10-Q 1 avaya-2012630x10q.htm FORM 10-Q AVAYA-2012.6.30-10Q

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
________________________________________________ 
FORM 10-Q
________________________________________________ 
x
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 2012
or
¨
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from              to             
Commission File Number 001-15951
________________________________________________ 
AVAYA INC.
(Exact name of registrant as specified in its charter)
________________________________________________ 
Delaware
 
22-3713430
(State or other jurisdiction
of incorporation or organization)
 
(I.R.S. Employer Identification No.)
 
 
 
211 Mount Airy Road
Basking Ridge, New Jersey
 
07920
(Address of principal executive offices)
 
(Zip Code)
(908) 953-6000
(Registrant’s telephone number, including area code)
None
(Former name, former address and former fiscal year, if changed since last report)
________________________________________________
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  ¨ No  x
*See Explanatory Note in Part II, Item 5
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes  x No  ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer  ¨
 
Accelerated filer  ¨
 
Non-accelerated filer  x
 
Smaller Reporting Company  ¨
 
 
 
 
(Do not check if a smaller
reporting company)
 
 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes  ¨ No  x
As of August 14, 2012, 100 shares of Common Stock, $.01 par value, of the registrant were outstanding.



TABLE OF CONTENTS
 

This Quarterly Report on Form 10-Q contains trademarks, service marks and registered marks of Avaya Inc. and its subsidiaries and other companies, as indicated. Unless otherwise provided in this Quarterly Report on Form 10-Q, trademarks identified by ® and TM are registered trademarks or trademarks, respectively of Avaya Inc. or its subsidiaries. All other trademarks are the properties of their respective owners.



PART I—FINANCIAL INFORMATION
 
Item 1.
Financial Statements.

Avaya Inc.
Consolidated Statements of Operations (Unaudited)
(In millions)
 
 
Three months ended
June 30,
 
Nine months ended
June 30,
 
2012
 
2011
 
2012
 
2011
REVENUE
 
 
 
 
 
 
 
Products
$
634

 
$
729

 
$
2,020

 
$
2,208

Services
616

 
643

 
1,874

 
1,920

 
1,250

 
1,372

 
3,894

 
4,128

COSTS
 
 
 
 
 
 
 
Products:
 
 
 
 
 
 
 
Costs (exclusive of amortization of technology intangible assets)
271

 
319

 
862

 
994

Amortization of technology intangible assets
47

 
65

 
146

 
198

Services
309

 
335

 
946

 
1,022

 
627

 
719

 
1,954

 
2,214

GROSS MARGIN
623

 
653

 
1,940

 
1,914

OPERATING EXPENSES
 
 
 
 
 
 
 
Selling, general and administrative
405

 
472

 
1,252

 
1,403

Research and development
116

 
115

 
344

 
351

Amortization of intangible assets
57

 
56

 
169

 
168

Restructuring and impairment charges, net
21

 
102

 
132

 
166

Acquisition-related costs
1

 

 
4

 
4

 
600

 
745

 
1,901

 
2,092

OPERATING INCOME (LOSS)
23

 
(92
)
 
39

 
(178
)
Interest expense
(107
)
 
(111
)
 
(324
)
 
(351
)
Loss on extinguishment of debt

 

 

 
(246
)
Other income (expense), net
6

 
(1
)
 
(7
)
 

LOSS BEFORE INCOME TAXES
(78
)
 
(204
)
 
(292
)
 
(775
)
Provision for (benefit from) income taxes
88

 
(52
)
 
62

 
(11
)
NET LOSS
$
(166
)
 
$
(152
)
 
$
(354
)
 
$
(764
)

The accompanying notes to consolidated financial statements are an integral part of these statements.
Avaya Inc.
Consolidated Balance Sheets (Unaudited)
(In millions, except per share and shares amounts)
 
 
June 30,
2012
 
September 30,
2011
ASSETS
 
 
 
Current assets:
 
 
 
Cash and cash equivalents
$
271

 
$
400

Accounts receivable, net
729

 
755

Inventory
278

 
280

Deferred income taxes, net
7

 
8

Other current assets
284

 
274

TOTAL CURRENT ASSETS
1,569

 
1,717

Property, plant and equipment, net
354

 
397

Deferred income taxes, net
54

 
28

Intangible assets, net
1,877

 
2,129

Goodwill
4,188

 
4,079

Other assets
194

 
196

TOTAL ASSETS
$
8,236

 
$
8,546

LIABILITIES
 
 
 
Current liabilities:
 
 
 
Debt maturing within one year
$
37

 
$
37

Accounts payable
440

 
465

Payroll and benefit obligations
260

 
323

Deferred revenue
590

 
639

Business restructuring reserve, current portion
109

 
130

Other current liabilities
293

 
352

TOTAL CURRENT LIABILITIES
1,729

 
1,946

Long-term debt
6,093

 
6,120

Pension obligations
1,669

 
1,636

Other postretirement obligations
506

 
502

Deferred income taxes, net
193

 
168

Business restructuring reserve, non-current portion
50

 
56

Other liabilities
524

 
496

TOTAL NON-CURRENT LIABILITIES
9,035

 
8,978

Commitments and contingencies

 

DEFICIENCY
 
 
 
Common stock, par value $.01 per share; 100 shares authorized, issued and outstanding

 

Additional paid-in capital
2,924

 
2,692

Accumulated deficit
(4,246
)
 
(3,892
)
Accumulated other comprehensive loss
(1,206
)
 
(1,178
)
TOTAL DEFICIENCY
(2,528
)
 
(2,378
)
TOTAL LIABILITIES AND DEFICIENCY
$
8,236

 
$
8,546


The accompanying notes to consolidated financial statements are an integral part of these statements.

1


Avaya Inc.
Consolidated Statements of Cash Flows (Unaudited)
(In millions)
 
Nine months ended
June 30,
 
2012
 
2011
OPERATING ACTIVITIES:
 
 
 
Net loss
$
(354
)
 
$
(764
)
Adjustments to reconcile net loss to net cash used for operating activities:
 
 
 
Depreciation and amortization
426

 
498

Share-based compensation
7

 
9

Amortization of debt issuance costs
16

 
18

Accretion of debt discount
1

 
18

Repayment of B-2 term loans related to cumulative accretion of debt discount

 
(50
)
Non-cash charge for debt issuance costs upon redemption of incremental B-2 term loans

 
5

Third-party fees expensed in connection with the debt modification

 
9

Provision for uncollectible receivables
4

 
2

Deferred income taxes, net
7

 
2

Loss on sale of investments and long-lived assets, net
3

 
1

Write-down of assets held for sale to net realizable value
4

 

Impairment of long-lived assets
2

 

Pension curtailment
5

 
7

Unrealized loss (gain) on foreign currency exchange
3

 
(25
)
Changes in operating assets and liabilities:
 
 
 
Accounts receivable
48

 
80

Inventory
3

 
(91
)
Accounts payable
(23
)
 
54

Payroll and benefit obligations
(87
)
 
(10
)
Business restructuring reserve
(16
)
 
40

Deferred revenue
(56
)
 
(49
)
Other assets and liabilities
(53
)
 
(146
)
NET CASH USED FOR OPERATING ACTIVITIES
(60
)
 
(392
)
INVESTING ACTIVITIES:
 
 
 
Capital expenditures
(60
)
 
(61
)
Capitalized software development costs
(30
)
 
(28
)
Acquisition of businesses, net of cash acquired
(212
)
 
(16
)
Return of funds held in escrow from the NES acquisition

 
6

Proceeds from sale of long-lived assets
2

 
7

Proceeds from sale of investments
73

 

Restricted cash

 
26

Advance to Parent
(8
)
 

Other investing activities, net
(2
)
 

NET CASH USED FOR INVESTING ACTIVITIES
(237
)
 
(66
)
FINANCING ACTIVITIES:
 
 
 
Repayment of incremental B-2 term loans

 
(696
)
Debt issuance and third-party debt modification costs

 
(42
)
Proceeds from senior secured notes

 
1,009

Repayment of long-term debt
(28
)
 
(32
)
Capital contribution from Parent
196

 

Borrowings under revolving credit facility
60

 

Repayments of borrowings under revolving credit facility
(60
)
 

Other financing activities, net
(1
)
 
(1
)
NET CASH PROVIDED BY FINANCING ACTIVITIES
167

 
238

Effect of exchange rate changes on cash and cash equivalents
1

 
9

NET DECREASE IN CASH AND CASH EQUIVALENTS
(129
)
 
(211
)
Cash and cash equivalents at beginning of period
400

 
579

Cash and cash equivalents at end of period
$
271

 
$
368

The accompanying notes to consolidated financial statements are an integral part of these statements.

2


AVAYA INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

1.
Background, Merger and Basis of Presentation

Background

Avaya Inc. together with its consolidated subsidiaries (collectively, the “Company” or “Avaya”) is a leading global provider of business collaboration and communications solutions. The Company’s solutions are designed to enable business users to work together more effectively as a team internally or with their customers and suppliers, increasing innovation, improving productivity and accelerating decision-making and business outcomes.

Avaya conducts its business operations in three segments. Two of those segments, Global Communications Solutions and Avaya Networking, make up Avaya's Enterprise Collaboration Solutions product portfolio. The third segment contains Avaya’s services portfolio and is called Avaya Global Services.

At the core of the Company’s business is a large and diverse global installed customer base which includes large enterprises, small- and medium-sized businesses and government organizations. Avaya provides solutions in five key business collaboration and communications product and related services categories:
Unified Communications Software, Infrastructure and Endpoints
Real Time Video Collaboration
Contact Center
Data Networking
Applications, including their Integration and Enablement

Avaya sells solutions directly and through its channel partners. As of June 30, 2012, Avaya had approximately 11,000 channel partners worldwide, including system integrators, service providers, value-added resellers and business partners that provide sales and service support.

Merger

On June 4, 2007, Avaya entered into an Agreement and Plan of Merger (the “Merger Agreement”) with Avaya Holdings Corp. (formerly Sierra Holdings Corp.), a Delaware corporation (“Parent”), and Sierra Merger Corp., a Delaware corporation and wholly owned subsidiary of Parent (“Merger Sub”), pursuant to which Merger Sub was merged with and into the Company, with the Company continuing as the surviving corporation and a wholly owned subsidiary of Parent (the “Merger”). Parent was formed by affiliates of two private equity firms, Silver Lake Partners (“Silver Lake”) and TPG Capital (“TPG”) (collectively, the “Sponsors”), solely for the purpose of entering into the Merger Agreement and consummating the Merger. The Merger Agreement provided for a purchase price of $8.4 billion for Avaya’s common stock and was completed on October 26, 2007 pursuant to the terms of the Merger Agreement.

Acquisition of the Enterprise Solutions Business of Nortel Networks Corporation

On December 18, 2009, Avaya acquired certain assets and assumed certain liabilities of the enterprise solutions business (“NES”) of Nortel Networks Corporation (“Nortel”), including all the shares of Nortel Government Solutions Incorporated, for $943 million in cash consideration. The Company and Nortel were required to determine the final purchase price post-closing based upon the various purchase price adjustments included in the acquisition agreements. During the first quarter of fiscal 2011, the Company and Nortel agreed on a final purchase price of $933 million. The terms of the acquisition did not include any significant contingent consideration arrangements.

Acquisition of RADVISION Ltd.

