10-12B/A 1 d427311d1012ba.htm AMENDMENT NO. 3 TO FORM 10 Amendment No. 3 to Form 10
Table of Contents

As filed with the Securities and Exchange Commission on January 10, 2018

File No. 001-38289

 

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

AMENDMENT NO. 3

TO

FORM 10

GENERAL FORM FOR REGISTRATION OF SECURITIES

PURSUANT TO SECTION 12(b) OR 12(g) OF

THE SECURITIES EXCHANGE ACT OF 1934

 

 

Avaya Holdings Corp.

(Exact Name of Registrant as Specified in its Charter)

 

 

 

Delaware   7372   26-1119726

(State or other jurisdiction of

incorporation or organization)

 

(Primary Standard Industrial

Classification Code Number)

 

(I.R.S. Employer

Identification No.)

4655 Great America Parkway

Santa Clara, California 95054

(Address of Principal Executive Offices)

(908) 953-6000

(Registrant’s telephone number, including area code)

 

 

Copies to:

Adele C. Freedman

Vice President & Deputy General Counsel, Corporate Law

Avaya Holdings Corp.

4655 Great America Parkway

Santa Clara, California 95054

(908) 953-6000

 

Joshua N. Korff, P.C.

Michael Kim

Kirkland & Ellis LLP

601 Lexington Avenue

New York, New York 10022

(212) 446-4800

 

 

Securities to be registered pursuant to Section 12(b) of the Act:

 

Title of each class

to be so registered

 

Name of each exchange on which

each class is to be registered

Common stock, $0.01 par value per share   New York Stock Exchange

Securities to be registered pursuant to Section 12(g) of the Act: None.

 

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company” and “emerging growth company” in Rule 12b-2 of the Exchange Act.

 

Large accelerated filer      Accelerated filer  
Non-accelerated filer   ☒  (Do not check if a smaller reporting company)    Smaller reporting company  
     Emerging growth company  

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.   ☐

 

 

 


Table of Contents

TABLE OF CONTENTS

 

          Page  

EXPLANATORY NOTE

     1  

CERTAIN TERMS USED IN THIS REGISTRATION STATEMENT

     3  

CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING STATEMENTS

     4  

MARKET, RANKING AND OTHER INDUSTRY DATA

     6  

ITEM 1.

  

BUSINESS

     7  

ITEM 1.A

  

RISK FACTORS

     30  

ITEM 2.

  

FINANCIAL INFORMATION

     49  

ITEM 3.

  

PROPERTIES

     108  

ITEM 4.

  

SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT

     109  

ITEM 5.

  

DIRECTORS AND EXECUTIVE OFFICERS

     111  

ITEM 6.

  

EXECUTIVE COMPENSATION

     121  

ITEM 7.

  

CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE

     148  

ITEM 8.

  

LEGAL PROCEEDINGS

     154  

ITEM 9.

  

MARKET PRICE OF AND DIVIDENDS ON THE REGISTRANT’S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS

     158  

ITEM 10.

  

RECENT SALES OF UNREGISTERED SECURITIES

     160  

ITEM 11.

  

DESCRIPTION OF REGISTRANT’S SECURITIES TO BE REGISTERED

     161  

ITEM 12.

  

INDEMNIFICATION OF DIRECTORS AND OFFICERS

     164  

ITEM 13.

  

FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

     165  

ITEM 14.

  

CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE

     166  

ITEM 15.

  

FINANCIAL STATEMENTS AND EXHIBITS

     F-1  

 

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EXPLANATORY NOTE

Avaya Holdings Corp. (“Avaya Holdings”) is filing this registration statement on Form 10 pursuant to Section 12(b) of the Securities Exchange Act of 1934, as amended (the “Exchange Act”) because we are seeking to list our common stock, par value $0.01 per share, on the New York Stock Exchange.

Once the registration of our common stock becomes effective, we will be subject to the requirements of Section 13(a) of the Exchange Act, including the rules and regulations promulgated thereunder, which will require us to file, among other things, annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and proxy statements with the U.S. Securities and Exchange Commission, or the SEC, and we will be required to comply with all other obligations of the Exchange Act applicable to issuers filing registration statements pursuant to Section 12 of the Exchange Act.

Our periodic and current reports will be available on our website, https://investors.avaya.com/financial-info/sec-filings, free of charge, as soon as reasonably practicable after such materials are filed with, or furnished to, the SEC.

On January 19, 2017, Avaya Inc. and certain of its affiliates, including Avaya Holdings (the “Debtor Affiliates” and, together with Avaya Inc., the “Debtors”), commenced chapter 11 cases (the “Bankruptcy Filing”) in the United States Bankruptcy Court for the Southern District of New York (the “Bankruptcy Court”). The Debtors completed the Restructuring (as defined below) and emerged from chapter 11 proceedings on December 15, 2017.

On the date of the Bankruptcy Filing, the capital structure of the Company, Avaya Inc. and the Debtor Affiliates and non-Debtor Affiliates (collectively, the “Avaya Enterprise”) included approximately $6.0 billion in funded debt. The majority of this funded debt was a legacy of the 2007 transaction in which the Avaya Enterprise was taken private. The remainder of the funded debt originated as part of the Avaya Enterprise’s 2009 acquisition of Nortel Enterprise Systems. In addition to this indebtedness, the following challenges led the Debtors to commence the chapter 11 cases in January 2017:

 

    Business model shift: The decline in economic activity between 2008 and 2010, together with the market trends away from hardware-based business communications under the capital expenditure model towards software and services offerings under the operating expense model, had a substantial impact on the Avaya Enterprise’s operations. The Avaya Enterprise also faced ongoing competition to its core Unified Communications Product and Service offerings from numerous competitors such as Cisco and Microsoft. In light of these factors, the Avaya Enterprise experienced significant revenue declines over the past several years.

 

    Substantial annual cash requirements: The Avaya Enterprise’s cash flow profile was negatively impacted by the substantial costs associated with its debt load, which increased over the last decade. Annual cash interest payments averaged approximately $440 million since fiscal 2014, with a corresponding impact on cash flow available to fund the research, development and other investments required to remain competitive in the market. From fiscal 2014 to fiscal 2016, annual cash requirements averaged approximately $900 million, including: (a) approximately $440 million in cash interest payments and (b) annual pension and other post-retirement employment benefits funding of approximately $180 million, as well as ongoing cash needs related to restructuring costs, capital expenditures and cash taxes.

 

    October 2017 debt maturities: Approximately $617 million of the Debtors’ indebtedness was scheduled to mature in October 2017.

On April 13, 2017, the Debtors filed a Joint Chapter 11 Plan of Reorganization of Avaya Inc. and its Debtor Affiliates and related disclosure statement for the Joint Chapter 11 Plan of Reorganization of Avaya Inc. and its

 

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Debtor Affiliates. On August 7, 2017, the Debtors filed the First Amended Joint Chapter 11 Plan of Reorganization of Avaya Inc. and its Debtor Affiliates (as amended, the “First Amended Plan of Reorganization”) and related disclosure statement for the First Amended Joint Chapter 11 Plan of Reorganization of Avaya Inc. and its Debtor Affiliates (the “Amended Disclosure Statement”). The Bankruptcy Court signed an order approving the Amended Disclosure Statement on August 25, 2017. On September 8, 2017, the Debtors filed the solicitation versions of the First Amended Plan of Reorganization and Amended Disclosure Statement. On September 9, 2017, the Bankruptcy Court assigned the Debtors and their major stakeholder constituencies to mediation. The mediation resulted in a resolution between these constituencies, and, as a result, the Debtors filed a further amended plan of reorganization, the Second Amended Joint Plan of Reorganization (as amended, the “Plan of Reorganization”), and a Disclosure Statement Supplement on October 24, 2017. On November 28, 2017, the Bankruptcy Court entered an order confirming the Debtors’ Plan of Reorganization, which, among other things, provided for the following treatments for certain creditor and equity classes:

 

    First lien debt claims: pro rata share of (i) new secured debt (or cash to the extent such debt is partially or fully syndicated) to be issued in connection with the Restructuring (as defined below) and (ii) 90.5% of the reorganized Avaya Holdings’ common stock (subject to dilution by the post-Emergence Date (as defined below) equity incentive plan, that provides for reorganized Avaya Holdings’ common stock, or other interests in Avaya Holdings, on a fully diluted basis, to be reserved for directors, officers and employees of the Debtors (the “Equity Incentive Plan”) and the Warrants (as defined below)) less the reservation of up to 2.55% of the reorganized Avaya Holdings’ common stock (subject to dilution by the Equity Incentive Plan and the Warrants) to be established on or prior to the Emergence Date for pro rata distributions on account of general unsecured claims (the “General Unsecured Recovery Equity Reserve”).

 

    Second lien notes claims: pro rata share of 4.0% of the reorganized Avaya Holdings’ common stock (subject to dilution by the Equity Incentive Plan and the Warrants) and a pro rata share of warrants to acquire 5.0% of reorganized Avaya Holdings’ common stock (subject to dilution by the Equity Incentive Plan) (the “Warrants”).

 

    General unsecured claims: pro rata share of the $58 million general unsecured recovery pool, which the general unsecured creditors may irrevocably elect to receive as reorganized Avaya Holdings’ common stock (subject to dilution by the Equity Incentive Plan and the Warrants) or cash proceeds (pursuant to an election submitted prior to the applicable voting deadline).

 

    Claims of Pension Benefit Guaranty Corporation (“PBGC”) in connection with the termination of the Avaya Inc. Pension Plan for Salaried Employees (“APPSE”): (i) $340 million in cash and (ii) 5.5% of the reorganized Avaya Holdings’ common stock (subject to dilution by the Equity Incentive Plan and the Warrants).

 

    Pre-emergence equity interests in Avaya Holdings: cancelled.

The Company is not required to file this registration statement pursuant to the Securities Act of 1933, as amended (the “Securities Act”). This registration statement shall not constitute an offer to sell, nor a solicitation of an offer to buy, its securities.

