 cents a diluted share for fiscal 1999.
Revenues from ongoing operations were $7.435 billion for the year, down
1.8 percent, from $7.570 billion in fiscal 1999.
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For the fourth fiscal quarter of 2000, net income from ongoing operations
was $20 million, or 7 cents a share on a diluted basis.
Revenues for the quarter were $2.016 billion, and both these metrics were
down on a year-over-year quarter, reflecting a number of factors. Obviously the
Y2K ramp-up at the end of 1999 exerted the greatest comparison impact. But the
restructuring of our sales force and softness in our traditional markets also
played a part.
On an as-reported basis for fiscal 2000, we posted a loss of $375
million, compared with net income of $282 million for fiscal 1999. This was in
line with expected impact of our restructuring charges.
Reported revenues for fiscal 2000 were $7.680 billion, down from $8.268
billion in 1999.
For the quarter we posted a loss of $543 million on an as-reported basis,
including business restructuring reserve charges of $684 million, in line with
our restructuring plan.
We expect approximate two year payback on the $684 million charge, as
benefits from the restructuring are fully realized.
Reported revenues for the quarter were $2.016 billion, down 15.9 percent
from the year ago quarter.
If you're familiar with our Form 10, you know that we report results
against three business segments. First is Communication Solutions, which
includes Customer
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Relationship Management, or CRM; Messaging Solutions; Definity Solutions; and
Enterprise Internetworking Solutions. Second is Connectivity Solutions and third
is Services.
A key driver of the decline in our revenues from ongoing operations for
the year was Communication Solutions revenue, which declined both year-over-year
and quarter-over-quarter.
Much of that can be traced to the changes in sales force operations which
Don mentioned a few minutes ago. In the sales universe in general and in US
sales in particular, we were working through several factors, many of which were
specific to the pre-spin transition period.
First, like many other technology vendors, we experienced a significant
ramp-up in customer spending during the fourth fiscal quarter of 1999, in
advance of Y2K.
Because of that spend, we also saw a lull in spending in the first two
quarters of fiscal 2000.
Second, as you might expect, we went through a period of uncertainty in
our sales force during the April/May timeframe, after the spin was announced.
What's more, we had to fight for brand awareness during that period. We
weren't really Lucent, but we didn't have our own name or brand image yet.
The situation added considerably to the challenge faced by our sales
teams. In addition, we engineered a significant retooling of the sales force,
re-staffing and
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retraining to build the skills and experience needed to help Avaya move from
selling traditional voice products, to selling offers on a converged data voice
platform. And from selling boxes to selling applications and solutions. That
created some of the disruption that Don mentioned. Those changes were continuing
to be implemented in the August and September timeframe, during a period when
the US market was soft and revenues flat in our traditional core PBX and
messaging businesses.
And while we've announced some key advances in the data and IP telephony
markets, the bulk of our revenues during that period came from our traditional
core businesses. Re-balancing that sales mix for the future is going to be the
major area of focus in fiscal 2001.
Our second segment is Connectivity Solutions. Ongoing revenues grew 9
percent over fiscal 1999 to nearly $1.4 billion. Connectivity Solutions
operating income for the year rose by 63.1 percent over fiscal 1999, driven by
increased demand from service providers, as well as by cost improvements.
Our third segment, Services, posted ongoing revenues for the year of
$1.958 billion and operating income of $[271] million for the year -- up 36.2
percent over fiscal 1999.
Those improvements and operating income reflect the effects of staff
reductions, as well as changes on our delivery model since mid-year.
Non US revenues in total grew by 2.5 percent as a percent of total
revenue for the year, representing about 21 percent of total sales. But that
average number masked
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some bright spots. For example, Communication Solutions sales outside the US
were up 9 percent on a year-over-year basis. That included 25 percent growth in
CRM and 42 percent growth in Enterprise Internetworking Solutions products.
Professional services outside the US was also up 34 percent.
Looking at our balance sheet I'd like to highlight two items. First we
are not in the sales financing business, it's not what we do and it will not be
an issue for us as we go forward.
And second, the Warburg, Pincus investment of $400 million was not
reflected in our 9/30 balance sheet, but was received on 10/1.
Now let me shift to our key measures of progress. During our road show we
highlighted five areas of operation that will be key to driving Avaya's earnings
growth over the next two to three years. The first is gross margin, where we've
targeted improvement of 1.5 to 2.5 points. Gross margin and ongoing revenues
were 43.5 percent for the year and 40.8 percent for the quarter, down from the
prior year and year ago quarter. This was our biggest miss and it is almost
entirely attributable to quarter four performance.
Except for the fourth quarter growth margins, we're essentially steady.