On June 5, 2012, Avaya acquired RADVISION Ltd. (“Radvision”) for $230 million in cash. Radvision is a global provider of videoconferencing and telepresence technologies over internet protocol (“IP”) and wireless networks. These unaudited consolidated financial statements include the operating results of Radvision since June 5, 2012.


3


Basis of Presentation

The consolidated financial statements include the accounts of Avaya Inc. and its subsidiaries. The accompanying unaudited interim consolidated financial statements as of June 30, 2012 and for the three and nine months ended June 30, 2012 and 2011 have been prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”) and the rules and regulations of the U.S. Securities and Exchange Commission (“SEC”) for interim financial statements, and should be read in conjunction with the consolidated financial statements and other financial information for the fiscal year ended September 30, 2011, which were included in the Company’s Annual Report on Form 10-K filed with the SEC on December 9, 2011. The condensed balance sheet as of September 30, 2011 was derived from the Company’s audited financial statements. The significant accounting policies used in preparing these unaudited interim consolidated financial statements are the same as those described in Note 2 to those audited consolidated financial statements except for recently adopted accounting guidance as discussed in Note 2 “Recent Accounting Pronouncements” of these unaudited interim consolidated financial statements. In management’s opinion, these unaudited interim consolidated financial statements reflect all adjustments, consisting of normal and recurring adjustments, necessary for a fair statement of the financial condition, results of operations and cash flows for the periods indicated.

Certain prior period amounts have been reclassified to conform to the current period’s presentation. The consolidated results of operations for the interim periods reported are not necessarily indicative of the results to be experienced for the entire fiscal year.

2.
Recent Accounting Pronouncements

New Accounting Guidance Recently Adopted

Disclosure of Supplementary Pro Forma Information for Business Combinations

In December 2010, the Financial Accounting Standards Board (“FASB”) issued revised guidance which requires that if a company presents pro forma comparative financial statements for business combinations, the company should disclose revenue and earnings of the combined entity as though the business combination(s) that occurred during the current year had occurred as of the beginning of the comparable prior annual reporting period only. This guidance also expands the supplemental pro forma disclosures to include a description of the nature and amount of material, nonrecurring pro forma adjustments directly attributable to the business combination included in the reported pro forma revenue and earnings. This accounting guidance became effective for the Company for business combinations for which the acquisition date was on or after October 1, 2011. The adoption of this guidance did not have a material impact on the Company’s financial statement disclosures.

Goodwill Impairment Test

In December 2010, the FASB issued revised guidance on when a company should perform step two of the goodwill impairment test for reporting units with zero or negative carrying amounts. This guidance requires that for reporting units with zero or negative carrying amounts, a company is required to perform step two of the goodwill impairment test if it is more likely than not that a goodwill impairment exists. In determining whether it is more likely than not that a goodwill impairment exists, an entity should consider whether there are any adverse qualitative factors indicating that an impairment may exist. This accounting guidance became effective for the Company beginning October 1, 2011 and did not have a material impact on the Company’s consolidated financial statements or financial statement disclosures.

Fair Value Measures

In May 2011, the FASB issued revised guidance which is intended to achieve common fair value measurement and disclosure guidance in GAAP and International Financial Reporting Standards. The majority of the changes represent a clarification to existing GAAP. Additionally, the revised guidance includes expanded disclosure requirements. This accounting guidance became effective for the Company beginning in the second quarter of fiscal year 2012 and did not have a material impact on the Company’s consolidated financial statements or financial statement disclosures.

Recent Accounting Guidance Not Yet Effective

In June 2011, the FASB issued revised guidance on the presentation of comprehensive income and its components in the financial statements. As a result of the guidance, companies will now be required to present net income and other comprehensive income either in a single continuous statement or in two separate, but consecutive statements. This standard eliminates the current option to report other comprehensive income and its components in the statement of changes in equity.

4


The standard does not, however, change the items that must be reported in other comprehensive income or the determination of net income. This new guidance is to be applied retrospectively. This accounting guidance is effective for the Company beginning in fiscal year 2013 and is only expected to impact the presentation of the Company’s consolidated financial statements.

In September 2011, the FASB issued revised guidance which requires additional disclosure about an employer’s participation in a multiemployer pension plan. The accounting guidance is effective for the Company as of September 30, 2012 and is to be applied retrospectively for all prior periods presented. This accounting guidance is not expected to have a material impact on the Company’s financial statement disclosures.

In December 2011, the FASB issued guidance which requires additional disclosures about financial instruments and derivative instruments that are either (1) offset in accordance with FASB Accounting Standards Codification (“ASC”) 210-20 “Balance Sheet - Offsetting” or (2) subject to an enforceable master netting arrangement or similar agreement. This accounting guidance is effective for the Company beginning in fiscal year 2014 and is not expected to have a material impact on the Company’s financial statement disclosures.

In September 2011, the FASB issued revised guidance intended to simplify how an entity tests goodwill for impairment. As a result of the guidance, an entity will be allowed to first assess qualitative factors to determine whether it is necessary to perform the two-step quantitative goodwill impairment test. An entity will not be required to calculate the fair value of a reporting unit unless the entity determines, based on a qualitative assessment, that it is more likely than not that its fair value is less than its carrying amount. The accounting guidance is effective for the Company beginning in fiscal year 2013 and early adoption is permitted. This accounting guidance is not expected to have a material impact on the consolidated financial statements or financial statement disclosures.

In July 2012, the FASB issued revised guidance intended to simplify how an entity tests indefinite-lived intangible assets other than goodwill for impairment. As a result of the guidance, an entity will be allowed to first assess qualitative factors to determine whether it is necessary to perform the quantitative impairment test. An entity will not be required to perform the quantitative impairment test unless the entity determines, based on a qualitative assessment, that it is more likely than not that the indefinite-lived asset is impaired. The accounting guidance is effective for the Company beginning in fiscal year 2013. This accounting guidance is not expected to have a material impact on the consolidated financial statements or financial statement disclosures.

3.
Business Combinations

RADVISION Ltd.

On June 5, 2012, Avaya acquired Radvision for $230 million in cash. The purchase price was funded with (i) a capital contribution to Avaya from Parent in the amount of $196 million from the Parent's issuance of Series B preferred stock and warrants to purchase common stock of Parent, and (ii) approximately $34 million of Avaya's cash.

The acquisition of Radvision has been accounted for under the acquisition method, which requires an allocation of the purchase price of the acquired entity to the assets acquired and liabilities assumed based on their estimated fair values from a market-participant perspective at the date of acquisition. The allocation of the purchase price as reflected within these unaudited consolidated financial statements is based on the best information available to management at the time these unaudited consolidated financial statements were issued and is provisional pending the completion of the final valuation analysis of the Radvision assets and liabilities and the completion of an appraisal of the long-lived assets acquired as of the acquisition date, which the Company has partially relied upon. During the measurement period (which is not to exceed one year from the acquisition date), the Company will be required to retrospectively adjust the provisional amounts recognized to reflect new information obtained about facts and circumstances that existed as of the acquisition date that, if known, would have affected the measurement of the amounts recognized as of that date. Further, during the measurement period, the Company is also required to recognize additional assets or liabilities if new information is obtained about facts and circumstances that existed as of the acquisition date that, if known, would have resulted in the recognition of those assets or liabilities as of that date.

The fair values of the assets acquired and liabilities assumed were preliminarily determined using the income, cost and market approaches. The fair value of acquired technologies, trade names and customer relationships were estimated using the income approach which values the subject asset using the projected cash flows to be generated by the asset, discounted at a required rate of return that reflects the relative risk of achieving the cash flow and the time value of money. The cost approach was used to estimate the fair values of property, plant and equipment and reflects the estimated reproduction or replacement costs for the

5


assets, less an allowance for loss in value due to depreciation. The market approach was utilized in combination with the income approach to estimate the fair values of most working capital accounts.
A preliminary allocation of the purchase price to the assets acquired and the liabilities assumed in the Radvision acquisition was performed based on their estimated fair values. As additional information becomes available, differences between the allocation of the purchase price and the allocation of the purchase price when finalized, particularly as it pertains to intangible assets, deferred income taxes and goodwill, may be identified. Intangible assets include acquired technologies of $31 million, trade names of $1 million and customer relationships of $11 million. The acquired technologies, trade names and customer relationships are being amortized over a weighted average useful life of seven years, two years and ten years, respectively, on a straight-line basis. No in-process research and development was acquired in the Radvision acquisition.
The excess of the purchase price over the preliminary assessment of the net tangible and intangible assets acquired resulted in goodwill of $96 million. The premium paid by the Company in the transaction is largely attributable to the acquisition of assembled workforce and the synergies and economies of scale provided to a market participant, particularly as it pertains to marketing efforts and customer base. None of the goodwill is deductible for income tax purposes.
These unaudited consolidated financial statements include the operating results of the Radvision business since June 5, 2012. The revenues and expenses specific to the Radvision business and the pro forma results are not material to these unaudited consolidated financial statements.

Other Acquisitions

During fiscal years 2012 and 2011, the Company completed several other acquisitions primarily to enhance the Company’s technology portfolio.

In October 2011, Parent completed a $31 million acquisition and immediately merged the acquired entity with and into the Company, with the Company surviving the merger. In connection with this acquisition, the Company advanced $8 million to Parent in exchange for a note receivable due October 2014 with interest at 1.63% per annum. The Company recognized $31 million of contributed capital associated with that merger. The aggregate purchase price of the other acquisitions completed by the Company and Parent was $36 million during the nine months ended June 30, 2012.

On January 3, 2011, the Company acquired all outstanding shares of Konftel AB (“Konftel”), for $14 million in cash consideration, inclusive of a working capital adjustment. Konftel is a Swedish-based vendor of conference room terminals, offering analog, internet protocol, soft, cellular, and session initiation protocol terminals.

The acquisitions have been accounted for under the acquisition method. Intangible assets include acquired technologies of $20 million during the nine months ended June 30, 2012. The acquired technologies are being amortized over a weighted average useful life of five years, on a straight-line basis. No in-process research and development was acquired in the acquisitions.

The excess of the purchase price over the preliminary assessment of the net tangible and intangible assets acquired in connection with these other acquisitions during the nine months ended June 30, 2012 resulted in goodwill of $16 million. The premiums paid by the Company and Parent in the transactions are largely attributable to the acquisition of assembled workforces and the synergies and economies of scale provided to a market participant, particularly as it pertains to marketing efforts and customer base. None of the goodwill is deductible for tax purposes.

These unaudited consolidated financial statements include the operating results of the acquired entities since their respective acquisition dates. The revenues and expenses specific to these businesses and their pro forma results are not material to these unaudited consolidated financial statements.

4.
Goodwill and Intangible Assets

Goodwill

Goodwill is not amortized but is subject to periodic testing for impairment in accordance with GAAP at the reporting unit level which is one level below the Company’s operating segments. The test for impairment is conducted annually each September 30th or more frequently if events occur or circumstances change indicating that the fair value of a reporting unit may be below its carrying amount.


6


March 31, 2012

During the three months ended March 31, 2012, the Company experienced a decline in revenue as compared to the same period of the prior year and sequential quarters. This revenue decline has impacted the Company’s forecasts for the remainder of fiscal 2012. As a result of these events, the Company determined that an interim impairment test of its long-lived assets and goodwill should be performed.