 

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CERTAIN TERMS USED IN THIS REGISTRATION STATEMENT

Unless otherwise indicated or the context otherwise requires, references in this registration statement to the terms below will have the following meanings:

 

    “Avaya,” “we,” “our,” “us” and the “Company” refer to Avaya Holdings Corp. and its consolidated subsidiaries;

 

    “Avaya Holdings” or the “Parent” refer to Avaya Holdings Corp.;

 

    “Bankruptcy Code” refers to title 11 of the United States Code;

 

    “Bankruptcy Court” refers to the U.S. Bankruptcy Court for the Southern District of New York;

 

    “Bankruptcy Filing” refers to the voluntary petition for relief filed by the Debtors on January 19, 2017 in the Bankruptcy Court;

 

    “Debtors” refers to Avaya Holdings, Avaya Inc. and certain of their affiliates;

 

    “Emergence Date” refers to the date, December 15, 2017, on which substantial consummation (as that term is defined by section 1102(2) of the Bankruptcy Code) of the Plan of Reorganization occurred;

 

    “Exchange Act” refers to the Securities Exchange Act of 1934, as amended;

 

    “PBGC” refers to the Pension Benefit Guaranty Corporation;

 

    “Plan of Reorganization” refers to the Second Amended Joint Plan of Reorganization filed by the Debtors on October 24, 2017 and approved by the Bankruptcy Court on November 28, 2017;

 

    “Restructuring” refers to the consummation of the transactions contemplated by the Plan of Reorganization; and

 

    “Securities Act” refers to the Securities Act of 1933, as amended.

 

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CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING STATEMENTS

Certain statements in this registration statement, including statements containing words such as “anticipate,” “believe,” “estimate,” “expect,” “intend,” “plan,” “project,” “target,” “can,” “could,” “may,” “should,” “will,” “would” or similar words, constitute “forward-looking statements.” These forward-looking statements, which are based on our current plans, expectations and projections about future events, should not be unduly relied upon. These statements involve known and unknown risks, uncertainties and other factors that may cause our actual results, performance and achievements to materially differ from any future results, performance and achievements expressed or implied by such forward-looking statements. We caution you therefore against relying on any of these forward-looking statements.

The forward-looking statements included herein are based upon our assumptions, estimates and beliefs and involve judgments with respect to, among other things, future economic, competitive and market conditions and future business decisions, all of which are difficult or impossible to predict accurately and many of which are beyond our control. Although we believe that the expectations reflected in such forward-looking statements are based on reasonable assumptions, our actual results and performance could differ materially from those set forth in the forward-looking statements and may be affected by a variety of risks and other factors, which may cause our actual results, performance or achievements to differ materially from any future results, performance or achievements expressed or implied by these forward-looking statements. Some of the key factors that could cause actual results to differ from our expectations include:

 

    we face formidable competition from providers of unified communications and contact center products and related services;

 

    market opportunity for business communications products and services may not develop in the ways that we anticipate;

 

    our ability to rely on our indirect sales channel;

 

    our products and services may fail to keep pace with rapidly changing technology and evolving industry standards;

 

    we rely on third-party contract manufacturers and component suppliers, some of which are sole source and limited source suppliers, as well as warehousing and distribution logistics providers;

 

    recently completed bankruptcy proceedings may adversely affect our operations in the future;

 

    our actual financial results may vary significantly from the financial projections filed with the Bankruptcy Court;

 

    our historical financial information may not be indicative of our future financial performance;

 

    our quarterly and annual revenues and operating results have historically fluctuated and the results of one period may not provide a reliable indicator of our future performance;

 

    operational and logistical challenges as well as changes in economic or political conditions, in a specific country or region;

 

    our revenues are dependent on general economic conditions and the willingness of enterprises to invest in technology;

 

    the potential that we may not be able to protect our proprietary rights or that those rights may be invalidated or circumvented;

 

    certain software we use is from open source code sources, which, under certain circumstances, may lead to unintended consequences;

 

    changes in its tax rates, the adoption of new U.S. or international tax legislation or exposure to additional tax liabilities;

 

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    cancellation of indebtedness income is expected to result in material reductions in, or elimination of, tax attributes;

 

    tax examinations and audits;

 

    fluctuations in foreign currency exchange rates;

 

    business communications products are complex, and design defects, errors, failures or “bugs” may be difficult to detect and correct;

 

    if we are unable to integrate acquired businesses effectively;

 

    failure to realize the benefits we expect from our cost-reduction initiatives;

 

    liabilities incurred as a result of our obligation to indemnify, and to share certain liabilities with, Lucent (as defined below) in connection with our spin-off from Lucent in September 2000;

 

    transfers or issuances of our equity may impair or reduce our ability to utilize our net operating loss carryforwards and certain other tax attributes in the future;

 

    our ability to retain and attract key personnel;

 

    our ability to establish and maintain proper and effective internal control over financial reporting;

 

    if we do not adequately remediate our material weaknesses, or if we experience additional material weaknesses in the future;

 

    potential litigation in connection with our emergence from bankruptcy;

 

    breach of the security of our information systems, products or services or of the information systems of our third-party providers;

 

    business interruptions, whether due to catastrophic disasters or other events;

 

    claims that were not discharged in the Plan of Reorganization could have a material adverse effect on our results of operations and profitability;

 

    potential litigation and infringement claims, which could cause us to incur significant expenses or prevent us from selling our products or services;

 

    the composition of our board of directors has changed significantly;

 

    we have entered into many related party transactions with a significant number of our foreign subsidiaries, which could adversely affect us in the event of their bankruptcy or similar insolvency proceeding; and

 

    environmental, health and safety, laws, regulations, costs and other liabilities.

Any of the assumptions underlying forward-looking statements could be inaccurate. All forward-looking statements are made as of the date of this registration statement and the risk that actual results will differ materially from the expectations expressed in this registration statement will increase with the passage of time. Except as otherwise required by the federal securities laws, we undertake no obligation to publicly update or revise any forward-looking statements after the date of this registration statement, whether as a result of new information, future events, changed circumstances or any other reason. In light of the significant uncertainties inherent in the forward-looking statements included in this registration statement, the inclusion of such forward-looking statements should not be regarded as a representation by us or any other person that the objectives and plans set forth in this registration statement will be achieved.

 

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MARKET, RANKING AND OTHER INDUSTRY DATA

This registration statement includes industry and trade association data, forecasts and information that we have prepared based, in part, upon data, forecasts and information obtained from independent trade associations, industry publications and surveys and other information available to us. Some data is also based on our good faith estimates, which are derived from management’s knowledge of the industry and independent sources. Industry publications and surveys and forecasts generally state that the information contained therein has been obtained from sources believed to be reliable. We have not independently verified any of the data from third-party sources, nor have we ascertained the underlying economic assumptions relied upon therein. In particular, the Gartner reports described below represent research opinion or viewpoints published, as part of a syndicated subscription service, by Gartner, Inc., (“Gartner”) and are not representations of fact. Each Gartner report speaks as of its original publication date (and not as of the date of this filing) and the opinions expressed in the Gartner reports are subject to change without notice. Gartner does not endorse any vendor, product or service depicted in its research publications, and does not advise technology users to select only those vendors with the highest ratings or other designation. Gartner research publications consist of the opinions of Gartner’s research organization and should not be construed as statements of fact. Gartner disclaims all warranties, expressed or implied, with respect to this research, including any warranties of merchantability or fitness for a particular purpose. Statements as to our market position are based on market data currently available to us. Our estimates involve risks and uncertainties and are subject to change based on various factors, including those discussed under the heading “Item 1.A. Risk Factors” in this registration statement.

Certain information in the text of this registration statement is contained in industry publications or data compiled by a third-party. The sources of these industry publications and data are provided below:

 

    Gartner Forecast: Mobile Phones, Worldwide, 2015-2021, 3Q17 Update, Annette Zimmermann, et al., September 2017.

 

    Gartner Forecast: PCs, Ultramobiles and Mobile Phones, Worldwide, 2015-2021, 3Q17 Update, Ranjit Atwal, et al., September 2017.

 

    Gartner Magic Quadrant for Unified Communications, Steve Blood, et al., July 2017.

 

    Gartner Magic Quadrant for Contact Center Infrastructure, Worldwide, Drew Kraus, et al., May 2017.

 

    IDC MarketScape: Worldwide Unified Communications and Collaboration 2017 Vendor Assessment, July 2017.

 

    Canalys, Worldwide Voice Messaging Market and Forecasts, September 2017.

 

    Canalys, Worldwide contact center market and forecasts, August 2017.

 

    Canalys, Worldwide Unified Communications Call Control Market Q2 2017.

 

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ITEM 1. BUSINESS

Our Company

Avaya is a leading global business communications company, providing an expansive portfolio of software and services for contact center and unified communications, offered on-premises, in the cloud or as a hybrid solution. We provide our solutions to a broad range of companies, from small businesses to large multinational enterprises and government organizations. As of September 30, 2017, we had a presence in more than 100 countries worldwide and during the past three fiscal years we serviced more than 90% of the Fortune 100 organizations. Our products and services portfolio spans software, hardware, professional and support services and cloud services. These fall under two reporting segments:

 

    Global Communications Solutions, or GCS, encompasses our contact center and unified communications solutions and our real-time collaboration software and hardware products, all of which target small and medium to very large enterprise businesses and are delivered through a hybrid cloud environment. Our omnichannel contact center applications offer highly reliable, scalable communications-centric solutions including voice, email, chat, social media, video, performance management and ease of third-party integration that can improve customer service and help companies compete more effectively. Our unified communications solutions help companies increase employee productivity, improve customer service and reduce costs by integrating multiple forms of communications, including telephony, e-mail, instant messaging and video. Avaya embeds communications directly into the applications, browsers and devices employees use every day to create a single, powerful gateway for voice, video, messaging, conferencing and collaboration. We free people from their desktop and give them a more natural and efficient way to connect, communicate and share—when, where and how they want. This reporting segment also includes an open, extensible development platform, which allows our customers and third parties to adapt our technology by creating custom applications and automated workflows for their unique needs and allows them to integrate Avaya’s capabilities into their existing infrastructure and business applications.

 

    Avaya Global Services, or AGS, includes professional and support services designed to help our customers maximize the benefits of using our products and technology. Our services include support for implementation, deployment, training, monitoring, troubleshooting and optimization, among others. This reporting segment also includes our private cloud and managed services, which enable customers to take advantage of our technology on-premises or in a private, public or hybrid (i.e., mix of on-premises, private and/or public) cloud environment, depending on our solution and customer needs. The majority of our revenue in this reporting segment is recurring in nature and based on multi-year services contracts.

Prior to July 2017 when we sold our Avaya Networking business, we had three reporting segments—GCS, AGS and Networking.

As businesses increasingly seek to improve customer experience and team engagement through the quality and efficiency of contact center and unified communications, they are confronted with several industry trends presenting emerging and varied challenges. We believe the key trends are:

 

    the increasing workforce mobility and use of smartphones and mobile tablets by consumers and employees;

 

    shifting priorities of business leaders as they work to digitally transform their companies, including an increased preference for cloud delivery of applications, and management of multiple and varied devices, all of which must be handled with the security the business demands;

 

    increasing demand for information technology (“IT”) purchases under operating expense models over capital expense models; and

 

    the rise of omnichannel customer service as consumers embrace new technologies and devices in creative ways and at an accelerating pace.