Fourth quarter declines in margin for ongoing revenues, were due to the factors
I've already mentioned: lower volumes, sales mix, skewed in favor of lower
margin products. Some true-up adjustments connected to the spin-off. And
increased discounting across the business which can be attributed in part to our
former ties to Lucent.
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Our second key measure is SG&A as a percent of revenue, which we intend
to improve by seven to ten points over the next few years.
For fiscal 2000, SG&A was 33.1 percent of ongoing revenues, down slightly
from fiscal 1999. On a gross dollar basis, though, SG&A was down $200 million
dollars for the year, driven by the restructuring and cost-cutting initiatives
we've discussed.
For the fourth quarter, SG&A was 33.4 percent of ongoing revenues, up
from 31.9 percent in the year-ago quarter.
Obviously SG&A as a percent of revenue is driven in-part by the size of
the revenue base, and our actual dollars spent was lower, but it was on a lower
revenue base for the quarter, so the percentage rose.
As we continue to move from a fixed cost structure to a variablized one
through innovations like our services agreement, we'll continue to see
improvements in SG&A.
The third key measure is R&D as a percent of revenue, where we've
targeted an increase of two to four points. R&D spending for both the year and
the quarter were down against ongoing revenue for 1999, but that's somewhat
misleading. Of the $72 million that R&D spending, was down year-over-year, $54
million came from Lucent allocations. As an independent company, we intend to
increase R&D spending in fiscal 2001 to about 9 percent of revenues, from 6.3
percent in fiscal 2000; and to spend it strategically in those areas that will
deliver the greatest value to Avaya going-forward.
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The fourth key measure is operating margin, where we've targeted a six to
eight point improvement. Operating margin in fiscal 2000 for ongoing operations
came in at 4.1 percent, compared to 1.9 percent in fiscal 1999.
For the fourth quarter, however, operating margin was 1.6 percent, versus
4.5 percent in the year ago quarter, reflecting the factors I've discussed.
Finally we intend to lower our tax rate by three to five points. Our
effective tax rate for fiscal 2000 on an ongoing basis was 39.5 percent, down
from 40.5 percent in fiscal 1999.
So here's a quick summary of our overall outlook. Looking ahead we expect
ongoing improvements in restructuring and cost reduction, to provide a
sustainable ramp-up in net income, which we expect to more than double in fiscal
2001.
Beyond that, as we increase our investment in R&D, and shift our
portfolio to faster growing segments that Don and I have described, our target
is to grow at the overall market rate within three to four years. We'll continue
to shift our distribution model to broader market coverage in the low to mid
size market, and it's our intention to keep the direct touch sales strategy at
the high end of the market, and leverage customer relationships we've
maintained, as we move from traditional voice to converged solutions.
Now I'd like to turn it back to Derek for the Q&A.
VIALIZ: Thank you. Operator, at this time we'd like to begin the Q&A
session.
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CONFERENCE FACILITATOR: At this time I will remind everyone if you do
have a question, please press the number 1 on your telephone keypad now.
Your first question is from Eric Buck of Wasserstein Perella.
ERIC BUCK: Good morning. I was just curious, the press release and what I
see on your website doesn't actually have an income statement and balance sheet.
Is that something that's forthcoming, or is out there and I just haven't seen
it?
Secondly, can you give us the sales and net income... or operating income
for the fourth quarter on an as-recorded basis for this year and the year ago
period?
And then finally, what was the magnitude of the charge that was related
to the agreement with the union?
VIALIZ: Eric the financial data will be available on our website
momentarily.
PETERSON: To the last point, Eric, there was no charge on the early
retirement of the union employees, there wasn't a change in... they retired
on... and took the retirement benefits, but there was no P&L charge related to
that.
BUCK: So the retirement... the accelerated retirement benefits were taken
as an expense item, not a... weren't part of the restructuring charges, is that
correct?
PETERSON: Well they actually retired from Lucent, not from Avaya, and
they would of... I believe they were substantially funded in the pension plan,
so there was no charge to earnings from that move. [There will be no additional
charge to earnings in fiscal 2001 related to the union agreement as the
agreement was included in Avaya's business restructuring reserves at
September 30, 2000.]
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CONFERENCE FACILITATOR: Your next question is from Ariane Mahler of
Dresdner Kleinwort.
ARIANE MAHLER: Yes good morning. My two questions, one is can you give me
the final fully-diluted number of shares, and if possible the average exercise
price of the options and tell me what the total plan was for the management and
the employees? Is it 20 percent? Is it 30 percent?
And secondly, on the PBX market, you said there was a significant ramp in
'99, ahead of Y2K and, therefore, decreasing 2000. Given the lifecycle of these
products, what do you think would make this product go up at all in the next two
years, given that it's mostly been replaced by companies.