The impairment test for goodwill is a two-step process. Step one consists of a comparison of the fair value of a reporting unit with its carrying amount, including the goodwill allocated to that reporting unit. The Company estimated the fair value of each reporting unit using an income approach which values the unit based on the future cash flows expected from that reporting unit. Future cash flows are based on forward-looking information regarding market share and costs for each reporting unit and are discounted using an appropriate discount rate. Future discounted cash flows can be affected by changes in industry or market conditions or the rate and extent to which anticipated synergies or cost savings are realized with newly acquired entities. In step one of the test, a market approach was used as a reasonableness test but was not given significant weighting in the final determination of fair value. The discounted cash flow model used in the Company’s income approach relies on assumptions regarding revenue growth rates, gross margin percentages, projected working capital needs, selling, general and administrative expenses, research and development expenses, business restructuring costs, capital expenditures, income tax rates, discount rates and terminal growth rates. To estimate fair value, the Company discounts the expected cash flows of each reporting unit. The discount rate Avaya uses represents the estimated weighted average cost of capital, which reflects the overall level of inherent risk involved in its reporting unit operations and the rate of return an outside investor would expect to earn. To estimate cash flows beyond the final year of its model, Avaya uses a terminal value approach. Under this approach, Avaya uses the estimated cash flows in the final year of its models and applies a perpetuity growth assumption and discount by a perpetuity discount factor to determine the terminal value. Avaya incorporates the present value of the resulting terminal value into its estimate of fair value.

The Company forecasted cash flows for each of its reporting units and took into consideration the then current economic conditions and trends, estimated future operating results, Avaya’s view of growth rates and anticipated future economic conditions. Revenue growth rates inherent in this forecast were based on input from internal and external market intelligence research sources that compare factors such as growth in global economies, regional trends in the telecommunications industry and product evolution from a technological segment basis. Economic factors such as changes in economies, product evolutions, industry consolidations and other changes beyond Avaya’s control could have a positive or negative impact on achieving its targets.

These valuations reflect the additional market risks, lower discount rates and the updated sales forecasts for the Company’s reporting units based off recent results. Specifically, the valuations at March 31, 2012 and September 30, 2011, were prepared assuming, among other things, discount rates of 11.5% and 12% and long-term growth rates of 3% and 3%, respectively. These key assumptions, along with other assumptions for lower short-term revenue growth rates, increased restructuring charges and changes in other operating costs and expenses resulted in lower estimated values for the Company’s reporting units. The adverse effect of these changes in assumptions was further compounded for the remainder of fiscal year 2012 and beyond, as the growth rate assumptions were applied to the Company’s actual results through March 31, 2012, which were below the levels estimated in September 2011. The Company does not believe that the historical results for the six months ended March 31, 2012 are indicative of its future operating results.

Using the revised valuations at March 31, 2012 and the valuation approach described above, the results of step one of the goodwill impairment test indicated that although the estimated fair values of each reporting unit were lower at March 31, 2012 when compared to September 30, 2011, their respective book values did not exceed their estimated fair values and therefore no impairment existed.

June 30, 2012 and 2011

The Company determined that no events occurred or circumstances changed during the three months ended June 30, 2012 that would indicate that the fair value of a reporting unit may be below its carrying amount. However, if market conditions continue to deteriorate, or if the Company is unable to execute on its cost reduction efforts and other strategies, it may be necessary to record impairment charges in the future.

The Company determined that no events occurred or circumstances changed during the nine months ended June 30, 2011 that would indicate that the fair value of a reporting unit may be below its carrying amount.


7


Intangible Assets

Intangible assets include acquired technology, customer relationships, trademarks and trade-names and other intangibles. Intangible assets with finite lives are amortized using the straight-line method over the estimated economic lives of the assets, which range from five years to fifteen years.

Acquired technology and patents do not include capitalized software development costs. Unamortized capitalized software developments costs of $58 million at June 30, 2012 and $58 million at September 30, 2011 are included in other assets.

Long-lived assets, including intangible assets with finite lives, are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of such assets may not be recoverable. Intangible assets determined to have indefinite useful lives are not amortized but are tested for impairment annually, or more frequently if events or changes in circumstances indicate the asset may be impaired.

The Company’s trademarks and trade names are expected to generate cash flow indefinitely. Consequently, these assets are classified as indefinite-lived intangibles.

March 31, 2012

Prior to the goodwill testing discussed above, the Company tested its intangible assets with indefinite lives and other long-lived assets as of March 31, 2012. Using the revised forecasts as of March 31, 2012, the Company performed step one of the impairment test of long-lived assets with finite lives. Although the revised forecasts provided for lower cash flows, in each case the revised undiscounted cash flows for each asset group were in excess of their respective net book values and therefore no impairment was identified. GAAP requires that the fair value of intangible assets with indefinite lives be compared to the carrying value of those assets. In situations where the carrying value exceeds the fair value of the intangible asset, an impairment loss equal to the difference is recognized. The Company estimates the fair value of its indefinite-lived intangible assets using an income approach; specifically, based on discounted cash flows. Although the estimated fair values of the Company’s tradenames and trademarks were lower at March 31, 2012 when compared to September 30, 2011, their respective book values did not exceed their estimated fair values and therefore no impairment existed.

June 30, 2012 and 2011

The Company determined that no events occurred or circumstances changed during the three months ended June 30, 2012 that would indicate that its intangible assets with indefinite lives and other long-lived assets may be impaired. However, if market conditions continue to deteriorate, it may be necessary to record impairment charges in the future.

The Company determined that no events occurred or circumstances changed during the nine months ended June 30, 2011 that would indicate that its intangible assets with indefinite lives and other long-lived assets may be impaired.

8



5.
Supplementary Financial Information

Consolidated Statements of Operations Information

  
Three months ended
June 30,
 
Nine months ended
June 30,
In millions
2012
 
2011
 
2012
 
2011
OTHER INCOME (EXPENSE), NET
 
 
 
 
 
 
 
Interest income
$
1

 
$
1

 
$
3

 
$
3

Gain (loss) on foreign currency transactions
5

 
(2
)
 
(7
)
 
7

Costs incurred in connection with debt modification

 

 

 
(9
)
Other, net

 

 
(3
)
 
(1
)
Total other income (expense), net
$
6

 
$
(1
)
 
$
(7
)
 
$

COMPREHENSIVE LOSS
 
 
 
 
 
 
 
Net loss
$
(166
)
 
$
(152
)
 
$
(354
)
 
$
(764
)
Other comprehensive income (loss):
 
 
 
 
 
 
 
Pension, postretirement and postemployment benefit-related items, net of tax benefit of $(18) and $0 for the three and nine months ended June 30, 2012 and $5 and $18 for the three and nine months ended June 30, 2011
(103
)
 
10

 
(75
)
 
28

Cumulative translation adjustment
13

 
(2
)
 
28

 
(23
)
Unrealized gain (loss) on term loan interest rate swap, net of tax benefit of $4 and $0 for the three and nine months ended June 30, 2012 and tax benefit of $4 and tax of $8 for the three and nine months ended June 30, 2011
9

 
(5
)
 
15

 
13

Unrealized loss on investments reclassified into earnings, net of tax of $0 for the three and nine months ended June 30, 2012 and $0 for the three and nine months ended June 30, 2011
(1
)
 
(1
)
 
2

 

Unrealized loss on investments, net of tax benefit of $2 and $0 for the three and nine months ended June 30, 2012 and $0 for the three and nine months ended June 30, 2011
2

 

 
2

 

Total comprehensive loss
$
(246
)
 
$
(150
)
 
$
(382
)
 
$
(746
)

6.
Business Restructuring Reserve and Programs

Fiscal 2012 Restructuring Program

During the first nine months of fiscal 2012, the Company continued to identify opportunities to streamline operations and generate cost savings which include exiting facilities and eliminating employee positions. Restructuring charges associated with these initiatives include employee separation costs primarily associated with employee severance actions in Germany, as well as the US, Europe, Middle East and Africa (“EMEA”) excluding Germany, and Canada. Employee separation charges included $70 million related to an agreement reached with the German Works Council representing employees of certain Avaya subsidiaries for the elimination of 327 positions. The headcount reductions identified in this action are expected to be completed in fiscal 2013 with the related payments to be completed in fiscal 2014. The payments include, but are not limited to, social pension fund payments and health care and unemployment insurance costs to be paid to or on behalf of the affected employees. The payments related to the headcount reductions for the other actions taken, globally, excluding Germany, are expected to be completed in fiscal 2014. As the Company continues to evaluate and identify additional operational synergies, additional cost saving opportunities may be identified.

The Company has initiated a plan to dispose of a Company owned facility in Munich, Germany and relocate to a new facility.  Accordingly, the Company has written the value of this asset down to its net realizable value of $4 million and has reclassified this asset as held for sale.  Included in restructuring and impairment charges, net in the Statement of Operations is an

9


impairment charge of $4 million for the three and nine months ended June 30, 2012.

The following table summarizes the components of the fiscal 2012 restructuring program during the nine months ended June 30, 2012:

 
In millions
Employee
Separation
Costs
 
Lease
Obligations
 
Total
2012 restructuring charges
$
112

 
$
13

 
$
125

Cash payments
(32
)
 
(2
)
 
(34
)
Impact of foreign currency fluctuations
(4
)
 

 
(4
)
Balance as of June 30, 2012
$
76

 
$
11

 
$
87


Fiscal 2011 Restructuring Program

During fiscal 2011, the Company identified opportunities to streamline operations and generate cost savings which included exiting facilities and eliminating employee positions. Restructuring charges associated with these initiatives included employee separation costs primarily associated with employee severance actions in Germany, as well as other EMEA countries and the U.S. Employee separation charges included $56 million associated with an agreement reached with the German Works Council representing employees of certain of Avaya’s German subsidiaries for the elimination of 210 employee positions. Severance and employment benefits payments associated with this program are expected to be completed in fiscal 2014, and include, but are not limited to, social pension fund payments and health care and unemployment insurance costs to be paid to or on behalf of the affected employees. Future rental payments, net of estimated sublease income, related to operating lease obligations for unused space in connection with the closing or consolidation of facilities are expected to continue through fiscal year 2020.

The following table summarizes the components of the fiscal 2011 restructuring program during the nine months ended June 30, 2012:
 
In millions
Employee
Separation
Costs
 
Lease
Obligations
 
Total
Balance as of October 1, 2011
$
101

 
$
24

 
$
125

Cash payments
(87
)
 
(5
)
 
(92
)
Adjustments (1)
(1
)
 
1

 

Impact of foreign currency fluctuations
(1
)
 
(2
)
 
(3
)
Balance as of June 30, 2012
$
12

 
$
18

 
$
30

 
(1) 
Included in adjustments are changes in estimates, whereby all increases and decreases in costs related to the fiscal 2011 restructuring program are recorded to the restructuring charges line item in operating expenses in the period of the adjustment.