 

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We aim to be the leader in our industry in addressing customer needs and priorities resulting from recent trends and emerging challenges. We have invested and continue to invest in open, mobile enterprise communication and collaboration platforms and are poised to serve a broad range of needs, from servicing phone systems to deploying leading-edge contact center technology via the cloud. While we remain committed to protecting and evolving the investments that customers have made in our technology and solutions, in the past several years we have also responded to the emerging landscape by evolving our market and product approach in three important ways.

 

  1) We have invested in R&D and new technologies to develop and provide more comprehensive contact center and unified communications products and services, continuing our focus on the enterprise while expanding the value we can provide to midmarket customers.

 

  2) We have evolved our product design philosophy, anticipating demand for applications that are cloud- and mobile-enabled. We design our products to be flexible, extensible, secure and reliable. This approach allows our customers to transition from traditional communications and collaboration technology to newer solutions that are more manageable and cost-effective.

 

  3) We have increased our focus on delivering integrated holistic solutions including:

 

    Customer Engagementa single, integrated, omnichannel solution consisting of software and services, which are open, context-driven, fully integrated and fully customizable through our open, easy-to-use development platform.

 

    Team Engagementa solution primarily comprised of our real-time collaboration and unified communications products and services (such as audio, web and video conferencing systems, mobile video software, phones and session border controller that increases communications security) and a development environment.

 

    Developer Engagementa flexible development platform and orchestration tool to communications-enable customer applications and workflows across the enterprise. It uses open Application Programming Interfaces, or APIs, pre-built application and workflow tasks and a visual workflow tool to put more power into the hands of the developer.

 

    Analytics Engagementthis solution takes data from relevant, disparate sources and collects, correlates and presents it in a unified interface for meaningful analysis in both instantaneous and historical trending scenarios.

We design and build these engagement solutions for our customers. We define “engagement” as improved team and customer communications and collaboration that lead to a set of tangible outcomes that a business experiences. These tangible benefits include higher employee productivity, customer satisfaction, customer value and, ultimately, profitability.

We take a hybrid cloud approach and believe all organizations, including large enterprises, will have a mix of how they leverage different deployment options to run and operate their applications. We support all of the different cloud models and mixes that exist to enable organizations to select the method that suits their business needs. We expect a continued hybridization of models, allowing our customers to mix and match these environments according to their needs.

With our solutions, we can address the needs of a diverse range of businesses, including large multinational enterprises, small and medium-sized businesses and government organizations. Our customers operate in a broad range of industries, including financial services, manufacturing, retail, transportation, energy, media and communications, hospitality, healthcare, education and government. We employ a flexible go-to-market strategy with direct or indirect presence in more than 100 countries. As of September 30, 2017, we had approximately 6,300 channel partners and for fiscal 2017 our product revenue from indirect sales through our channel partners represented approximately 73% of our total product revenue.

 

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For fiscal 2017 and 2016, we generated revenue of $3,272 million and $3,702 million, of which 44% and 47% was generated by products and 56% and 53% by services, respectively. Revenue from software and services was 78% and 75% of total revenue, and recurring revenue (which we define as revenue from products and services that are delivered pursuant to multi-period contracts) was approximately 56% and 51% for fiscal 2017 and 2016, respectively. Revenue generated in the United States for fiscal 2017 and 2016 represented 55% and 56% of our total revenue, respectively. For fiscal 2017 and 2016, operating income (loss) was $137 million and $(316) million and Adjusted EBITDA was $866 million and $940 million, respectively. For fiscal 2016, operating loss reflected $542 million of impairment of goodwill and intangibles. See “Item 2. Financial Information—Management’s Discussion and Analysis of Financial Condition and Results of Operations—EBITDA and Adjusted EBITDA” for a definition and explanation of Adjusted EBITDA and a reconciliation of loss from continuing operations to Adjusted EBITDA.

In addition, for fiscal 2017 and 2016, revenue outside of the U.S. represented 45% and 44% of total revenue, respectively.

The Benefits of Our Solutions

Avaya combines our products and servicesincluding products, applications and services from our partners—into innovative, comprehensive and customer-focused solutions that help our customers digitally transform their enterprises and address their team, customer, developer and analytics needs. We do this through a flexible approach to deployment, from on-premises to mobile and hybrid cloud environments. We believe our unified communications, contact center, developer and analytics technology help businesses and organizations of all sizes deliver superior customer experiences while increasing productivity and profitability.

Avaya Customer Engagement Solutions

Avaya Customer Engagement Solutions are designed to accommodate the future of fast-paced consumer adoption and to help our customers improve customer experience and maximize customer lifetime value, while expanding communications channels to include chat, email, mobile applications, analytics, video, social, branch offices and more. Our solutions can be implemented relatively quickly by leveraging automation, which helps customers dramatically reduce time-to-value on their investment. Our execution has paid off in increased customer lifetime value, revenue and profitability for our customers, as they evolve to integrate more communications channels and mobile devices into their customer service strategies. These solutions are predominantly made up of our contact center products and services and are supported by our development environment. Some of the benefits of Avaya Customer Engagement Solutions include enabling customers to:

 

    Cultivate the ultimate customer journey by enabling businesses to personalize every step and possibility of customer-agent interactions. This purpose-built, omnichannel solution gives customers complete integration and management of their traditional voice and digital channels, assisted or self-service (i.e., interactive voice response, chatbots, etc.).

 

    Take a holistic view of the customer contact world by addressing customer touchpoints, routing, resource matching, leveraging context and acknowledging preferences—capturing every detail along the way.

 

    Capitalize on big data across the enterprise. Customers can get real-time, fully meshed insights into what’s going on with their customers and break down the silos around traditional analytics tools. Avaya delivers rich visualization of data to support smarter decision-making that shapes business strategies while also driving increased customer satisfaction and improving the agent experience.

Avaya Team Engagement Solutions

Avaya Team Engagement Solutions are designed to offer businesses the simplicity of a single solution to address workforce communication and collaboration needs, including via mobile devices. Our solutions help our

 

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customers build more efficient and responsive businesses, improve workforce productivity and mobility, while allowing employees to securely use a variety of devices and communications channels to collaborate. Some of the benefits of Avaya Team Engagement Solutions include:

 

    Communications modernization: Avaya helps modernize communications ecosystems by centralizing, consolidating and virtualizing underlying technology infrastructures and making applications available via the cloud. This model is built to accommodate mobile device usage, reduce total cost of ownership (“TCO”) for the entire collaboration environment and allows firms to transition from a capital expenditure to operating expenditure model. For example, an Avaya cloud solution can be implemented to integrate virtualized voice, calendar, directory, video, messaging, chat and conferencing capabilities. This enables cloud access to communications tools for desk-based and remote workers and improves security, delivering TCO efficiencies and rapid payback.

 

    Worker productivity: Our conferencing, messaging and other unified communications solutions are designed to help our customers integrate products that support desk-workers, teleworkers and frequent business travelers, thereby increasing the mobility and productivity of their workforce. Our customers are increasingly demanding that individual workers be able to communicate across device types, channels and geographic locations, knowing that their devices, data and connections are reliable and secure. For example, our customers using the Avaya Session Border Controller can securely extend the corporate unified communications capabilities to a remote user on a mobile device and to desk phones in their remote and home offices.

 

    Team productivity: We help our customers improve team productivity by reducing the complexity of team collaboration channels, enabling off-the-shelf and customizable application integration, and providing omnichannel conferencing across audio, web and video for room, desktop and mobile platforms. Our solutions also provide the opportunity to simplify and expand by moving conferencing services into the cloud. For example, Avaya Equinox can enable employees or remote workers to collaborate using high-definition, secure video conferencing accessed through on-premises conference rooms, desktop systems and mobile devices.

 

    Devices: We offer a range of hard-phones with models supporting wideband audio and touchscreens, and video conferencing room systems, making it convenient to collaborate “face-to-face” with colleagues, partners and customers. Our most recent device, Avaya Vantage, is an innovative, all-glass, dedicated desktop device that comes with the superior telephony capabilities such as security, ease of administration, excellent acoustics, and is fully customizable and designed for mobility.

 

    Communications Enabled Business Processes: Embedding communications into the business applications customers use every day makes it easier for employees to find and distribute information, prioritize work and communicate both needs and decisions. With the Avaya Breeze Application Development Platform, customers can integrate unified communications technology and contact center capabilities, including voice, video, text and email into social, mobile and cloud applications, automated workflows for their unique needs, and Avaya’s capabilities into their existing infrastructure and business applications. This application development platform is user-friendly, with no detailed or specialized knowledge of communications protocols required.

Avaya Developer Engagement Solutions

Avaya Developer Engagement Solutions, grounded in Avaya Breeze, enable users to take control of their customer experience, driving more automated and informed workflows that meet the specific needs of the customer interaction, including when and how they want it. Developers can bring disparate systems together seamlessly, as well as embed voice, short message service, or SMS, multimedia messaging service, or MMS, and video collaboration in their existing applications rather than having to develop these capabilities natively.

The Avaya Breeze platform includes a software developer kit (“SDK”); an application store (i.e., Avaya Snapp Store); commercially available Snap-ins that run on Avaya Breeze developed by Avaya, our customers

 

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and our partner network; a cloud-based developer sandbox environment (i.e., Avaya Collaboratory) for building and testing apps; a partner developer community; and a client SDK (i.e., Avaya Breeze Client SDK) that developers can use to develop clients on any device—MacOS, Android, iOS, etc.—as well as for operation on the new Avaya Vantage device.

Another key part of our Developer Engagement Solutions is Zang Cloud, a fully formed communications platform-as-a-service, or CPaaS, offering voice, text message and call recording services as communications-enabling apps and workflows across the enterprise. Zang Cloud makes it easy to integrate “click-to-connect” communication such as chat, voice and SMS into mobile, web or desktop environments. Integrated with Avaya Breeze, Zang Cloud provides a cloud-based or hybrid complement to on-premises UC platforms.

This family of products and solutions, driven by Avaya Breeze, provides the following benefits:

 

    Reduce IT overhead and drive a consistent user experience: Avaya Breeze orchestrates across disparate enterprise applications via open interfaces into one cohesive enterprise workflow.

 

    Reduce the burden on developers: Avaya Breeze leverages predefined tasks via Engagement Designer’s visual-based drag-and-drop tool, re-using the piece parts across multiple applications and workflows. This enables other technology individuals who may lack Java skills to build applications and workflows via this powerful visual design tool.

 

    Enable more cost-effective customer interactions: Reduce costly phone-based interactions by seamlessly inserting multi-channel communications based on preference and context.