PETERSON: OK, on the... fully diluted number of shares... is about 289
million, actually 289.5 million. [The number of shares used to calculate
diluted earnings per share as of September 30, 2000 was approximatley 289.5
million]. None of the existing options in this... that we dealt with are vested
and I don't believe any of them, as of the date of this--
MC GUIRE: Very few would be in the--
PETERSON: ...are in the money. So there are... all of their exercises
were above the share price at the opening. I don't have an average exercise
price for all of them that are outstanding, they range up into the mid-40's and
from probably something in the mid-20's.
In terms of the PBX market and what its future might be, there was a
buy-up in that market, we think, in 1999, going into year 2K. There have been
other cycles in this market where people had to upgrade their systems ... new
dialing plans and so forth,
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and we have seen cyclical patterns of demand. There are a lot of... Going
forward, you would expect... I would expect that to continue to control what the
obvious added impact of a switch into IP over time. There've been various
estimates of the IP telephony migration. I think I've seen them as high as 60
percent of new lines by 2003 to 2004. Obviously anything like that would see a
fall off in the number of new line shipments, and then you're left with, how do
you want to construct the market? Do you see IP PBXs as part of the PBX market,
or is it a new market and so forth?
I think the demand for connectivity is gonna continue to rise. We'll have
to wait and see how the actual demand for circuit switch PBXs evolves.
CONFERENCE FACILITATOR: Your next question is from George Kelley, of
Morgan Stanley Dean Witter.
GEORGE KELLEY: Yes, could we move to connectivity solutions? This is a
segment that's not nearly as well known in the investment community. We
understand the product cycle upgrades for the PBX business, but what about the
connectivity solutions? Are there new product cycles ahead, or is this a fairly
stable business going-forward?
PETERSON: Well actually the business itself has shown a strong resurgence
in the last quarter plus of 20000 for us. It's largely driven in the US and
largely driven in the exchange max product, going into service providers.
In the longer term, I think there is an open question, at least in my
mind, about what capacities will be required in the enterprise. We've been
pulling wire... cable with
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connectivity capacities generally spec'ed out at 10 megabits to the desktop, and
a hundred in the backbone. People are adding a gigabit in the backbone now, but
have not really deployed what might be the next step that talk about anyway, as
a hundred megabits to the desktop.
It remains to be seen whether that can be accommodated reliably in the
existing infrastructure, and if not there would be a substantial investment
required to upgrade that infrastructure. That's kind of the unknown opportunity
around that business right now.
KELLEY: Thank you.
CONFERENCE FACILITATOR: Your next question is from James Crichton of
Scout Capital.
JAMES CRICHTON: Yes, good morning! A couple of questions, one you haven't
discussed the outsourcing opportunities that I know you referred to in the road
show presentation, you know specifically I guess outsourcing some of the
manufacturing to contract manufacturers.
And then... That's my first question, if you'd please answer that.
MC GUIRE: The outsource contract manufacturing that we discussed in the
road show is something that we're continuing to pursue. We don't have anything
at this point to talk any further about.
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CRICHTON: OK. And then also, what are your plans right now for
Connectivity Solutions?
PETERSON: Connectivity Solutions has performed extremely well in the last
quarter and it looks for us to have a terrific future. We're looking at all of
the businesses continually. We look at all the businesses that we have to make
sure they fit in our overall strategy going-forward, which we've described as
migrating into higher-growth spaces.
We don't have anything to announce about our plans for any of the
business units, but we'll certainly bring that to all of the investors'
attention as soon as we have some firm plans.
CRICHTON: Got it. Thank you.
CONFERENCE FACILITATOR: Your next question is from Jason Miller of Libra
Advisors.
JASON MILLER: Hello gentlemen. Can you talk a little bit about the sales
force reorganization? The timing for that being complete? What the issues were?
And if you could also give us an order of magnitude on the outsource contract
manufacturing? Is it a hundred million dollars? Is it a billion dollars? That
would be great. Thank you.
MC GUIRE: Let me take the outsource first from a magnitude standpoint.
Let me qualify it. First of all we're not looking at outsourcing our
Connectivity Solutions piece, but everything else we would look at from an
outsource standpoint.
The size of it would be probably towards the higher end of your range
there.
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MILLER: You would expect a payment of that amount?
PETERSON: Oh, no, no, I'm sorry. The payment is something yet to be
negotiated if we were to do something like that, because that depends on how
much ongoing improvement you get from a cost standpoint, as opposed to up-front
payment, so that... as you get into those type of discussions, those things can
vary widely.
MC GUIRE: Jason just to give you a reference point from the financials,
we have about $3.3 billion of product costs in our as-reported numbers -- a
little bit less than that on an ongoing basis. If you exclude Connectivity
Solutions, which has probably about [$1 billion] of that, you're left with a
total product cost of [$2.3] billion, some of that would probably include
logistics and other things, so if when you subtract that out, you're left with a
fairly substantial number in the high $1 billions probably, approaching $2, that
would be a candidate for an outsourcing transaction.