Fiscal 2010 Restructuring Program

The following table summarizes the components of the fiscal 2010 restructuring program during the nine months ended June 30, 2012:
 
In millions
Employee
Separation
Costs
 
Lease
Obligations
 
Total
Balance as of October 1, 2011
$
5

 
$
14

 
$
19

Cash payments
(6
)
 
(6
)
 
(12
)
Adjustments
1

 
1

 
2

Impact of foreign currency fluctuations

 
1

 
1

Balance as of June 30, 2012
$

 
$
10

 
$
10


10



Fiscal 2009 Restructuring Program

The following table summarizes the components of the fiscal 2009 restructuring program during the nine months ended June 30, 2012:
 
In millions
Employee
Separation
Costs
 
Lease
Obligations
 
Total
Balance as of October 1, 2011
$
3

 
$
3

 
$
6

Cash payments
(3
)
 
(1
)
 
(4
)
Adjustments 
1

 

 
1

Balance as of June 30, 2012
$
1

 
$
2

 
$
3

 
Fiscal 2008 Restructuring Reserve

The following table summarizes the components of this reserve during the nine months ended June 30, 2012:
 
In millions
Employee
Separation
Costs
 
Lease
Obligations
 
Total
Balance as of October 1, 2011
$
6

 
$
30

 
$
36

Cash payments

 
(3
)
 
(3
)
Adjustments (1)
(1
)
 
(2
)
 
(3
)
Impact of foreign currency fluctuations
(1
)
 

 
(1
)
Balance as of June 30, 2012
$
4

 
$
25

 
$
29

 
(1) 
Included in adjustments are changes in estimates, whereby all increases in costs related to the fiscal 2008 restructuring program are recorded to the restructuring charges line item in operating expenses in the period of the adjustment and decreases in costs are recorded as adjustments to goodwill, as these reserves relate to actions taken prior to the Company’s adoption of ASC 805, “Business Combinations.”

7.
Financing Arrangements

In connection with the Merger, on October 26, 2007, the Company entered into financing arrangements consisting of a senior secured credit facility, a senior unsecured credit facility, which later became senior unsecured notes, and a senior secured multi-currency asset-based revolving credit facility. On February 11, 2011, the Company amended and extended its senior secured credit facility and issued senior secured notes, the proceeds of which were used to repay the senior secured incremental term B-2 loans in full under the Company’s senior secured credit facility and related fees and expenses. Long-term debt consists of the following:
 
In millions
June 30,
2012
 
September 30,
2011
Senior secured term B-1 loans
$
1,438

 
$
1,449

Senior secured term B-3 loans
2,149

 
2,165

Senior secured notes
1,009

 
1,009

9.75% senior unsecured cash pay notes due 2015
700

 
700

10.125%/10.875% senior unsecured PIK toggle notes due 2015
834

 
834

 
6,130

 
6,157

Debt maturing within one year
(37
)
 
(37
)
Long-term debt
$
6,093

 
$
6,120



11


Senior Secured Credit Facility

Prior to refinancing on February 11, 2011, the senior secured credit facility consisted of (a) a senior secured multi-currency revolver allowing for borrowings of up to $200 million, (b) a $3,800 million senior secured term loan (the “term B-1 loans”), which was drawn in full on the closing date of the Merger, and (c) a $1,000 million incremental senior secured term loan (the “incremental term B-2 loans”), which was drawn in full at an original issue discount of 20.0% on December 18, 2009 to finance the acquisition of NES.

On February 11, 2011, the Company amended and restated the senior secured credit facility to reflect modifications to certain provisions thereof. The modified terms of the senior secured credit facility include (1) an amendment which allowed the Company to extend the maturity of a portion of the term B-1 loans representing outstanding principal amounts of $2.2 billion from October 26, 2014 to October 26, 2017 (potentially springing to July 26, 2015, under the circumstances described below) by converting such loans into a new tranche of senior secured B-3 loans (the “term B-3 loans”); (2) permission, at the election of the Company, to apply prepayments of term loans to the incremental term B-2 loans prior to the term B-1 loans and term B-3 loans and thereafter to the class of term loans with the next earliest maturity; (3) permission to issue indebtedness (including the senior secured notes described below) to refinance a portion of the term loans under the senior secured credit facility and to secure such indebtedness (including the senior secured notes) on a pari passu basis with the obligations under the senior secured credit facility, (4) permission for future refinancing of the term loans under the senior secured credit facility, and (5) permission for future extensions of the term loans and revolving credit commitments (including, in the case of the revolving credit commitments, by obtaining new revolving credit commitments) under the senior secured credit facility.

The new tranche of term B-3 loans bears interest at a rate per annum equal to either a base rate or a LIBOR rate, in each case plus an applicable margin. The base rate is determined by reference to the higher of (1) the prime rate of Citibank, N.A. and (2) the federal funds effective rate plus 1/2 of 1%. The applicable margin for borrowings of term B-3 loans is 3.50% per annum with respect to base rate borrowings and 4.50% per annum with respect to LIBOR borrowings. No changes were made to the maturity date or interest rates payable with respect to the non-extended term B-1 loans described above.

The maturity of the term B-3 loans will automatically become due July 26, 2015 unless (i) the total net leverage ratio as tested on that date based upon the most recent financial statements provided to the lenders under the senior secured credit facility is no greater than 5.0 to 1.0 or (ii) on or prior to such date, either (x) an initial public offering of Parent shall have occurred or (y) at least $750 million in aggregate principal amount of the Company’s senior unsecured cash-pay notes and/or senior unsecured paid-in-kind (“PIK”) toggle notes have been repaid or refinanced or their maturity has been extended to a date no earlier than 91 days after October 26, 2017.

The amendment and restatement of the senior secured credit facility represents a debt modification for accounting purposes. Accordingly, third party expenses of $9 million incurred in connection with the transaction were expensed as incurred and included in other income, net during the nine months ended June 30, 2011. Avaya’s financing sources that held term B-1 loans and/or revolving credit commitments under the senior secured credit facility and consented to the amendment and restatement of the senior secured credit facility received in aggregate a consent fee of $10 million. Fees paid to or on behalf of the creditors in connection with the modification were recorded as a discount to the face value of the debt and are being accreted over the term of the debt as interest expense.

Additionally, as discussed more fully below, on February 11, 2011, the Company completed a private placement of $1,009 million of senior secured notes, the proceeds of which were used to repay in full the incremental term B-2 loans outstanding under the Company’s senior secured credit facility.

Funds affiliated with Silver Lake and TPG were holders of incremental term B-2 loans. Similar to other holders of senior secured incremental term B-2 loans, those senior secured incremental term B-2 loans held by affiliates of TPG and Silver Lake were repaid in connection with the issuance of the senior secured notes.

The senior secured multi-currency revolver, which allows for borrowings of up to $200 million, was not impacted by the refinancing. The senior secured multi-currency revolver includes capacity available for letters of credit and for short-term borrowings, and is available in euros in addition to dollars. Borrowings are guaranteed by Parent and substantially all of the Company’s U.S. subsidiaries. The senior secured facility, consisting of the term loans and the senior secured multi-currency revolver referenced above, is secured by substantially all assets of Parent, the Company and the subsidiary guarantors.

On August 8, 2011, the Company amended the terms of the senior secured multi-currency revolver to extend the final maturity from October 26, 2013 to October 26, 2016. All other terms and conditions of the senior secured credit facility remain unchanged. As of June 30, 2012 there were no amounts outstanding under the senior secured multi-currency revolver.

12



As a result of the refinancing transaction, the term loans outstanding under the senior secured credit facility include term B-1 loans and term B-3 loans with remaining face values as of June 30, 2012 (after all principal payments to date) of $1,438 million and $2,157 million, respectively. The Company is required to make scheduled quarterly principal payments under the term B-1 loans and the term B-3 loans, equal to $10 million in the aggregate.

As of June 30, 2012 affiliates of Silver Lake held $46 million and $122 million in outstanding principal amounts of term B-1 loans and term B-3 loans, respectively. As of September 30, 2011 affiliates of Silver Lake held $54 million and $123 million in outstanding principal amounts of term B-1 loans and term B-3 loans, respectively.

As of June 30, 2012 affiliates of TPG held $44 million in outstanding principal amounts of term B-1 loans. As of September 30, 2011 affiliates of TPG held $119 million in outstanding principal amounts of term B-1 loans.

Senior Unsecured Notes

The Company has issued $700 million of senior unsecured cash-pay notes and $750 million of senior unsecured PIK toggle notes, each due November 1, 2015. The interest rate for the cash-pay notes is fixed at 9.75% and the interest rates for the cash interest and PIK interest portions of the PIK-toggle notes are fixed at 10.125% and 10.875%, respectively. The Company may prepay the senior unsecured notes at 102.4375% of the cash-pay note and 102.5313% of the PIK-toggle note principal amount redeemed on November 1, 2012 which decreases to 100% of each on or after November 1, 2013. Upon the occurrence of specific kinds of changes of control, the Company will be required to make an offer to purchase the senior unsecured notes at 101% of their principal amount. If the Company or any of its restricted subsidiaries engages in certain asset sales, under certain circumstances the Company will be required to use the net proceeds to make an offer to purchase the senior unsecured notes at 100% of their principal amount. Substantially all of the Company’s U.S. 100%-owned subsidiaries are guarantors of the senior unsecured notes.

For the periods May 1, 2009 through October 31, 2009 and November 1, 2009 through April 30, 2010, the Company elected to pay interest in kind on its senior PIK toggle notes. PIK interest of $41 million and $43 million was added, for these periods, respectively, to the principal amount of the senior unsecured notes effective November 1, 2009 and May 1, 2010, respectively, and will be payable when the senior unsecured notes become due. For the periods from May 1, 2010 to October 31, 2011 the Company elected to make such payments in cash interest. Under the terms of these notes, after November 1, 2011 the Company is required to make all interest payments on the senior unsecured PIK toggle notes entirely in cash.

Senior Secured Asset-Based Credit Facility

The Company’s senior secured multi-currency asset-based revolving credit facility allows for borrowings of up to $335 million, subject to availability under a borrowing base, of which $150 million may be in the form of letters of credit. The borrowing base at any time equals the sum of 85% of eligible accounts receivable plus 85% of the net orderly liquidation value of eligible inventory, subject to certain reserves and other adjustments. The Company and substantially all of its U.S. subsidiaries are borrowers under this facility, and borrowings are guaranteed by Parent, the Company and substantially all of the Company’s U.S. subsidiaries. The facility is secured by substantially all assets of Parent, the Company and the subsidiary guarantors. The senior secured multi-currency asset-based revolving credit facility also provides the Company with the right to request up to $100 million of additional commitments under this facility.

On August 8, 2011, the Company amended the terms of its senior secured multi-currency asset-based revolving credit facility to extend its final maturity from October 26, 2013 to October 26, 2016. All other terms and conditions of the senior secured multi-currency asset-based revolving credit facility remain unchanged.

In connection with the acquisition of Radvision, the Company borrowed $60 million under its senior secured asset-based credit facility. Following the completion of the acquisition, all amounts borrowed were repaid in full. Borrowings under the senior secured multi-currency asset-based revolving credit facility bear interest at a rate per annum equal to, at the Company's option, either (a) a LIBOR rate plus a margin of 1.50% or (b) a base rate plus a margin of 0.50%. The interest rate election made was the base rate.
At June 30, 2012 and September 30, 2011, there were no borrowings under this facility. At June 30, 2012 and September 30, 2011 there were $75 million and $75 million, respectively, of letters of credit issued in the ordinary course of business under the senior secured asset-based credit facility resulting in remaining availability of $225 million and $252 million, respectively.


13


Senior Secured Notes

On February 11, 2011, the Company completed a private placement of $1,009 million of senior secured notes. The senior secured notes were issued at par, bear interest at a rate of 7% per annum and mature on April 1, 2019. The senior secured notes were sold through a private placement to qualified institutional buyers pursuant to Rule 144A (and outside the United States in reliance on Regulation S) under the Securities Act of 1933, as amended (the “Securities Act”) and have not been, and will not be, registered under the Securities Act or applicable state securities laws.