 

    Reduce error-prone processes: Avaya Breeze enables developers to intercept inbound and outbound calls and insert intelligence or automate steps based on the context of the interaction. Customers simply set triggers in the platform, which are then activated as part of the workflow in real time.

 

    Drive out the use of costly or risky legacy applications: Customers can replace one-off tools or services by automating and communication-enabling mundane and expensive tasks. This enables them to remove potentially error-prone manual processes across systems.

 

    Enable more expedient use of multi-channel communications: Businesses can leverage web service and publicly available APIs, bringing telephone, web SMS, MMS or video interactions into the customer workflow, just as they would another application or computing device. While they can develop applications from scratch to embed communications with Avaya Breeze, they can also communications-enable existing applications, saving time and money.

Avaya Analytics Engagement Solutions

Avaya Analytics Engagement Solutions provide the information that companies need to optimize their team and customer engagement ecosystems. With this information, businesses can better understand customer preferences, agent performance and system effectiveness as their business grows and evolves. Some of the benefits include:

 

    Omnichannel data silos are integrated: Rigid data models and report writers are made open and customizable.

 

    Publish/Subscribe analytics platform supports a variety of analysis methodologies: The data model is extensible, allowing for enterprise customer and application data to be easily correlated together.

 

    Open, modular analytics platform with data collectors, event processor and rich presentation interface: Ad hoc reports and custom dashboards are available for preferred analysis at any stage of the journey.

 

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Trends Shaping Our Industry

We believe there are a number of key trends shaping our industry and that there is a substantial market opportunity for market participants to capitalize on these trends.

A New Mobile Workforce

The increase in mobile technology has created a world more focused on real-time, flexible and always-on communication. We see companies increasingly looking for ways to make corporate applications and customer information and interaction more accessible via mobile devices as the usage of those devices by workers continues to rise worldwide.

Investment in Digital Transformation

Although we have traditionally sold our products, services and solutions to Chief Information Officers (“CIOs”), our research finds that more and more of the buying decisions are being influenced by Chief Executive Officers (“CEOs”), Chief Marketing Officers (“CMOs”) and Chief Digital Officers (“CDOs”). They are becoming more involved because digital transformation has expanded beyond the data center and IT infrastructure to encompass business operations and customer experiences. CEOs, CMOs and CDOs are recognizing growing customer and employee demand for better interactions across multiple channels, and they see an opportunity to differentiate their companies and lines of business through superior customer experience. We believe the increasing importance of technology as both an internal and external facing presence of the enterprise, as well as the high stakes of data breaches, are reasons CEOs are increasingly engaged in the decision-making process. CMOs and CDOs are gaining additional budget authority as they are tasked with managing customer experience and marketing activities using modern communications technology and rich data. We believe that as a result of this shift in decision-making roles, customer engagement solutions need to provide businesses with better ways to engage with end users securely across multiple platforms and channels, creating better customer experiences and thus higher revenues for the business.

Chief Technology Officers (“CTOs”) and CIOs, we believe, have three critical priorities:

 

  1) Manage the reliable and secure integration of an increasing number and variety of devices and endpoints: Today, business users not only use desk-based devices, but also laptops, smartphones and tablets. Gartner reports from a September 2017 forecast that these devices are growing at a compound annual growth rate of 3.4% for smartphones, and 3.1% for tablets through 2021. To communicate seamlessly and securely across devices, applications and endpoints must be managed as part of an integrated communications infrastructure.

 

  2) Leverage existing technology infrastructure while positioning for the future: The speed at which new enterprise technology enters the market is challenging companies to rapidly adopt and install new technology. We believe this pressure creates strong demand for systems that do not require enterprise-wide overhauls of existing technology. Instead, it favors incremental, flexible, extensible technologies that are easy to adopt and compatible with existing infrastructures. As a result, many customers are in the midst of transitioning from on-premises to cloud-based delivery models.

 

  3) Shift to cloud-based applications: Companies today seek technology that helps them lower TCO and increase deployment speed and application agility, including a variety of public, private and hybrid cloud solutions. They also seek to shift away from a complex, proprietary capital-intensive model to one that is more open and efficient.

Communications Enabled Business Applications

Teams need to work together from any location, using their favorite business applications, and are increasingly accessing these applications via the cloud. Moving in and out of applications to perform communications functions reduces worker productivity. Avaya helps employees get access to real-time information quickly and easily by integrating communications functionality directly into business applications.

 

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Omnichannel Engagement Hubs Replacing Call Centers

Like workforces, the customers of our customers are also increasingly using mobile devices and expecting service interactions with companies across multiple communications channels and devices. Customer interactions are evolving from voice-centric, point-in-time, contact center transactions to ongoing customer conversations over multiple interactions and across multiple media and modes of communication. Customers expect businesses to know about the history of their interactions, even when they occur across a mix of self-service and agent assisted communications methods, including voice, video, email, chat, mobile, web and social media.

Our Large and Growing Addressable Market Opportunity

We believe that the above trends create significant market opportunity for Team, Customer, Developer and Analytics engagement solutions. In addition, we believe the limitations of traditional collaboration products and services and capital-intensive buying models present an opportunity for differentiated vendors to gain market share. We believe that the total available market for these solutions includes spending on unified communications and contact center applications, as well as spending on one-time and recurring professional, managed/cloud and support services to implement, maintain and manage these tools. We believe we can expand our business in some segments such as private cloud and managed services, and other markets that we serve will grow and continue to represent a large opportunity for us. The markets we serve includes large enterprises having 2,000 or more employees, as well as midmarket enterprises having between 100 and 2,000 employees.

These markets are impacted positively by the need for enterprises to increase productivity and upgrade their unified communications strategy to a more integrated approach, accounting for mobility, varied devices and multiple communications channels. In response to this need, we expect that aggregate total spending on unified communications, contact center, developer engagement, analytics, support services, and managed/cloud and professional services will grow.

Furthermore, the midmarket is a growing opportunity for our products and services. We believe the market opportunity for the portion of the midmarket segment which we serve is growing, but we also believe it is underserved and willing to invest in IT enhancements. We have a set of offerings that are specifically designed to address the needs of midmarket businesses and to simplify processes and streamline information exchange within companies. Our set of offerings lets midmarket companies deliver a collaboration experience that integrates voice, video and mobile device communications at price points affordable to them.

Our Competitive Strengths

We believe the following competitive strengths position us well to capitalize on the opportunities created by the market trends affecting our industry.

A Leading Position across our Primary Markets

We are a leader in business communications, with leading market share in worldwide contact center and unified messaging and among the leaders in unified communications and enterprise telephony. Recently, we were named as a Leader in the IDC MarketScape: Worldwide Unified Communications and Collaborations 2017 Vendor Assessment. We are also positioned in the visionaries’ quadrant in each of Gartner’s Magic Quadrants for Unified Communications and Contact Center Infrastructure, Worldwide as of July and May 2017, respectively. Additionally, we believe we are a leading provider of private cloud and managed services. We also believe that our market leadership and our incumbent position within our customer base provides us with a better opportunity to cross-sell to existing customers and win new customers.

Open Standards Technology that Supports Multi-vendor, Multi-platform Environments

Our open standards-based technology is designed to accommodate customers with multi-vendor environments seeking to leverage existing investments. Providing enterprises with strong integration capabilities

 

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allows them to take advantage of new collaboration and contact center technology as it is introduced. It does not limit customers to a single vendor or add to the backlog of integration work. We also continue to invest in our developer ecosystem, Avaya DevConnect, which has grown to include approximately 28,900 members as of September 30, 2017. We believe Avaya DevConnect, together with our APIs and applications development environments allow businesses to derive unique value from our architecture.

Leading Service Capabilities Tied to a Large Recurring Revenue Stream

AGS is a leading provider of recurring support services relating to business communications products. Our worldwide services-delivery infrastructure and capabilities help customers address critical business communications needs from initial planning and design through implementation, maintenance and day-to-day operation, monitoring and troubleshooting. We believe AGS is uniquely positioned as a result of close collaboration between our R&D and service planning teams in advance of new products being released. AGS was a pioneer of the omnichannel support experience in enterprise support: customers can use “Ava,” our virtual agent, to get immediate answers online. They can also connect with one of our experts via web chat, web talk or web video. AGS can also directly access our R&D teams when necessary to quickly resolve customer issues. Avaya service includes proactive and preventive measuring including automated system monitoring and EXPERTS™ automated resolution linked to human expertise when appropriate and included are a wide variety of diagnostics and tools which help optimize performance and uptime for customer systems. These capabilities allow Avaya to provide quality service for Avaya products.

AGS offers a broad portfolio of capabilities through our Professional Services organization, including implementation/enablement services, system optimization, innovation services, management partnership and custom applications development.

In addition, AGS delivers private cloud and managed services with a focus on customer performance and growth. These services can range from managing software releases to operating customer communication systems to helping customers migrate to next-generation business communications environments. We believe that our deep understanding of application management supporting unified communications, contact center and video uniquely position us to best manage and operate cloud-based communications systems for our customers.

We believe our personnel are the best in the industry, trained by the best in the industry and supported by the best in the industry. Award winning levels of customer satisfaction for support transactions are a testament to the asset which is our people. These dedicated professionals have shown, time and again, their passion for satisfying customer needs, driving proactive and preventive agenda to help customers maintain optimum levels of service.

Our service delivery is most often provided to customers through recurring contracts. In fiscal 2017, we generated 56% of our revenues from services with 83% of service revenues from recurring contracts. Recurring contracts for support services typically have terms that range from one to five years, and contracts for private cloud and managed services typically have terms that range from one to seven years. In fiscal 2017, the U.S. accounted for approximately 60% of our revenue for support service. We believe our services relationships have provided us with a large recurring revenue base and significant visibility into our customers’ future collaboration needs.

Lower Total Cost of Ownership

Many vendors try to address customer demands by layering on more architectures and protocols. In the process, they frequently sacrifice simplicity, flexibility and TCO. In contrast, our products and services are able to address these needs with less hardware and without sacrificing performance, which when combined with our deployment methods, we believe help contribute to a lower TCO for Team and Customer Engagement solutions.

 

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Large, Diverse and Global Customer Installed Base

Our products and services address the needs of a diverse range of customers from large multinational enterprises to small and medium-sized businesses in various industries, including financial services, manufacturing, retail, transportation, energy, media and communications, health care, education and government. As of September 30, 2017, we had a presence in more than 100 countries worldwide and during the past three fiscal years we serviced more than 90% of the Fortune 100. We believe our large and diverse customer base provides us with recurring revenue and the opportunity to further expand within our customer base.