In the sales force area, the issues there included complexity in the
organization structure, as well as skills within the individuals in the
organization itself. We have been trying in a very general sense, we've been
trying to sell data through an organization primarily structured historically
around voice communication sales. We've made a decision to change that
philosophy a bit by adding in leadership, in particular that was out of the data
business. We think we can do a better job supporting experienced data people in
selling voice, then we can in supporting voice people, adding data to their
portfolio. So, that has guided our thinking and this is primarily a comment in
the US.
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We're now looking at skill mixes within the organization and how we can
supplement those and enhance those to be effective across the board.
Our organizations outside the US, we think, have been doing a pretty good
job. We want to make sure they get the resources that they need to do even a
better job in the future, but we've seen, you know, reasonable growth in our
high end voice-oriented solutions around call centers and so forth, as well as
in our data business and our CRM business.
So, international looks like it's in good shape to build on. The US, we
are addressing... continuing to address the capabilities of the force, but I
think we're making great progress.
MILLER: So, when do you anticipate having that completely addressed?
PETERSON: Probably when we hit those market growth rates for our revenue.
I think this is gonna be an ongoing issue for us, although I expect we're mostly
through the area of what we want to build on and now it's a matter of making
them increasingly effective. But I think we've got a few more quarters of
core-building, in terms of capability and then on from there.
CONFERENCE FACILITATOR: Your next question is a follow up question from
Ariane Mahler of Dresdner Kleinwort Benson.
ARIANE MAHLER: Yes and I apologize but the fully diluted number of shares
explanation was not entirely clear to me. I just need to understand the
magnitude of the
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options pool again, because I wasn't sure how... if it was 20, 30 percent
additional and what the terms were. You said they were not granted or vested
yet.
And secondly on SG&A and the various other targets you gave during the
road show, it looks like you're making progress as to these targets pretty
quickly. Would you say that most of the low hanging fruit has been picked, and
therefore, you know, the progress will be a little less rapid going-forward, so
in other words it may take you much longer to get to these targets from now on?
PETERSON: I'll ask Garry to take the SG&A one. I believe the option data
runs something like this, there's about [46] million options that were converted
and we'll get you more precise data, but about [46] million options that were
converted from Lucent, all of those were underwater and none of those were
vested.
In addition, we have also issued since October 1st about 27.8 million
options, with a range of price from $14 to $21. These include the global grant
that I announced in the first day, as well as grants throughout the management
structure. So the total number of shares outstanding today is about 75 to 80
million and the exercise prices would range from $14 up to probably $40 or
higher, and at this moment I believe all of them are underwater and as I said,
none of them are vested.
CONFERENCE FACILITATOR: Your next question is--
MC GUIRE: Let me just answer the SG&A question for her first.
I would not categorize that we've picked most of the low hanging fruit
already. I think you'll see some significant improvement over the next two
quarters in that area,
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and then it will take us some sustaining reduction as we re-engineer the
business over the next couple of years to get the rest out, but I'd look to the
next couple of quarters for some significant improvement.
CONFERENCE FACILITATOR: Your next question is from Michael Weintraub of
Paine Webber.
MICHAEL WEINTRAUB: Good morning. Two questions. Both have to deal with
revenue. You're tell us that you're moving towards 50/50 split, as opposed to an
80/20 percent in your cash engine products? I understand 50/50 is your three to
four year target and could you please tell us what it is we could expect at the
end of the 7 and 1, what the revenue mix will be there?
And also, second question, if you could quantify please the number of
trials you may be in, in your IP telephony and VPN product?
PETERSON: OK. The mix in 2001 is going to obviously move up from the
roughly 18 percent in these areas that we've reported on the road show for 2000.
I would look for it to be in the low, low 20's. Keep in mind we're gonna be
moving this, but frankly the early days are not going.... We're gonna accelerate
over time into these new spaces, so not going to be an even progression.
We don't have the number of trials in the room here that we are... now
have in IP telephony. We'll get you that number and find a way to get it back to
you, obviously we'll have to do that broadly so we'll figure out how to put that
out.
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WEINTRAUB: So the mix is changing from 80/20 to say 75/25, something like
that?
PETERSON: I'd say that would be at the very high end of the opportunity
for next year. I wouldn't rule it out. I would call the number somewhat lower,
but within the range of our ability to predict it is probably OK.
CONFERENCE FACILITATOR: I'm showing there are no further questions at
this time.
VIALIZ: Again, on behalf of Avaya, we'd like to thank you all for your
participation in this morning's call and look forward to your future
participation.
If you have any additional questions, please feel free to contact me at
908-953-7500.
Thank you.