The Company may redeem the senior secured notes commencing April 1, 2015 at 103.5% of the principal amount redeemed, which decreases to 101.75% on April 1, 2016 and to 100% on or after April 1, 2017. The Company may redeem all or part of the notes at any time prior to April 1, 2015 at 100% of the principal amount redeemed plus a “make-whole” premium. In addition, the Company may redeem up to 35% of the original aggregate principal balance of the senior secured notes at any time prior to April 1, 2014 with the net proceeds of certain equity offerings at 107% of the aggregate principal amount of senior secured notes redeemed. Upon the occurrence of specific kinds of changes of control, the Company will be required to make an offer to purchase the senior secured notes at 101% of their principal amount. If the Company or any of its restricted subsidiaries engages in certain asset sales, under certain circumstances the Company will be required to use the net proceeds to make an offer to purchase the senior secured notes at 100% of their principal amount.

Substantially all of the Company’s U.S. 100%-owned subsidiaries are guarantors of the senior secured notes. The senior secured notes are secured by substantially all of the assets of the Company and the subsidiary guarantors.

The proceeds from the senior secured notes were used to repay in full the senior secured incremental term B-2 loans outstanding under the Company’s senior secured credit facility (representing $988 million in aggregate principal amount and $12 million in accrued and unpaid interest) and to pay related fees and expenses.

The issuance of the senior secured notes and repayment of the incremental term B-2 loans was accounted for as an extinguishment of the incremental term B-2 loans and issuance of new debt. Accordingly, the difference between the reacquisition price of the incremental term B-2 loans (including consent fees paid by Avaya to the holders of the incremental term B-2 loans that consented to the amendment and restatement of the senior secured credit facility of $1 million) and the carrying value of the incremental term B-2 loans (including unamortized debt discount and debt issue costs) of $246 million was recognized as a loss upon debt extinguishment during the nine months ended June 30, 2011. In connection with the issuance of the senior secured notes, the Company capitalized financing costs of $23 million during fiscal 2011 and is amortizing these costs over the term of the senior secured notes.

The Company’s senior secured credit facility, senior secured multi-currency asset-based revolving credit facility, and indentures governing its senior secured notes, senior unsecured cash-pay notes and senior unsecured PIK toggle notes contain a number of covenants that, among other things and subject to certain exceptions, restrict the Company’s ability and the ability of certain of its subsidiaries to: (a) incur or guarantee additional debt and issue or sell certain preferred stock; (b) pay dividends on, redeem or repurchase capital stock; (c) make certain acquisitions or investments; (d) incur or assume certain liens; (e) enter into transactions with affiliates; (f) merge or consolidate with another company; (g) transfer or otherwise dispose of assets; (h) redeem subordinated debt; (i) incur obligations that restrict the ability of the Company’s subsidiaries to make dividends or other payments to the Company or Parent; and (j) create or designate unrestricted subsidiaries. They also contain customary affirmative covenants and events of default.

As of June 30, 2012 and September 30, 2011, the Company was not in default under its senior secured credit facility, the indenture governing its senior secured notes, the indenture governing its senior unsecured notes or its senior secured multi-currency asset-based revolving credit facility.

The weighted average interest rate of the Company’s outstanding debt as of June 30, 2012 was 6.1% excluding the impact of the interest rate swaps described in Note 8, “Derivatives and Other Financial Instruments”.


14


Annual maturities of long-term debt for the next five years ending September 30 and thereafter consist of:
 
In millions
 
Remainder of fiscal 2012
$
10

2013
38

2014
38

2015
1,442

2016
1,542

2017 and thereafter
3,068

Total
$
6,138


Capital Lease Obligations

Included in other liabilities at June 30, 2012 is $21 million of capital lease obligations, primarily associated with an office facility.

8.
Derivatives and Other Financial Instruments

Interest Rate Swaps

The Company uses interest rate swaps to manage the amount of its floating rate debt in order to reduce its exposure to variable rate interest payments associated with certain borrowings under the senior secured credit facility. The interest rate swaps presented below are designated as cash flow hedges. The fair value of each interest rate swap is reflected as an asset or liability in the Consolidated Balance Sheets, reported as a component of other comprehensive loss and reclassified to earnings in the same period or periods during which the hedged transaction affects earnings. Gains and losses on derivative instruments representing hedge ineffectiveness are recognized in current earnings. The fair value of each interest rate swap is estimated as the net present value of their projected cash flows at the balance sheet date.

The details of these swaps are as follows:
 
In millions
 
Effective Date
 
Maturity Date
 
Notional
Amount
 
Floating Rate
Received by Avaya
 
Fixed Rate
Paid by Avaya
5-year swap
 
November 26, 2007
 
November 26, 2012
 
$
300

 
3-month LIBOR
 
4.591
%
3-year swap
 
August 26, 2010
 
August 26, 2013
 
750

 
3-month LIBOR
 
1.160
%
3-year swap
 
August 26, 2010
 
August 26, 2013
 
750

 
3-month LIBOR
 
1.135
%
Notional amount—Total
 
 
 
$
1,800

 
 
 
 

The following table summarizes the (gains) and losses of the interest rate contracts qualifying and designated as cash flow hedging instruments:
 
  
Three months ended
June 30,
 
Nine months ended
June 30,
In millions
2012
 
2011
 
2012
 
2011
(Gain) Loss on interest rate swaps
 
 
 
 
 
 
 
Recognized in other comprehensive loss
$
(5
)
 
$
9

 
$
(15
)
 
$
(21
)
Reclassified from accumulated other comprehensive loss into interest expense
$
6

 
$
8

 
$
19

 
$
33

Recognized in operations (ineffective portion)
$

 
$

 
$

 
$


The Company expects to reclassify approximately $14 million from accumulated other comprehensive loss into expense in the next twelve months related to the Company’s interest rate swaps based on the projected borrowing rates as of June 30, 2012.


15


Foreign Currency Forward Contracts

The Company utilizes foreign currency forward contracts primarily to manage short-term exchange rate exposures on certain receivables, payables and intercompany loans residing on foreign subsidiaries’ books, which are denominated in currencies other than the subsidiary’s functional currency. When those items are revalued into the subsidiaries’ functional currencies at the month-end exchange rates, the fluctuations in the exchange rates are recognized in the Consolidated Statements of Operations as other income (expense), net. Changes in the fair value of the Company’s foreign currency forward contracts used to offset these exposed items are also recognized in the Consolidated Statements of Operations as other income (expense), net in the period in which the exchange rates change.

The gains and (losses) of the foreign currency forward contracts included in other income (expense), net were $(2) million and $1 million for the three months ended June 30, 2012 and 2011, respectively, and $(7) million and $(2) million for the nine months ended June 30, 2012 and 2011, respectively.

The following table summarizes the estimated fair value of derivatives:
 
In millions
June 30, 2012
 
September 30, 2011
Balance Sheet Location
Total
 
Foreign
Currency
Forward
Contracts
 
Interest
Rate
Swaps
 
Total
 
Foreign
Currency
Forward
Contracts
 
Interest
Rate
Swaps
Other current assets
$
1

 
$
1

 
$

 
$
1

 
$
1

 
$

Other current liabilities
(16
)
 

 
(16
)
 
(26
)
 
(2
)
 
(24
)
Other non-current liabilities
(2
)
 

 
(2
)
 
(10
)
 

 
(10
)
Net Liability
$
(17
)
 
$
1

 
$
(18
)
 
$
(35
)
 
$
(1
)
 
$
(34
)

9.
Fair Value Measures

Pursuant to the accounting guidance for fair value measurements and its subsequent updates, fair value is defined as the price that would be received from selling an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. When determining the fair value measurements for assets and liabilities required or permitted to be recorded at fair value, the Company considers the principal or most advantageous market in which it would transact and it considers assumptions that market participants would use when pricing the asset or liability.

Fair Value Hierarchy

The accounting guidance for fair value measurements also requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. A financial instrument’s categorization within the fair value hierarchy is based upon the lowest level of input that is significant to the fair value measurement. The inputs are prioritized into three levels that may be used to measure fair value:
Level 1: Inputs that reflect quoted prices for identical assets or liabilities in active markets that are observable.
Level 2: Inputs that reflect quoted prices for similar assets or liabilities in active markets; quoted prices for identical or similar assets or liabilities in markets that are not active; or model-derived valuations in which significant inputs are observable or can be derived principally from, or corroborated by, observable market data.
Level 3: Inputs that are unobservable to the extent that observable inputs are not available for the asset or liability at the measurement date.


16


Asset and Liabilities Measured at Fair Value on a Recurring Basis

Assets and liabilities measured at fair value on a recurring basis as of June 30, 2012 and September 30, 2011 were as follows:
 
 
June 30, 2012
 
Fair Value Measurements Using
In millions
Total
 
Quoted Prices in 
Active Markets
for Identical
Instruments
(Level 1)
 
Significant
Other
Observable
Inputs
(Level 2)
 
Significant
Unobservable
Inputs
(Level 3)
Other Current Assets:
 
 
 
 
 
 
 
Foreign currency forward contracts
$
1

 
$

 
$
1

 
$

Investments
1

 
1

 

 

 
$
2

 
$
1

 
$
1

 
$

Other Non-Current Assets:
 
 
 
 
 
 
 
Investments
$
6

 
$
4

 
$
2

 
$

Other Current Liabilities:
 
 
 
 
 
 
 
Interest rate swaps
$
16

 
$

 
$
16

 
$

Other Non-Current Liabilities:
 
 
 
 
 
 
 
Interest rate swaps
$
2

 
$

 
$
2

 
$


 
September 30, 2011
 
Fair Value Measurements Using
In millions
Total
 
Quoted Prices in
Active Markets
for Identical
Instruments
(Level 1)
 
Significant
Other
Observable
Inputs
(Level 2)
 
Significant
Unobservable
Inputs
(Level 3)
Other Current Assets:
 
 
 
 
 
 
 
Foreign currency forward contracts
$
1

 
$

 
$
1

 
$

Other Non-Current Assets:
 
 
 
 
 
 
 
Investments
$
11

 
$
9

 
$
2

 
$

Other Current Liabilities:
 
 
 
 
 
 
 
Foreign currency forward contracts
$
2

 
$

 
$
2

 
$

Interest rate swaps
24

 

 
24

 

 
$
26

 
$

 
$
26

 
$

Other Non-Current Liabilities:
 
 
 
 
 
 
 
Interest rate swaps
$
10

 
$

 
$
10

 
$


Interest Rate Swaps

Interest rate swaps classified as Level 2 assets and liabilities are priced using discounted cash flow techniques which are corroborated by using non-binding market prices. Significant inputs to the discounted cash flow model include projected future cash flows based on projected 3-month LIBOR rates, and the average margin for companies with similar credit ratings and similar maturities. These are classified as Level 2 as they are not actively traded and are valued using pricing models that use observable market inputs.

Foreign Currency Forward Contracts

Foreign currency forward contracts classified as Level 2 assets and liabilities are priced using quoted market prices for similar assets or liabilities in active markets.


17


Investments

Investments classified as Level 2 assets and liabilities are priced using quoted market prices for identical assets which are subject to infrequent transactions (i.e. a less active market).

Fair Value of Financial Instruments

The fair values of cash and cash equivalents, accounts receivable, accounts payable and accrued expenses, to the extent the underlying liability will be settled in cash, approximate carrying values because of the short-term nature of these instruments.