Our Growth Strategy

We believe we are well-positioned worldwide and have a multi-faceted strategy to capture a significant share of the technology refresh cycle being driven by digital transformation and the industry’s focus on omnichannel, workflow automation and cloud-based solutions.

Expand our Cloud Offerings and Capabilities

In our experience, technology and business leaders are increasingly turning to cloud-based technologies and business models that allow enterprises to cut costs, increase productivity, simplify IT environments and shift when possible to subscription-based models.

We are investing in a strategy to expand our hybrid cloud solutions and to deliver a complete portfolio of technologies that consist of Customer Engagement, Team Engagement, Developer Engagement and Analytics Engagement solutions across on-premises, private, public and hybrid cloud development models.

Increase Mobility Offerings to Customers

As global workforces change and demand mobile engagement solutions, we intend to meet these demands. For example, the Avaya Aura Platform and Avaya IP Office Platform are designed to support mobility, providing dynamic access to applications and services based on need, not location.

Invest in Open Standards, Product Differentiation and Innovation

As potential customers look to migrate to our products and services, our open architecture can integrate with incumbent competitor systems and provide a path for gradual transition while still achieving cost savings and improved functionality.

During fiscal 2017, we enhanced our product line with 70 new product releases. We also expect to continue to make investments in product innovation and R&D across the portfolio to create enhancements and breakthroughs. We believe this will encourage customers to upgrade their products more frequently. We also plan to continue embracing cloud computing and mobility opportunities, and to seek new ways to leverage the virtual desktop infrastructure trend to securely deliver business communications to users.

Expand our Services Business

We are working to broaden the options for cloud-based service offerings, expand our consulting services capabilities and to upsell the installed base to our private cloud and managed services offerings. We also strive to provide more options along the spectrum of our existing service offerings for customers who want such services. We are constantly improving our tools and infrastructure to improve the service levels we provide. Our custom applications development team also currently has a backlog of customer-funded applications development opportunities that we are working to monetize.

 

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Increase our Midmarket Offerings, Capabilities and Market Share

We believe our communications market opportunity for the portion of the midmarket segment which Avaya serves is growing. We define the midmarket as firms with between 100 and 2,000 employees. Not only do we believe this segment is growing, but we believe midmarket businesses are underserved and willing to invest in IT enhancements. We intend to continue to invest in our midmarket offerings and go-to-market resources to increase market share and meet the growing demands of this segment.

Increase Sales to Existing Customers and Pursue New Customers

We believe that we have a significant opportunity to increase our sales to our existing customers by offering new solutions from our diverse product portfolio, including cloud and mobility solutions. This ability is supported by our market leadership, global scale and extensive customer interaction, including at the C-suite, and creates a strong platform from which to drive and shape the evolution of enterprise communications. Our track record with our customers gives us credibility that we believe provides us with a competitive advantage in helping them cope with this evolution. In addition, we believe our refreshed product and services portfolio provides increased potential for acquiring new customers.

Invest in Sales and Distribution Capabilities

Our flexible go-to-market strategy, which consists of both a direct sales force and approximately 6,300 channel partners as of September 30, 2017, allows us to reach customers across industries and around the globe while allowing them to interact with Avaya in a way that fits their organization. We intend to continue investing in our channel partners and sales force to optimize their market focus, enter new vertical segments and provide our channel partners with training, marketing programs and technical support through our Avaya Edge program. We also leverage our sales and distribution channels to accelerate customer adoption and generate an increasing percentage of our revenue from our new high-value software products, video collaboration, midmarket offerings and user experience-centric applications.

Expand Margins and Profitability

We have maintained our focus on profitability levels and implemented a number of cost savings initiatives. These initiatives, along with decreases in the amortization of acquired technology intangible assets, have contributed to improvements in our gross margin. Our gross margin has improved from 59.5% in fiscal 2015 to 61.1% in fiscal 2017. This improvement in gross margin along with other cost savings is also reflected in Adjusted EBITDA, a key metric management uses to evaluate our performance. Adjusted EBITDA as a percentage of revenues improved from 22.1% in fiscal 2015 to 26.5% in fiscal 2017. See “Item 2. Financial Information—Management’s Discussion and Analysis of Financial Condition and Results of Operations—EBITDA and Adjusted EBITDA” for a definition and explanation of Adjusted EBITDA and a reconciliation of loss from continuing operations to Adjusted EBITDA.

We expect to pursue additional cost reduction opportunities which are likely to be more targeted and may include increased automation of our processes, headcount attrition, actions to address unproductive assets, real estate consolidation, sales back office and front line skill transformations and balancing our professional services structure. For example, in July 2017, we sold our Networking business, which had underperformed our other two segments in EBITDA and Adjusted EBITDA. Having delivered substantial cost structure reductions over the past several years, we believe the opportunities for additional savings and execution of our growth strategy can result in further margin and profitability expansion.

 

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Our Products and Services

Overview

Avaya possesses diverse product and services portfolios and combines individual products and services to solve customer challenges. The products and services that make up these solutions are organized in two reporting segments: GCS and AGS, as described above.

The majority of our product portfolio is made up of software products that reside with either a client or server. Our client software resides on both our own and third-party devices, including desk phones, tablets, laptops and smartphones. It provides users with access to unified communications capabilities such as voice and video calling, audio conferencing, instant messaging and contact directories. Our server-side software controls communication and collaboration for the enterprise. It delivers rich value-added applications such as messaging, telephony, voice, video and web conferencing, mobility and customer service. Our hardware includes a broad range of desk phones, servers and gateways. A portion of our portfolio has been subjected to rigorous interoperability and security testing and is approved for acquisition by the U.S. Government. Avaya’s portfolio of services includes product support, integration, private cloud and managed services as well as professional services that enable customers to optimize and manage their communications networks worldwide and achieve enhanced business results.

Global Communications Solutions

Enterprises of all sizes depend on Avaya for unified communications, collaboration, and contact center applications and technology that help improve efficiency, engagement and competitiveness. Our people-centric products integrate voice, video and data, enabling users to communicate and collaborate in real-time, in the mode best suited to each interaction. This eliminates inefficiencies in communications to help make organizations more productive and responsive.

The following is a representative list of products included in the GCS reporting segment:

Conferencing and Video

 

    Avaya Equinox Conferencing: Avaya Equinox provides a single platform supporting all the different modes of conferencing. High-scale audio conferencing, extensive web collaboration, rich multi-vendor HD video, along with event streaming to 100,000 users in an all-in-one solution. Users have one login and one easy solution to learn for all conferencing requirements.

 

    Avaya Scopia XT Video Conferencing Endpoints: Dedicated hardware video conferencing endpoints ranging from immersive multi-stream telepresence and conference room systems to dedicated desktop systems.

 

    Avaya Equinox Client: The Avaya Equinox client is a soft phone application that provides access to UC and conferencing on Windows, MacOS, iOS, Android and Avaya Vantage devices.

The Equinox “mobile-first” user experience with the unique “Top of Mind” screen aggregates all communications activity—meeting calendar, instant messaging, send and access messages for text, audio, video, images and files, call history—for single touch, rapid response. Important activities are displayed in the Top of Mind screen where one can see at a glance when their next meeting is, who called or instant messaged. Single touch response enables rapid return calls, instant messages, or IMs, and video sessions, along with the ability to easily join and invite colleagues to secure online meetings with rich collaboration tools. Equinox also supports easy escalation. For example, an instant message can migrate to a full multiparty collaboration session. The Favorites and Contacts lists, combined with real-time presence, makes tracking down and engaging colleagues fast and effective.

 

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Communications and Messaging

 

    Avaya one-X Communicator and one-X Mobile: Ideal for users who communicate frequently, manage multiple calls, set up ad-hoc conferencing and need to be highly reachable, Avaya one-X Communicator software provides users with access to unified communications capabilities including voice and video calling, audio conferencing, instant messaging and presence, corporate directories and communication logs. Avaya one-X Mobile software enables users to access enterprise communications from a wide selection of mobile devices, including high-end smart phones and tablets. A choice of one-X Mobile clients is available for popular platforms including iOS and Android.

 

    Avaya Client Applications: Software that provides access to Avaya voice and video services from business applications such as Microsoft Skype for Business/Microsoft Lync, Microsoft Office Communications Server, Microsoft Outlook, Microsoft Office, IBM Sametime and customer relationship management applications such as Salesforce.com and Microsoft Dynamics.

 

    Avaya Aura Messaging: Unified messaging software that gives users access to email, voicemail and fax from a single interface. It uses an all-Linux platform with local survivability and geo-redundant capabilities to serve large distributed or centralized configurations, with the option to store messages in an Avaya and/or Microsoft Exchange message store.

 

    Avaya Equinox for Web: Avaya Equinox for Web is a browser extension that embeds access to Avaya communications and collaboration tools, including voice and video calling, phone control, IM and presence, into web environments, including standard browsers like Microsoft Internet Explorer or Google Chrome and web applications like Salesforce.com, Google Apps or Microsoft Office 365.

Platforms, Infrastructure and Phones

 

    Avaya Equinox: Avaya Equinox enables a single, unified, device agnostic experience that lets employees communicate and collaborate on any device from any location at any time.

Equinox delivers next generation unified communications between employees, customers, partners and colleagues through voice and video calling, presence, IM and meetings. Equinox includes collaboration tools such as screen and application sharing, a virtual whiteboard and online meeting spaces including streaming and can be accessed from virtually any location or device—everything to keep active employees connected, engaged and productive.

 

    Avaya Aura Core: Avaya Aura Core is a next-generation architecture powering our customers’ communications and collaboration services. Based on Internet-Protocol Multimedia System, or IMS, an industry standard defined by the 3rd Generation Partnership Project, this core provides a flat communications control and management function using Session Initiation Protocol, or SIP, methods. Unlike point-to-point SIP, or even standard client server SIP approaches used by most of our competitors, the Avaya Aura Core uses the Session Initiation Protocol IMS Service Control signaling standard to allow multiple independent applications to serve communication sessions. Avaya Aura Core can scale to hundreds of thousands of users, serving the small enterprise all the way through the largest enterprise customers in the world.

The Avaya Aura Core virtualized approach allows it to be very flexible in deployment models, from operating on-site at the customer location, to running in public clouds like Amazon Web Services. It supports multiple hypervisors and provides the customer with a variety of choices, including perpetual and subscription licensing models. It can also be delivered as a service from Avaya.

 

   

Avaya IP Office: Avaya IP Office is a unified communications software solution designed specifically for midmarket customers. Avaya IP Office offers significant deployment and licensing flexibility. It can be deployed on-premises or in the cloud with licensing models ranging from perpetual to subscription models. It was designed to simplify processes and streamline information exchange within companies. Communications capabilities can be added as needed. The latest version of Avaya IP Office (10.1) gives

 

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midmarket customers features and functions that large enterprises use, but at a scale that is efficient and affordable for them. Avaya IP Office delivers a seamless collaboration experience across voice, video and mobility for up to 3,000 users.