In connection with an acquisition completed by Parent in October 2011, the Company advanced $8 million to Parent in exchange for a note receivable. The note receivable is due October 2014 with interest at 1.63% per annum and is included in other assets in the Company’s Consolidated Balance Sheet. The estimated fair value of the note receivable at June 30, 2012 was $6 million and was determined based on a Level 2 input using discounted cash flow techniques.

The estimated fair values of the amounts borrowed under the Company’s financing arrangements at June 30, 2012 and September 30, 2011 were estimated based on a Level 2 input using quoted market prices for the Company’s debt which is subject to infrequent transactions (i.e. a less active market).

The estimated fair values of the amounts borrowed under the Company’s credit agreements at June 30, 2012 and September 30, 2011 are as follows:

 
June 30, 2012
 
September 30, 2011
In millions
Carrying
Amount
 
Fair
Value
 
Carrying
Amount
 
Fair
Value
Senior secured term B-1 loans
$
1,438

 
$
1,354

 
$
1,449

 
$
1,298

Senior secured term B-3 loans
2,149

 
1,910

 
2,165

 
1,833

Senior secured notes
1,009

 
934

 
1,009

 
854

9.75% senior unsecured cash pay notes due 2015
700

 
581

 
700

 
511

10.125%/10.875% senior unsecured PIK toggle notes due 2015
834

 
696

 
834

 
612

Total
$
6,130

 
$
5,475

 
$
6,157

 
$
5,108


10.
Income Taxes

The provision for income taxes for the three months ended June 30, 2012 was $88 million, as compared to the benefit from income taxes of $52 million for the three months ended June 30, 2011. The effective tax rate for the three months ended June 30, 2012 was 112.8% as compared to the effective rate of 25.5% for the three months ended June 30, 2011, and differs from the U.S. Federal tax rate primarily due to the effect of taxable income in non-U.S. jurisdictions and due to the valuation allowance established against the Company’s U.S. deferred tax assets.

The provision for income taxes for the nine months ended June 30, 2012 was $62 million, as compared to the benefit from income taxes of $11 million for the nine months ended June 30, 2011. The effective tax rate for the nine months ended June 30, 2012 was 21.2% as compared to the effective rate of 1.4% for the nine months ended June 30, 2011, and differs from the U.S. Federal tax rate primarily due to the effect of taxable income in non-U.S. jurisdictions and due to the valuation allowance established against the Company’s U.S. deferred tax assets.

For interim financial statement purposes, U.S. GAAP income tax expense related to ordinary income is determined by applying an estimated annual effective income tax rate against the Company's ordinary income. Income tax expense related to items not characterized as ordinary income is recognized as a discrete item when incurred. The estimation of the Company's annual effective income tax rate requires the use of management forecasts and other estimates, projection of jurisdictional taxable income and losses, statutory income tax rates, and valuation allowances. The Company's estimated annual effective income tax rate may be revised, if necessary, in each interim period during the fiscal year.

18



11.
Benefit Obligations

The Company sponsors non-contributory defined benefit pension plans covering a portion of its U.S. employees and retirees, and postretirement benefit plans for U.S. retirees that include healthcare benefits and life insurance coverage. The Company froze benefit accruals and additional participation in the pension and postretirement plan for its U.S. management employees effective December 31, 2003. Effective October 12, 2011 and November 18, 2011, the Company entered into a two-year contract extension with the Communications Workers of America (“CWA”) and the International Brotherhood of Electrical Workers (“IBEW”), respectively. With the contract extension, the contracts with the CWA and IBEW now terminate on June 7, 2014. The contract extension did not affect the level of pension and postretirement benefits available to U.S. employees of the Company who are represented by the CWA or IBEW (“represented employees”).
Certain non-U.S. operations have various retirement benefit programs covering substantially all of their employees. Some of these programs are considered to be defined benefit pension plans for accounting purposes.
 
The components of the pension and postretirement net periodic benefit cost for the three and nine months ended June 30, 2012 and 2011 are provided in the table below:
 
 
Pension Benefits  -
U.S.
 
Pension Benefits -
Non-U.S.
 
Postretirement
Benefits - U.S.
 
Three months ended
June 30,
 
Three months ended
June 30,
 
Three months ended
June 30,
In millions
2012
 
2011
 
2012
 
2011
 
2012
 
2011
Components of Net Periodic Benefit Cost
 
 
 
 
 
 
 
 
 
 
 
Service cost
$
1

 
$
2

 
$
2

 
$
2

 
$
1

 
$
1

Interest cost
37

 
38

 
5

 
6

 
8

 
7

Expected return on plan assets
(42
)
 
(44
)
 

 

 
(3
)
 
(2
)
Amortization of unrecognized prior service cost

 

 

 

 
1

 

Amortization of previously unrecognized net actuarial loss
25

 
16

 

 

 
2

 
1

Curtailment
2

 

 
3

 
7

 

 

Net periodic benefit cost
$
23

 
$
12

 
$
10

 
$
15

 
$
9

 
$
7

 
 
Pension Benefits -
U.S.
 
Pension Benefits -
Non-U.S.
 
Postretirement
Benefits - U.S.
 
Nine months ended
June 30,
 
Nine months ended
June 30,
 
Nine months ended
June 30,
In millions
2012
 
2011
 
2012
 
2011
 
2012
 
2011
Components of Net Periodic Benefit Cost
 
 
 
 
 
 
 
 
 
 
 
Service cost
$
4

 
$
5

 
$
5

 
$
7

 
$
2

 
$
3

Interest cost
112

 
113

 
17

 
17

 
23

 
23

Expected return on plan assets
(128
)
 
(131
)
 
(1
)
 
(1
)
 
(8
)
 
(8
)
Amortization of unrecognized prior service cost
1

 
1

 

 

 
2

 
2

Amortization of previously unrecognized net actuarial loss
74

 
48

 

 
1

 
6

 
2

Curtailment
2

 

 
3

 
7

 

 

Net periodic benefit cost
$
65

 
$
36

 
$
24

 
$
31

 
$
25

 
$
22


As a result of business restructuring initiatives, certain U.S. pension and postretirement plans and certain non-U.S. pension plans experienced a curtailment during the quarter ended June 30, 2012, which resulted in curtailment charges of $2 million and $3 million, respectively.

The Company’s general funding policy with respect to its U.S. qualified pension plans is to contribute amounts at least sufficient to satisfy the minimum amount required by applicable law and regulations. For the nine month period ended June 30, 2012, the Company made contributions of $49 million to satisfy minimum statutory funding requirements. Estimated payments to satisfy minimum statutory funding requirements for the remainder of fiscal 2012 are $46 million.

The Company provides certain pension benefits for U.S. employees, which are not pre-funded, and certain pension benefits for non-U.S. employees, the majority of which are not pre-funded. Consequently, the Company makes payments as these benefits are disbursed or premiums are paid. For the nine month period ended June 30, 2012, the Company made payments for these U.S. and non-U.S. pension benefits totaling $5 million and $20 million, respectively. Estimated payments for these U.S. and non-U.S. pension benefits for the remainder of fiscal 2012 are $2 million and $5 million, respectively.

During the nine months ended June 30, 2012, the Company contributed $38 million to the represented employees’ post-retirement health trust to fund current benefit claims and costs of administration in compliance with the terms of the agreements between the Company and the CWA and IBEW, as extended through June 7, 2014. Estimated contributions under the terms of the agreements are $11 million in the aggregate for the remainder of fiscal 2012.

The Company also provides certain retiree medical benefits for U.S. employees, which are not pre-funded. Consequently, the Company makes payments as these benefits are disbursed or premiums are paid. For the nine month period ended June 30, 2012, the Company made payments totaling $8 million for these retiree medical benefits. Estimated payments for these retiree medical benefits for the remainder of fiscal 2012 are $3 million.

12.
Share-based Compensation

Avaya Holdings Corp.’s Amended and Restated 2007 Equity Incentive Plan (“2007 Plan”) governs the issuance of equity awards, including restricted stock units (“RSUs”) and stock options, to eligible plan participants. Key employees, directors, and consultants of the Company may be eligible to receive awards under the 2007 Plan. Each stock option, when vested and exercised, and each RSU, when vested, entitles the holder to receive one share of Parent’s common stock, subject to certain restrictions on their transfer and sale as defined in the 2007 Plan and related award agreements. As of June 30, 2012, Parent had authorized the issuance of up to 49,848,157 shares of its common stock under the 2007 Plan, in addition to 2,924,125 shares of common stock underlying certain continuation awards that were permitted to be issued at the time of the Merger. There remained 6,164,626 shares available for grant under the 2007 Plan as of June 30, 2012.

Option Awards

During the nine months ended June 30, 2012, 2,845,214 time-based and 1,532,039 multiple-of-money options were granted in the ordinary course of business. All of the options expire ten years from the date of grant or upon cessation of employment, in which event there are limited exercise provisions allowed for vested options. Options granted between October 1, 2011 and April 30, 2012 have an exercise price of $4.40 per share. Options granted subsequent to April 30, 2012 have an exercise price of $4.00 per share.

Time-based options granted during the nine months ended June 30, 2012 vest over their performance periods, generally four years. Compensation expense equal to the fair value of the option measured on the grant date is recognized utilizing graded attribution over the requisite service period.

Multiple-of-money options vest upon the achievement of defined returns on the Sponsors’ initial investment in Parent. Because vesting of the multiple-of-money market-based options is outside the control of the Company and the award recipients, compensation expense relative to the multiple-of-money options must be recognized upon the occurrence of a triggering event (e.g., sale or initial public offering of Parent).

The fair value of option awards is determined at the date of grant utilizing the Cox-Ross Rubinstein (“CRR”) binomial option pricing model which is affected by the fair value of Parent’s common stock as well as a number of complex and subjective assumptions. Expected volatility is based primarily on a combination of the Company’s peer group’s historical volatility and estimates of implied volatility of the Company’s peer group. The risk-free interest rate assumption was derived from reference to the U.S. Treasury Spot rates for the expected term of the stock options. The dividend yield assumption is based on Parent’s current intent not to issue a dividend under its dividend policy. The expected holding period assumption was estimated based on

19


the Company’s historical experience.

For the three months ended June 30, 2012 and 2011, the Company recognized share-based compensation associated with options issued under the 2007 Plan of less than $1 million and $2 million, respectively, which is included in costs and operating expenses. For the nine months ended June 30, 2012 and 2011, the Company recognized share-based compensation associated with options issued under the 2007 Plan of $4 million and $7 million, respectively, which is included in costs and operating expenses.

Restricted Stock Units

The Company has issued RSUs each of which represents the right to receive one share of Parent’s common stock when fully vested. The fair value of the RSUs is estimated by the Board of Directors on the respective dates of grant.

During the nine months ended June 30, 2012, 1,362,888 RSUs were awarded in the ordinary course of business. For RSUs awarded between October 1, 2011 and April 30, 2012, the fair market value (as defined in the 2007 Plan) of these awards at the date of grant was $4.40 per share. For RSUs awarded subsequent to April 30, 2012, the fair market value (as defined in the 2007 Plan) of these awards at the date of grant was $4.00 per share.

In addition, in December 2011, Parent and the Company appointed Mr. Gary Smith as an independent director to serve on their respective boards of directors and on Parent’s Audit and Compensation Committees. Upon his election, he received an initial grant of 79,546 RSUs, representing an inaugural grant of 45,455 RSUs and an annual equity grant of 34,091 RSUs. In addition, of his total annual retainer worth $120,000, based on his service on the board and his appointment as a member of the Audit and Compensation Committees, Mr. Smith elected to receive that retainer $60,000 in cash and $60,000 in RSUs (equaling 13,636 RSUs). All RSUs were awarded to Mr. Smith based upon the fair market value of Parent’s common stock on December 6, 2011, the date of grant, which was $4.40 per share. The RSUs were granted pursuant to the terms of the 2007 Plan and were fully vested on the date of grant. The shares underlying the RSUs will not be distributed to him until he ceases to serve on the board of directors.

On December 5, 2011, the Compensation Committee approved a plan to provide incentives to certain executive officers of the Company to continue to grow revenue in fiscal year 2012 (the “2012 Sales Incentive Program”). Under the terms of the 2012 Sales Incentive Program, effective December 6, 2011 the committee approved a grant to each program participant of the conditional right to receive a number of RSUs under Parent’s 2007 Plan upon the achievement of certain revenue objectives. All RSUs awarded under the 2012 Sales Incentive Program will be based upon the fair market value of Parent’s common stock on the date of grant. During the nine months ended June 30, 2012 certain executive officers have been granted the opportunity to receive up to 329,545 RSUs under the 2012 Sales Incentive Program.

The number of RSUs that a participating employee in the 2012 Sales Incentive Program will have the right to receive (subject to vesting requirements and the other terms and conditions of the applicable award agreement) will be determined based upon achievement of both of the following: (i) revenue targets for specific sales territories/divisions/product units (each, a “Performance Gateway”) and (ii) an overall revenue target for the Company. Achievement of targets under the 2012 Sales Incentive Program will be measured twice in fiscal year 2012, with a participating employee being able to earn half of his total opportunity based on results for the first half of fiscal year 2012 and the second half of his total opportunity based on results for the second half of fiscal year 2012. All RSU awards granted under the 2012 Sales Incentive Program will vest on December 6, 2013 for each program participant who achieves the performance objectives.

On February 16, 2012, the Compensation Committee approved amendments to the 2012 Sales Incentive Program with respect to all participants to set certain revenue targets and to reduce certain other revenue targets previously established. All other terms and conditions of the 2012 Sales Incentive Program remain unchanged.

At June 30, 2012, there were 3,159,024 awarded RSUs outstanding under the 2007 Plan, of which 1,178,182 were fully vested. For the three months ended June 30, 2012 and 2011, the Company recognized share-based compensation associated with RSUs granted under the 2007 Plan of $1 million and $1 million, respectively. For each of the nine months ended June 30, 2012 and 2011, the Company recognized share-based compensation associated with RSUs granted under the 2007 Plan of $3 million and $2 million, respectively.

13.
Reportable Segments

Avaya conducts its business operations in three segments. Two of those segments, Global Communications Solutions (“GCS”) and Avaya Networking (“Networking”), make up Avaya’s Enterprise Collaboration Solutions (“ECS”) product portfolio. The

20


third segment contains Avaya’s services portfolio and is called Avaya Global Services (“AGS”).

The GCS segment primarily develops, markets, and sells unified communications and contact center solutions by integrating multiple forms of communications, including telephone, e-mail, instant messaging and video. Avaya’s Networking segment’s portfolio of products offers integrated networking solutions which are scalable across customer enterprises. The AGS segment develops, markets and sells comprehensive end-to-end global service offerings that allow customers to evaluate, plan, design, implement, monitor, manage and optimize complex enterprise communications networks.

For internal reporting purposes, the Company’s chief operating decision maker makes financial decisions and allocates resources based on segment margin information obtained from the Company’s internal management systems. Management does not include in its segment measures of profitability selling, general, and administrative expenses, research and development expenses, amortization of intangible assets, and certain discrete items, such as charges relating to restructuring actions, impairment charges, and merger-related costs as these costs are not core to the measurement of segment management’s performance, but rather are controlled at the corporate level.

Summarized financial information relating to the Company’s reportable segments is shown in the following table:
 
  
Three months ended
June 30,
 
Nine months ended
June 30,
In millions
2012
 
2011
 
2012
 
2011
REVENUE
 
 
 
 
 
 
 
Global Communications Solutions
$
561

 
$
659

 
$
1,802

 
$
1,984

Avaya Networking
74

 
71

 
220

 
226

Enterprise Collaboration Solutions
635

 
730

 
2,022

 
2,210

Avaya Global Services
616

 
643

 
1,874

 
1,922

Unallocated Amounts (1)
(1
)
 
(1
)
 
(2
)
 
(4
)
 
$
1,250

 
$
1,372

 
$
3,894

 
$
4,128

GROSS MARGIN
 
 
 
 
 
 
 
Global Communications Solutions
$
329

 
$
383

 
$
1,047

 
$
1,119

Avaya Networking
29

 
29

 
93

 
96

Enterprise Collaboration Solutions
358

 
412

 
1,140

 
1,215

Avaya Global Services
300

 
304

 
909

 
903

Unallocated Amounts (1)
(35
)
 
(63
)
 
(109
)
 
(204
)
 
623

 
653

 
1,940

 
1,914

OPERATING EXPENSES
 
 
 
 
 
 
 
Selling, general and administrative
405


472


1,252


1,403

Research and development
116


115


344


351

Amortization of intangible assets
57


56


169


168

Restructuring and impairment charges, net
21


102


132


166

Acquisition-related costs
1




4


4

 
600

 
745

 
1,901

 
2,092

OPERATING INCOME (LOSS)
23

 
(92
)
 
39

 
(178
)
INTEREST EXPENSE, LOSS ON EXTINGUISHMENT OF DEBT AND OTHER INCOME (EXPENSE), NET
(101
)
 
(112
)
 
(331
)
 
(597
)
LOSS BEFORE INCOME TAXES
$
(78
)
 
$
(204
)
 
$
(292
)
 
$
(775
)
 
(1)
Unallocated Amounts in Gross Margin include the effect of the amortization of acquired technology intangibles and costs that are not core to the measurement of segment management’s performance, but rather are controlled at the corporate level. Unallocated Amounts in Revenue and Gross Margin also include the impacts of certain fair value adjustments recorded in purchase accounting in connection with the Merger.

21




14.
Commitments and Contingencies

Legal Proceedings

In the ordinary course of business, the Company is involved in litigation, claims, government inquiries, investigations and proceedings, including, but not limited to, those identified below, relating to intellectual property, commercial, employment, environmental and regulatory matters.

Other than as described below, the Company believes there is no litigation pending or environmental and regulatory matters against the Company that could have, individually or in the aggregate, a material adverse effect on the Company’s financial position, results of operations or cash flows.

Antitrust Litigation

In 2006, the Company instituted an action in the U.S. District Court, District of New Jersey, against defendants Telecom Labs, Inc., TeamTLI.com Corp. and Continuant Technologies, Inc. and subsequently amended its complaint to include certain individual officers of these companies as defendants. Defendants purportedly provide maintenance services to customers who have purchased or leased the Company’s communications equipment. The Company asserts in its amended complaint that, among other things, defendants, or each of them, have engaged in tortious conduct and/or violated federal intellectual property laws by improperly accessing and utilizing the Company’s proprietary software, including passwords, logins and maintenance service permissions, to perform certain maintenance services on the Company’s customers’ equipment. Defendants have filed counterclaims against the Company, alleging a number of tort claims and alleging that the Company has violated the Sherman Act’s prohibitions against anticompetitive conduct through the manner in which the Company sells its products and services. Defendants seek to recover the profits they claim they would have earned from maintaining Avaya’s products, and ask for injunctive relief prohibiting the conduct they claim is anticompetitive. Under the federal antitrust laws, defendants could be entitled to three times the amount of any actual damages awarded for lost profits plus attorney’s fees and costs. The parties have engaged in extensive discovery and motion practice to, among other things, amend and dismiss pleadings and compel and oppose discovery requests. A trial date originally set for September 2011 has been adjourned and no new date has been set by the court. In January 2012, Avaya’s motions to dismiss defendants’ counterclaims were granted in part and denied in part. In February 2012, the parties filed motions for reconsideration of certain aspects of the Court’s ruling and Avaya filed a motion for certification of an interlocutory appeal. The parties’ motions were denied on April 26, 2012. Expert discovery on the Company’s claims and the defendants’ surviving counter-claims is completed, and in July 2012 the parties filed motions to exclude the opinion testimony of certain of each others' experts. Therefore, at this time an outcome cannot be predicted and, as a result, the Company cannot be assured that this case will not have a material adverse effect on the manner in which it does business, its financial position, results of operations, or cash flows.

Intellectual Property

In the ordinary course of business, the Company is involved in litigation alleging it has infringed upon third parties’ intellectual property rights, including patents; some litigation may involve claims for infringement against customers by third parties relating to the use of Avaya’s products, as to which the Company may provide indemnifications of varying scope to certain customers. These matters are on-going and the outcomes are subject to inherent uncertainties. As a result, the Company cannot be assured that any such matter will not have a material adverse effect on its financial position, results of operations or cash flows. However, management does provide for estimated losses if and when it believes the facts and circumstances indicate that a loss is probable and the loss can be reasonably estimated. While it is not possible at this time to determine with certainty the ultimate outcome of these cases, the Company believes there are no such infringement matters that could have, individually or in aggregate, a material adverse effect on the Company’s financial position, results of operations or cash flows.

Other

In October 2009, a group of former employees of Avaya’s former Shreveport, Louisiana manufacturing facility brought suit in Louisiana state court, naming as defendants Alcatel-Lucent USA, Inc., Lucent Technologies Services Company, Inc., and AT&T Technologies, Inc. The former employees allege hearing loss due to hazardous noise exposure from the facility dating back over forty years, and stipulate that the total amount of each individual’s damages does not exceed fifty thousand dollars. In February 2010 plaintiffs amended their complaint to add the Company as a named defendant. There are 101 plaintiffs in the case. Defendants’ motion to dismiss plaintiffs’ complaint was denied on April 30, 2012. At this time an outcome cannot be predicted however, because the amount of the claims are not material, the Company believes the outcome of this matter will not
have a material adverse effect on the manner in which it does business, its financial position, results of operations, or cash flows.

General

The Company records accruals for legal contingencies to the extent that it has concluded it is probable that a liability has been incurred and the amount of the loss can be reasonably estimated. No estimate of the possible loss or range of loss in excess of amounts accrued, if any, can be made at this time regarding the matters specifically described above because the inherently unpredictable nature of legal proceedings may be exacerbated by various factors, including: (i) the damages sought in the proceedings are unsubstantiated or indeterminate; (ii) discovery is not complete; (iii) the proceeding is in its early stages; (iv) the matters present legal uncertainties; (v) there are significant facts in dispute; (vi) there are a large number of parties (including where it is uncertain how liability, if any, will be shared among multiple defendants); or (vii) there is a wide range of potential outcomes.

Product Warranties

The Company recognizes a liability for the estimated costs that may be incurred to remedy certain deficiencies of quality or performance of the Company’s products. These product warranties extend over a specified period of time generally ranging up to two years from the date of sale depending upon the product subject to the warranty. The Company accrues a provision for estimated future warranty costs based upon the historical relationship of warranty claims to sales. The Company periodically reviews the adequacy of its product warranties and adjusts, if necessary, the warranty percentage and accrued warranty reserve, which is included in other current liabilities in the Consolidated Balance Sheets, for actual experience.
 