 

    Avaya Session Border Controller, or SBC, for Enterprise: SBC provides enhanced security for collaboration within and outside of the enterprise, helping to protect SIP trunks from multiple threats and allowing SIP remote users to simply and securely connect communication and collaboration applications to the enterprise without the need of VPN connection. This is made up of hardware, software or both.

 

    Avaya Vantage: Avaya Vantage is a new dedicated desktop communications device that integrates voice, video, chat and collaboration apps. The all glass device has no mechanical buttons, offers signature unmatched audio quality and an optional corded or cordless handset. Avaya Vantage is a convenient and cost-effective platform to provide vertical and use-case specific client interfaces developed with the Avaya Breeze Client SDK.

 

    Avaya Phones: Avaya’s range of phones and portable technologies include internet protocol (“IP”) and digital desk phones, digital enhanced cordless telecommunications, or DECT, handsets, wireless phones and conference room phones. Avaya phones offer capabilities such as touch screen and applications such as integration to corporate calendar, directory and presence, enhanced audio quality for a “you-are-there” experience, customization and soft keys, and multiple lines appearances.

Assisted Customer Experience Management

 

    Avaya Oceana: This is our newest family of customer engagement software solutions built on the Avaya Breeze platform. It delivers omnichannel engagement across voice, chat, email, mobile, co-browsing and social media channels. Customers can be matched to agents based on key attributes and agents are provided with full visibility of the context of previous customer interactions. Avaya Oceana also provides visual workflow automation for customer journey-driven experiences that generate customer loyalty, retention, share of wallet and repeat business. It extends channels, workspaces, analytics and workflows to provide unprecedented flexibility, and enables organizations to customize the solution for their exact use cases.

 

    Avaya Aura Call Center Elite: With intelligent routing and resource selection features, Avaya Aura Call Center Elite allows a business to determine if its customers should be served by the least busy agent, the first available agent or the agent with skills that best match the customer’s needs. Calls can be routed across a pool of agents regardless of physical location. Avaya Oceana is complementary to this offer, providing a complete voice and omnichannel solution.

 

    Avaya Aura Contact Center: Avaya Aura Contact Center lets customers connect with a company in ways beyond phone calls, including via text, IM, email and chat. The omnichannel call center solution gives agents the context (real-time and historical) to deliver a differentiated customer experience. It is designed to provide a unified, efficient and highly personalized experience that builds brand and customer loyalty.

 

    Avaya IP Office Contact Center: A contact center software solution designed specifically for midmarket business needs. It enables seamless conversations for hundreds of agents across multiple modes of communication, including voice, email, chat, text and fax.

 

    Avaya Contact Center Select: This advanced software provides enterprise-level contact center capabilities to midmarket clients on the Avaya IP Office platform. It provides, among other things, omnichannel support (voice, email, chat, SMS and fax) scalability for 30-250 agents and skills-based routing.

Automated Experience Management

 

    Avaya Aura Experience Portal: The Avaya Aura Experience Portal enables organizations to connect with customers in new ways and take advantage of all the popular mobile channels, including SMS text and mobile phones. The product enables customers to connect with agents using their favorite channels and devices and gives them powerful, unique service experiences with multi-party conferencing, intelligent routing and pre-identified customer preferences.

 

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    Avaya Proactive Contact: This enables firms to optimize outbound customer care, like payment reminders, announce product enhancements, explain service changes and deliver surveys, with best-in-class predictive dialing.

 

    Avaya Proactive Outreach Manager: Avaya Proactive Outreach Manager lets customers of a business choose when and where they want to connect and whether it is via mobile, online, in store or over the phone.

Analytics

 

    Avaya Oceanalytics: Avaya Oceanalytics is a modular, flexible and extensible analytics and reporting platform which provides a single, comprehensive view of customer interactions across all sources, including Avaya and non-Avaya systems. It enables additions of other data sources as needed to allow processing and analysis of data across real-time and historical systems for visualization of data and support for feeding data into many existing, modern visualization tools.

Performance Management

 

    Avaya Aura Workforce Optimization: Avaya Aura Workforce Optimization is designed to give firms a deeper, more meaningful look at customer interactions by uniting all workforce optimization requirements under one, integrated platform. Firms can use this to capture, share and act on information from across the enterprise—especially contact centers and back-office systems—and use the data to make informed decisions faster.

 

    Avaya Workforce Optimization Select: Avaya Aura Workforce Optimization Select, or AWFOS, delivers flexible, scalable, midmarket and enterprise workforce optimization capabilities that enable contact centers to improve agent performance at every interaction, improving the overall customer experience contact centers deliver at one of the industry’s lowest TCO profiles. AWFOS includes Voice and Non-Voice Recording, Quality Management, Performance Management, Live Call Monitoring, Screen Capture, Coach and Learn, Reporting and Workforce Management (third-party integration with Teleopti).

AWFOS seamlessly connects to Avaya Oceana, Avaya Aura Call Center Elite, Avaya Aura Contact Center, Avaya Contact Center Select, Avaya IP Office Contact Center, Avaya Proactive Outreach Manager and Avaya Proactive Contact.

 

    Avaya Call Management System: Avaya Call Management System is designed for businesses with complex contact-center operations and high call volume. Call Management System is a database, administration and reporting application to help businesses identify operational issues and take immediate action to solve them.

 

    KnoahSoft Harmony: KnoahSoft Harmony gives contact centers enterprise-level interaction recording, quality, performance and workforce management, and analytics functionality with the lowest TCO. Harmony is a secure web-based platform that is seamlessly integrated with Avaya Aura Call Center and Avaya Contact Center Select from end-to-end to provide the ultimate in flexibility, scalability and ease of use.

Cloud Enablement Products

 

    Unified Communications as a Service (“UCaaS”), Contact Center as a Service (“CCaaS”), Video as a Service (“VaaS”) and PodFX: The CCaaS, UCaaS and VaaS products are software reference architectures that use multi-tenant control technology and virtualized communications platforms to extend Avaya’s industry leading contact center, unified communications and video products to the cloud, allowing third parties to make them available as a service. PodFx is a hardware delivery mechanism for the solutions, available for partners who want a fully-installed solution.

 

   

Avaya Aura Control Manager: Aura Control Manager is a cloud-based product for centralizing administration and management for Avaya contact centers. This product is designed to allow a customer to

 

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easily update call center functions and business processes across the entire organization. Administrators can apply rules and definitions using as little as a single keystroke, allowing quick and error-free changes to agents, skills, call flows, interactive voice response prompts and more.

 

    Powered By: Partner hosted Avaya IP Office, Avaya IP Office Contact Center and Avaya Contact Center Select software are comprised of Avaya’s proprietary software hosted by a partner in its datacenter and resold as the partner’s service offering to end customers. It leverages Avaya’s unique hybrid cloud solutions for seamless integration and migration between a customer’s premises-based solution and cloud-delivered services.

 

    Avaya Equinox Meetings Online: Avaya Equinox Meetings Online is a cloud service hosted by Avaya where customers can purchase virtual HD video meeting rooms in the cloud for a monthly fee or through an annual contract. Users can connect with Windows, MacOS, iOS and Android devices along with video conferencing rooms systems.

 

    Avaya Collaboratory: Avaya Collaboratory is an Avaya cloud-based execution and test environment intended for development of non-production, proof-of-concept Collaboration Environment services.

Developer Engagement Products

 

    Avaya Breeze: Avaya Breeze is a software platform that simplifies embedding robust communications and collaboration capabilities into business applications, such as customer relationship management or enterprise resources planning. This platform allows customers, third parties and Avaya to create customized engagement applications and environments to meet unique needs. Customers and third parties can integrate business applications with unified communications technology and contact center capabilities including voice, SMS and email.

 

    Avaya Breeze Client SDK: Avaya Breeze Client SDK provides a common, developer-friendly set of tools that allows customers and developers to build innovative user experiences. Any and all functionality Avaya uses in its own clients and applications is available to developers through the SDK. Developers can now mix and match functionality that has previously been siloed.

 

    Zang Cloud: Zang Cloud is a fully formed CPaaS platform offering voice, text message and call recording services as communications-enabling applications and workflows across the enterprise.

 

    Avaya Snapp Store: Avaya Snapp Store is a focused online e-commerce-enabled marketplace for Avaya Breeze Snap-in applications and services from Avaya and our growing developer ecosystem. The Avaya Snapp Store is an online store where enterprise line of business and IT professionals can browse, register and purchase Snap-ins for Avaya Breeze from Avaya and third-party application developers.

The store makes it easier for customers to find, design, try and rollout relevant solutions in months, not years. Developers can innovate business applications with Avaya’s full stack of communication capabilities. The store is a direct channel for developers to monetize the value they create.

Avaya Global Services

The Company’s AGS portfolio consults, enables, supports, manages, optimizes and even outsources enterprise communications products (applications and networks) to help customers achieve better business outcomes both directly and through partners. Avaya’s portfolio of services is designed to enable customers to mitigate risk, reduce TCO and optimize communication products. AGS is supported by patented design and management tools, and by network operations and technical support centers around the world.

The Company’s AGS portfolio is divided into Avaya Professional Services (“APS”) and Avaya Client Services (“ACS”).

 

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Avaya Professional Services

APS helps organizations leverage technologies effectively to meet their business objectives. Our strategic and technical consulting, as well as deployment and customization services, help customers accelerate business performance and deliver an improved customer experience. Whether deploying new products or optimizing existing capabilities, APS leverages its specialists globally across three core areas:

 

  1) Enablement Services: Provide access to expertise and resources for planning, defining and deploying Avaya products to maximize technology potential, simplify business processes, improve security and minimize risk. Avaya integrates and tests equipment, trains employees and deploys a plan to help ensure success.

 

  2) Optimization Services: Help drive increased value and improved business results by leveraging customers’ existing technology. Avaya advanced solution architects analyze a communications environment in the context of customer business priorities, recommend enhancements and implement proven best practices.

 

  3) Innovation Services: Help identify improved methods for using communications and collaboration to increase business productivity, employee efficiency and customer service levels. Our consultative approach, deep industry experience and custom application services, from business planning through to execution and product integration, are designed to create alignment with customer’s specific business objectives.