In millions
 
Balance as of October 1, 2011
$
24

Reductions for payments and costs to satisfy claims
(15
)
Accruals for warranties issued during the period
7

Balance as of June 30, 2012
$
16


Guarantees of Indebtedness and Other Off-Balance Sheet Arrangements

Letters of Credit

As of June 30, 2012, the Company had outstanding an aggregate of $116 million in irrevocable letters of credit which ensure the Company's performance or payment to third parties.  Included in this amount is $75 million issued under its $535 million committed revolving credit facilities, which facilities are available through October 26, 2016.  Also included is $41 million of letters of credit issued under uncommitted facilities.

Surety Bonds

The Company arranges for the issuance of various types of surety bonds, such as license, permit, bid and performance bonds, which are agreements under which the surety company guarantees that the Company will perform in accordance with contractual or legal obligations. These bonds vary in duration although most are issued and outstanding from three months to three years. These bonds are backed by $12 million of the Company’s letters of credit. If the Company fails to perform under its obligations, the maximum potential payment under these surety bonds is $13 million as of June 30, 2012. Historically, no surety bonds have been drawn upon.

Purchase Commitments and Termination Fees

The Company purchases components from a variety of suppliers and uses several contract manufacturers to provide manufacturing services for its products. During the normal course of business, in order to manage manufacturing lead times and to help assure adequate component supply, the Company enters into agreements with contract manufacturers and suppliers that allow them to produce and procure inventory based upon forecasted requirements provided by the Company. If the Company does not meet these specified purchase commitments, it could be required to purchase the inventory, or in the case of certain agreements, pay an early termination fee. Historically, the Company has not been required to pay a charge for not meeting its designated purchase commitments with these suppliers, but has been obligated to purchase certain excess inventory levels from its outsourced manufacturers due to actual sales of product varying from forecast and due to transition of

22


manufacturing from one vendor to another.

The Company’s outsourcing agreements with its two most significant contract manufacturers expire in July and September 2013. After the initial term, the outsourcing agreements are automatically renewed for successive periods of twelve months each, subject to specific termination rights for the Company and the contract manufacturers. All manufacturing of the Company’s products is performed in accordance with either detailed requirements or specifications and product designs furnished by the Company, and is subject to rigorous quality control standards.

Product Financing Arrangements

The Company sells products to various resellers that may obtain financing from certain unaffiliated third-party lending institutions. For the Company’s product financing arrangement with resellers outside the U.S., in the event participating resellers default on their payment obligations to the lending institution, the Company is obligated under certain circumstances to guarantee repayment to the lending institution. The repayment amount fluctuates with the level of product financing activity. The guaranteed repayment amount was approximately $4 million as of June 30, 2012. The Company reviews and sets the maximum credit limit for each reseller participating in this financing arrangement. Historically, there have not been any guarantee repayments by the Company. The Company has estimated the fair value of this guarantee as of June 30, 2012, and has determined that it is not significant. There can be no assurance that the Company will not be obligated to repurchase inventory under this arrangement in the future.

Long-Term Cash Incentive Bonus Plan

Parent has established a long-term incentive cash bonus plan (“LTIP”). Under the LTIP, Parent will make cash awards available to compensate certain key employees upon the achievement of defined returns on the Sponsors’ initial investment in the Parent (a “triggering event”). Parent has authorized LTIP awards covering a total of $60 million, of which $46 million in awards were outstanding as of June 30, 2012. The Company will begin to recognize compensation expense relative to the LTIP awards upon the occurrence of a triggering event (e.g., a sale or initial public offering). As of June 30, 2012, no compensation expense associated with the LTIP has been recognized.

Credit Facility Indemnification

In connection with its obligations under the credit facilities described in Note 7, “Financing Arrangements,” the Company has agreed to indemnify the third-party lending institutions for costs incurred by the institutions related to changes in tax law or other legal requirements. While there have been no amounts paid to the lenders pursuant to this indemnity in the past, there can be no assurance that the Company will not be obligated to indemnify the lenders under this arrangement in the future.

Transactions with Alcatel-Lucent

Pursuant to the Contribution and Distribution Agreement effective October 1, 2000, Lucent Technologies, Inc. (now Alcatel-Lucent) contributed to the Company substantially all of the assets, liabilities and operations associated with its enterprise networking businesses (the “Company’s Businesses”) and distributed the Company’s stock pro-rata to the shareholders of Lucent (“distribution”). The Contribution and Distribution Agreement, among other things, provides that, in general, the Company will indemnify Alcatel-Lucent for all liabilities including certain pre-distribution tax obligations of Alcatel-Lucent relating to the Company’s Businesses and all contingent liabilities primarily relating to the Company’s Businesses or otherwise assigned to the Company. In addition, the Contribution and Distribution Agreement provides that certain contingent liabilities not allocated to one of the parties will be shared by Alcatel-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 is unable to determine the maximum potential amount of other future payments, if any, that it could be required to make under this agreement.

The Tax Sharing Agreement governs Alcatel-Lucent’s and the Company’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 or benefits that are clearly attributable to the business of one party will be borne solely by that party, and other pre-distribution taxes or benefits will be shared by the parties based on a formula set forth in the Tax Sharing Agreement. The Company may be subject to additional taxes or benefits pursuant to the Tax Sharing Agreement related to future settlements of audits by state and local and foreign taxing authorities for the periods prior to the Company’s separation from Alcatel-Lucent.


23


15.
Guarantor—Non Guarantor financial information

Borrowings by Avaya Inc. under the senior secured credit facility are jointly and severally, fully, and unconditionally guaranteed (subject to certain customary release provisions) by substantially all wholly owned U.S. subsidiaries of Avaya Inc. (collectively, the “Guarantor Subsidiaries”) and Parent. Each of the Guarantor Subsidiaries is 100% owned, directly or indirectly by Avaya Inc. The senior secured notes, the senior unsecured cash-pay notes and the senior unsecured PIK toggle notes issued by Avaya Inc. are jointly and severally, fully and unconditionally guaranteed by the Guarantor Subsidiaries. None of the other subsidiaries of Avaya Inc., either directly or indirectly, guarantees the senior secured credit facility, the senior secured notes, the senior unsecured cash-pay notes or the senior unsecured PIK toggle notes (“Non-Guarantor Subsidiaries”).

Avaya Inc. and each of the Guarantor Subsidiaries are authorized to borrow under the senior secured asset-based credit facility. Borrowings under that facility are jointly and severally, fully, and unconditionally guaranteed by Avaya Inc. and the Guarantor Subsidiaries (subject to certain customary release provisions). Additionally these borrowings are fully and unconditionally guaranteed by Parent.

The senior secured notes and the related guarantees are secured equally and ratably (other than with respect to real estate) with the senior secured credit facility and any future first lien obligations by (i) a first-priority lien on substantially all of the Avaya Inc.’s and the Guarantor Subsidiaries’ assets, other than (x) any real estate and (y) collateral that secures the senior secured multi-currency asset based revolving credit facility on a first-priority basis (the “ABL Priority Collateral”), and (ii) a second-priority lien on the ABL Priority Collateral, subject to certain limited exceptions.

The following tables present for Avaya Inc., the Guarantor Subsidiaries, the Non-Guarantor Subsidiaries and Intercompany Eliminations the results of operations for the three and nine months ended June 30, 2012 and 2011, financial position as of June 30, 2012 and September 30, 2011 and cash flows for the nine months ended June 30, 2012 and 2011 to arrive at the information for Avaya Inc. on a consolidated basis.

24


Supplemental Condensed Consolidating Schedule of Operations
 
 
Three Months Ended June 30, 2012
In millions
Avaya
Inc.
 
Guarantor
Subsidiaries
 
Non-Guarantor
Subsidiaries
 
Intercompany
Eliminations
 
Consolidated
REVENUE
$
663

 
$
96

 
$
615

 
$
(124
)
 
$
1,250

COST
358

 
68

 
325

 
(124
)
 
627

GROSS MARGIN
305

 
28

 
290

 

 
623

OPERATING EXPENSES
 
 
 
 
 
 
 
 
 
Selling, general and administrative
153

 
22

 
230

 

 
405

Research and development
63

 
3

 
50

 

 
116

Amortization of intangible assets
52

 
1

 
4

 

 
57

Restructuring and impairment charges, net
9

 
1

 
11

 

 
21

Acquisition-related costs
1

 

 

 

 
1

 
278

 
27

 
295

 

 
600

OPERATING INCOME (LOSS)
27

 
1

 
(5
)
 

 
23

Interest expense
(103
)
 
(4
)
 

 

 
(107
)
Other (expense) income, net
(5
)
 

 
11

 

 
6

LOSS BEFORE INCOME TAXES
(81
)
 
(3
)
 
6

 

 
(78
)
Provision for income taxes
13

 

 
75

 

 
88

Equity in net loss of consolidated subsidiaries
(72
)
 

 

 
72

 

NET LOSS
$
(166
)
 
$
(3
)
 
$
(69
)
 
$
72

 
$
(166
)


25


Supplemental Condensed Consolidating Schedule of Operations
 
 
Three Months Ended June 30, 2011
In millions
Avaya
Inc.
 
Guarantor
Subsidiaries
 
Non-Guarantor
Subsidiaries
 
Intercompany
Eliminations
 
Consolidated
REVENUE
$
747

 
$
107

 
$
643

 
$
(125
)
 
$
1,372

COST
401

 
71

 
372

 
(125
)
 
719

GROSS MARGIN
346

 
36

 
271

 

 
653

OPERATING EXPENSES
 
 
 
 
 
 
 
 
 
Selling, general and administrative
131

 
25

 
316

 

 
472

Research and development
66

 
3

 
46

 

 
115

Amortization of intangible assets
51

 
1

 
4

 

 
56

Restructuring charges, net
3

 
6

 
93

 

 
102

 
251

 
35

 
459

 

 
745

OPERATING INCOME (LOSS)
95

 
1

 
(188
)
 

 
(92
)
Interest expense
(108
)
 
(4
)
 

 
1

 
(111
)
Other income (expense), net
3

 

 
(3
)
 
(1
)
 
(1
)
LOSS BEFORE INCOME TAXES
(10
)
 
(3
)
 
(191
)
 

 
(204
)
Provision for (benefit from) income taxes
1

 

 
(53
)
 

 
(52
)
Equity in net loss of consolidated subsidiaries
(141
)
 

 

 
141

 

NET LOSS
$
(152
)
 
$
(3
)
 
$
(138
)
 
$
141

 
$
(152
)

26


Supplemental Condensed Consolidating Schedule of Operations
 
 
Nine Months Ended June 30, 2012
In millions
Avaya
Inc.
 
Guarantor
Subsidiaries
 
Non-Guarantor
Subsidiaries
 
Intercompany
Eliminations
 
Consolidated
REVENUE
$
2,160

 
$
294

 
$
1,947

 
$
(507
)
 
$
3,894

COST
1,184

 
199

 
1,078

 
(507
)
 
1,954

GROSS MARGIN
976

 
95

 
869

 

 
1,940

OPERATING EXPENSES
 
 
 
 
 
 
 
 
 
Selling, general and administrative
499

 
71

 
682

 

 
1,252

Research and development
189

 
10

 
145

 

 
344

Amortization of intangible assets
155

 
3

 
11

 

 
169

Restructuring and impairment charges, net
25

 
2

 
105

 

 
132

Acquisition-related costs
4