Avaya Client Services

ACS is a market-leading organization offering support, management and optimization of enterprise communications networks to help customers mitigate risk, reduce TCO and optimize product performance. ACS is supported by patented design and management tools, and by network operations and technical support centers around the world. The contracts for these services range from one to multiple years, with three-year terms being the most common. Custom or complex services contracts are typically five years in length. The portfolio of ACS services includes:

 

    Global Support Services: Provides a comprehensive suite of support options both directly and through partners to proactively resolve issues and improve uptime. Global Support Services offers and capabilities include 24x7 remote support, proactive remote monitoring, sophisticated diagnostic tools, parts replacement and on-site response.

Recent innovations include our Avaya Support Web site that quickly connects customers to advanced Avaya technicians via live chat, voice or video. The web site also provides access to “Ava,” an interactive virtual chat agent based on Avaya Automated Chat that quickly searches our knowledge base and a wide range of “how-to” videos to answer customer support questions. Ava learns with each customer interaction and can make the decision to transition the chat to an Avaya technician—often without the customer realizing the change is taking place.

All new support solutions are published to the web by our engineers, generally within 30 minutes of finding a resolution, adding value for customers by providing known solutions for potential issues rapidly. Most of our customers also benefit from Avaya EXPERT Systems, which provides real-time monitoring of diagnostic and system status. This solution proactively identifies potential issues to improve reliability, uptime and faster issue resolution.

 

    Avaya Private Cloud Services and Avaya Enterprise Cloud and Managed Services: Private cloud and managed services can be procured in standard packages or in fully custom arrangements that include on-premises or private cloud options, Service Level Agreements, billing and reporting.

Avaya can also manage existing infrastructure from nearly any communications vendor. Many customers leverage this model as a way to manage existing complex environments. Customers are also provided with the

 

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option of upgrading to the latest technology through a recurring operational expense, rather than a one-time capital expenditure.

Our Technology

Avaya technology enhances the way people communicate and collaborate, enabling Team, Customer, Developer and Analytics Engagement solutions. Instead of having to coordinate multiple, independent media and communications systems, customers can use Avaya technology and open standards to create an environment where multiple media and resources can be brought into a seamless and flexible user experience. This supports more fluid, effective and persistent collaboration across media such as voice, video and text and modes of communications such as calls or conferences, and fixed and mobile infrastructures and devices.

While our products have traditionally been deployed on a customer’s premises, many can now also be deployed in public, private and hybrid cloud models. Further, through comprehensive monitoring technologies, these products and services can also be consumed by our customers as managed services.

Multimedia Session Management

At the core of our architecture, SIP-based Avaya Aura Session Manager centralizes communications control and application integration. Applications are decoupled from the network and can be deployed to individual users based on their need, rather than by where they work or the capabilities of the system to which they are connected. This allows for extreme scalability, with the Avaya Aura Session Manager currently capable of handling up to 350,000 devices per system and over 2,000,000 busy hour call completions.

Unique End User Experiences

Avaya Equinox was awarded the Communications Solutions Product of the Year Award by Technology Marketing Corporation in July 2017. It is Avaya’s most advanced solution for employee communication and collaboration. Deployable either on-premises or from the cloud, the client integrates multimedia calling with voice/video/web conferencing or enterprise directories and messaging platforms. It can be deployed in Microsoft Windows, Apple MacOS and iOS, and Google Android environments.

The Avaya Breeze platform is software that abstracts the core Avaya Aura system and allows customers and developers with common web and JAVA programming skills to develop innovative applications that embed communications into their existing infrastructure and business applications. For example, a customer escalation registered in an insurance claims application could start an Avaya Engagement Development platform workflow that would automatically find and join the customer, claims adjuster and claims manager via email or SMS and bring them into a video conferencing session. This ability to invoke and combine communications functions allows our customers to generate more business value from their Avaya products as they continue to deploy more integrated workflow functions.

Management and Orchestration

Simple and consistent management and operations are essential to customers. We believe our management products facilitate efficient operations and better overall performance, covering a wide range of functions, from initial provisioning to monitoring and orchestration of components to enable networking of communications services.

Additional Technologies

We also use technologies including:

 

    Assured Services SIP: Assured Services SIP allows for communications sessions to be prioritized by session urgency consistent with industry standards. This capability is often featured in military grade networks, or in secure communication networks often used by security sensitive government agencies.

 

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    Messaging and Presence via SIP/SIMPLE and XMPP: The Avaya Aura Presence Services collects, aggregates and disseminates rich presence and enables instant messaging, including using SIP/SIMPLE and XMPP, which provide interoperability with systems from other vendors, such as Microsoft and IBM.

 

    Cross Operating System Support: Our client software applications run on a broad range of operating systems including, but not limited to, Microsoft Windows, Apple MAC OS/iOS and Google Android. We also support virtualization to reduce the physical server footprint using hypervisor technology to run multiple applications concurrently on a single physical platform, as well as to facilitate certain tasks such as system expansion or recovery.

 

    High Quality/Low Bandwidth Video: Avaya’s video products and services deliver high quality video while minimizing bandwidth consumption and responding to adverse network conditions such as congestion or packet loss.

 

    WebRTC: This is a new and evolving technology that Avaya is leveraging to develop a new generation of unified communications. WebRTC allows for communication clients to be supported directly from HTML 5 browsers. Voice and video are embedded in web applications, allowing ubiquitous access to these media.

Alliances and Partnerships

Avaya has formed commercial and partnering arrangements through global alliances to expand the availability of our products and services and enhance the value derived by customers. Global alliances are strategically oriented commercial relationships with key partners. We have three primary types of Global alliances: Global Service Provider alliances, Global Systems Integrator alliances and Ecosystem alliances.

 

  1) Global Service Provider alliances are partnering arrangements with leading telecommunications service providers, such as AT&T, for enterprise communications and collaboration. We pursue sell-to and sell-through opportunities for Avaya products and services. These alliances are integral in selling and implementing our cloud-based services. We also see them as a principal route to market for our UCaaS and CCaaS solutions.

 

  2) Global Systems Integrator alliances are identical in nature to our Global Service Provider alliances, except that these are forged with systems integrator partners, such as IBM.

 

  3) Ecosystem alliances are partnering arrangements by Avaya with IT and telecommunications industry leaders, such as ConvergeOne, to bring to our joint customers solutions that leverage our combined range of products and services.

As of September 30, 2017, there were approximately 6,300 channel partners serving our customers worldwide through Avaya Edge, our business partner program. Through the use of certifications, the program positions partners to sell, implement and maintain our communications systems, applications and services. Avaya Edge offers clearly defined partner categories with financial, technical, sales and marketing benefits that grow with levels of certification. We support partners in the program by providing a portfolio of industry-leading products in addition to sales, marketing and technical support. Although the terms of individual channel partner agreements may deviate from our standard program terms, our standard program agreements for resellers generally provide for a term of one year with automatic renewal for successive one-year terms. They may generally be terminated by either party for convenience upon 30 days prior notice, and our standard program agreements for distributors may generally be terminated by either party for convenience upon 90 days prior notice. Certain of our contractual agreements with our largest distributors and resellers, however, permit termination of the relationship by either party for convenience upon prior notice of 180 days. Our partner agreements generally provide for responsibilities, conduct, order and delivery, pricing and payment, and include customary indemnification, warranty and other similar provisions. No single channel partner represented more than 10% of total Company revenue during each of the last three fiscal years.

 

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Development Partnerships

The Avaya DevConnect program is designed to promote the development, compliance-testing and co-marketing of innovative third-party products that are compatible with Avaya’s standards-based products. Member organizations have expertise in a broad range of technologies, including IP telephony, contact center and unified communications applications.

As of September 30, 2017, approximately 28,900 companies have registered with the program, including more than 370 companies operating at higher program levels, eligible for technical support and to submit their products or services for compatibility testing by the Avaya Solution Interoperability and Test Lab, or Avaya Test Lab. Approximately 290 of these companies have been specifically designated as Technology Partners. Avaya Test Lab engineers work in concert with each submitting member company to develop comprehensive test plans for each application to validate the product integrations.

Customers, Sales and Distribution

Customers

We have a diverse customer base, ranging in size from small businesses employing a few employees to large government agencies and multinational companies with over 100,000 employees. As of September 30, 2017, we had a presence in more than 100 countries worldwide and during the past three fiscal years we serviced more than 90% of the Fortune 100. Our customers operate in a broad range of industries, including financial services, manufacturing, retail, transportation, energy, media and communications, hospitality, health care, education and government. They represent leading companies from the Forbes Global 2000 from industries such as airlines, auto & truck manufacturers, hotels & motels, major banks and investment services firms. We employ a flexible go-to-market strategy with direct or indirect presence in more than 100 countries. As of September 30, 2017, we had approximately 6,300 channel partners and for 2017 our product revenue from indirect sales through our channel partners represented approximately 73% of our total product revenue.

Sales and Distribution

Our global go-to-market strategy is designed to focus and strengthen our reach and impact on large multinational enterprises, midmarket and regional enterprises and small businesses. Our go-to-market strategy is intended to serve our customers the way they prefer to work with us, either directly with Avaya or through our indirect sales channel, which includes our global network of alliance partners, distributors, dealers, value-added resellers, telecommunications service providers and system integrators. Our sales organizations are equipped with a broad product and software portfolio, complemented with services offerings including product support, integration and professional, private cloud and managed services.

We continue to focus on efficient deployment of Avaya sales resources, both directly and through our channel partners, for maximum market penetration and global growth. Our investment in our sales organization includes sales process, skills and solutions curricula for all roles within our sales organization.

Research and Development

We make substantial investments in R&D to develop new systems, services and software in support of business communications, including, but not limited to, converged communications systems, communications applications, multimedia contact center innovations, collaboration tools, messaging applications, video, speech enabled applications, business infrastructure and architectures, converged mobility systems, cloud offerings, web services, communications-enabled business processes and applications, and services for our customers. Since 2012 we have invested more than $2 billion in R&D, including over $275 million of technology acquisitions.

We invested $229 million, $275 million and $338 million in fiscal 2017, 2016 and 2015, respectively, in R&D. Although investment in R&D has decreased over the past three years, investment in R&D as a percentage of product revenue has been consistent between 15.7% and 16.7%.

 

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Manufacturing and Suppliers

We have outsourced substantially all of our manufacturing operations to several contract manufacturers. Our contract manufacturers produce the vast majority of our products in facilities located in southern China, with other products manufactured in facilities located in Israel, Mexico, Taiwan, Germany, Ireland and the U.S. All manufacturing of our products is performed in accordance with detailed specifications and product designs, furnished or approved by Avaya, and is subject to rigorous quality control standards. We periodically review our product manufacturing operations and consider changes we believe may be necessary or appropriate. We also purchase certain hardware components and license certain software components from third-party original equipment manufacturers, or OEMs, and resell them separately or as part of our products under the Avaya brand. The Restructuring has not materially affected our outsourcing of manufacturing operations and purchasing, licensing and reselling of hardware and software components.

In some cases, certain components are available only from a single source or from a limited number of suppliers. Delays or shortages associated with these components could cause significant disruption to our operations. We have also outsourced substantially all of our warehousing and distribution logistics operations to several providers of such services on a global basis, and any delays or material changes in such services could cause significant disruption to our operations. For more information on risks related to products, components and logistics, see “Item 1.A. Risk Factors—Risks Related to Our Business—We rely on third-party contract manufacturers and component suppliers, some of which are sole source and limited source suppliers, as well as warehousing and distribution logistics providers.”

As our business and operations related relationships have expanded globally, certain operational and logistical challenges, changes in economic or political conditions or natural disasters, in a specific country or region, could negatively affect our revenue, costs, expenses or financial condition or those of our channel partners and distributors. We believe we maintained strong relationships during the Bankruptcy Filing and have continued to do so following the Emergence Date.

Competition

As a provider of team and customer engagement solutions—made up of unified communications and real-time collaboration products, call center applications and services—we believe we are differentiated from any single competitor.

For the sale of unified communications products and services, specifically in the enterprise segment, we compete with companies such as Cisco, Microsoft, NEC, Unify, Alcatel-Lucent (now Nokia) and Huawei. In the midmarket we compete with companies such as ShoreTel and Mitel. In cloud products and services we compete with companies such as Cisco, Broadsoft, Microsoft, 8x8, RingCentral, ShoreTel and Mitel. Our video products and services compete with companies such as Cisco, Polycom, Huawei, ZTE, Vidyo, Blue Jeans and LifeSize (now a division of Logitech International S.A.).

Our contact center products and services compete with companies such as Genesys Telecommunications Laboratories (Genesys), Cisco, Huawei, Enghouse Interactive and Mitel in the enterprise segment. In the midmarket, as well as cloud products and services, we compete with companies such as Cisco, Genesys, Five9 and NICE.

We face competition in certain geographies with companies that have a particular strength and focus in these regions, such as Huawei and ZTE in China, Intelbras in Latin America and Matsushita Electric in Asia.

While we believe our global, in-house end-to-end services organization as well as our indirect channel provide us with a competitive advantage, we face competition from companies offering products and services directly or indirectly through their channel partners, as well as resellers, consulting and systems integration firms and network service providers.

 

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Technological developments and consolidation within the industry, as well as changes in the products and services that we offer, result in frequent changes to our group of competitors. The principal competitive factors applicable to our products and services include:

 

    perceived and real value of the products and services as paths to solving meaningful team and customer engagement challenges;

 

    perceived and real ability to integrate various products into a customer’s existing environment, including the ability of a provider’s products to interoperate with other providers’ business communications products;

 

    the ability to offer on-premises or cloud products and services, with all services available via mobile;

 

    product features, performance and reliability;

 

    customer service and technical support;

 

    relationships with distributors, value-added resellers and systems integrators;

 

    an installed base of similar or related products;

 

    relationships with buyers and decision makers;

 

    price;

 

    the relative financial condition of competitors;

 

    brand recognition; and

 

    the ability to be among the first to introduce new products and services.

For more information on risks related to our competition, see “Item 1.A. Risk Factors—Risks Related to Our Business—We face formidable competition from providers of unified communications and contact center products and related services. As these markets evolve, we expect competition to intensify and expand to include companies that do not currently compete directly against us.”

Patents, Trademarks and Other Intellectual Property

We own a significant number of patents important to our business and we expect to continue to file new applications to protect our R&D investments in new products and services across all areas of our business. As of September 30, 2017, we had approximately 4,800 patents and pending patent applications, including foreign counterpart patents and foreign applications. Our patents and pending patent applications cover a wide range of products and services involving a variety of technologies, including, but not limited to, unified communications (including video, social media, telephony and messaging), contact centers, wireless communications and networking. The durations of our patents are determined by the laws of the country of issuance. For the U.S., patents may be 17 years from the date of issuance of the patent or 20 years from the date of its filing, depending upon when the patent application was filed. In addition, we hold numerous trademarks, both in the U.S. and in other countries. We also have licenses to intellectual property for the manufacture, use and sale of our products.

We will obtain patents and other intellectual property rights used in connection with our business when practicable and appropriate. Historically, we have done so organically or through commercial relationships as well as in connection with acquisitions.

Our intellectual property policy is to protect our products, technology and processes by asserting our intellectual property rights where appropriate and prudent. From time to time, assertions of infringement of certain patents or other intellectual property rights of others have been made against us. In addition, certain pending claims are in various stages of litigation. Based on industry practice, we believe that any licenses or other rights that might be necessary for us to continue with our current business could be obtained on

 

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commercially reasonable terms. For more information concerning the risks related to patents, trademarks and other intellectual property, see “Item 1.A. Risk Factors—Risks Related to Our Business—We may be subject to litigation and infringement claims, which could cause us to incur significant expenses or prevent us from selling our products or services.”

Backlog

Due to our diverse products and services portfolio, including the large volume of products delivered from finished goods or channel partner inventories we believe that backlog information is not material to an understanding of our overall business. As a result of these factors, we do not believe that our product backlog, as of any particular date, is necessarily indicative of actual product revenue for any future period.

Employees

As of September 30, 2017, we had approximately 8,700 employees, of whom 3,000 were located in the U.S. and 5,700 were located outside the U.S. Approximately 8,200 were non-represented employees and 500 were represented employees covered by collective bargaining agreements. Of the approximately 500 full-time employees covered by collective bargaining agreements, approximately 470 were in the U.S. and the rest were located outside the U.S.

Environmental, Health and Safety Matters

We are subject to a wide range of governmental requirements relating to safety, health and environmental protection, including:

 

    certain provisions of environmental laws governing the cleanup of soil and groundwater contamination;

 

    various local, federal and international laws and regulations regarding the material content and electrical design of our products that require us to be financially responsible for the collection, treatment, recycling and disposal of those products; and

 

    various employee safety and health regulations that are imposed in various countries within which we operate.

For example, we are currently involved in several remediations at currently or formerly owned or leased sites, which we do not believe will have a material impact on our business or results of operations. See “Item 1.A. Risk Factors—Risks Related to Our Business—We may be adversely affected by environmental, health and safety, laws, regulations, costs and other liabilities” for a discussion of the potential impact such governmental requirements and climate change risks may have on our business.

Corporate Responsibility at Avaya

Avaya’s Corporate Responsibility Program incorporates four key elements: Environment, Community, Marketplace and Workplace. For the Environment element, Avaya looks to implement environmental stewardship practices at our global locations. The element of Community represents Avaya working to positively impact society as a whole and supporting the communities where we are located. The Marketplace element includes engaging in fair and ethical business dealings with our customers, our partners and our supply chain. The Workplace element focuses on developing a desirable place to work for our employees across the globe.

Corporate Information

Our principal executive offices are located at 4655 Great America Parkway, Santa Clara, CA 95054. Our telephone number is (908) 953-6000. Our website address is www.avaya.com. Information contained in, and that can be accessed through, our website is not incorporated into and does not form a part of this registration statement.

 

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Avaya Holdings was formed by affiliates of two private equity firms, Silver Lake Partners (“Silver Lake”) and TPG Capital (“TPG,” and together with Silver Lake, the “Sponsors”) as a Delaware corporation in 2007 under the name Sierra Holdings Corp. The Sponsors, through Avaya Holdings, acquired Avaya Inc. in a transaction that was completed on October 26, 2007. The Sponsors no longer hold a controlling interest in the Company following the Restructuring.

Avaya Holdings is a holding company with no stand-alone operations and has no material assets other than its ownership interest in Avaya Inc. and its subsidiaries. All of the Company’s operations are conducted through its various subsidiaries, which are organized and operated according to the laws of their jurisdiction of incorporation, and consolidated by the Company.

The Restructuring

The Plan of Reorganization resulted from, among other things, extensive negotiations among the Debtors, PBGC, certain members of the Ad Hoc Group of First Lien Debt Holders (the “Ad Hoc First Lien Group”) and the Unsecured Creditors Committee. In connection with the Plan of Reorganization, the Debtors entered into that certain Plan Support Agreement, dated as of August 6, 2017 (the “First Lien PSA”), among the Debtors and members of the Ad Hoc First Lien Group. The First Lien PSA was subsequently amended on August 23, 2017 and October 23, 2017. Also in connection with the Plan of Reorganization, the Debtors entered into that certain Plan Support Agreement, dated as of October 23, 2017 (the “Crossover PSA” and, together with the First Lien PSA, the “PSAs”), among the Debtors and members of the ad hoc group comprising certain holders of first lien debt and second lien notes as set forth in the Eighth Amended Verified Statement of the Ad Hoc Crossover Group Pursuant to Bankruptcy Rule 2019 (the “Ad Hoc Crossover Group”). Together, the holders of approximately over two-thirds of the total amount of first lien debt and holders of approximately over two-thirds of the total amount of second lien notes were party to the PSAs.

Additionally, under the Plan of Reorganization, the Debtors terminated the APPSE on substantially the terms set forth in the PSAs. In connection with the termination of the APPSE and the transfer of the APPSE assets to PBGC, PBGC received $340 million in cash and 5.5% of the reorganized Avaya Holdings’ common stock (subject to dilution by the Equity Incentive Plan and the Warrants), as well as the Company’s agreement to maintain and continue to sponsor the Avaya hourly pension plan (the “PBGC Settlement”). The PBGC Settlement also provides certain protections with respect to the Avaya hourly pension plan in the event of certain “material transactions,” each as described in the Plan of Reorganization.

The Bankruptcy Court approved the Debtors’ Amended Disclosure Statement and the First Lien PSA at a hearing on August 25, 2017, and the Bankruptcy Court approved the Crossover PSA at a hearing on October 31, 2017. On September 9, 2017, the Bankruptcy Court assigned the Debtors and their major stakeholder constituencies to mediation. The mediation resulted in a resolution between the constituencies, and, as a result, the Debtors filed a further amended Plan of Reorganization and a Disclosure Statement Supplement on October 24, 2017. On October 10, 2017, the Debtors filed a motion for entry of an order approving the PBGC Settlement. On November 27, 2017, the Bankruptcy Court entered an order approving the PBGC Settlement. On November 28, 2017, the Bankruptcy Court entered an order confirming the Debtors’ Plan of Reorganization.

In connection with the Company’s emergence from bankruptcy on December 15, 2017, Avaya Holdings contributed shares of Avaya Holdings’ common stock and warrants with respect to such stock to Avaya Inc. and Avaya Inc. transferred such warrants to holders of second lien notes claims and such shares to holders of first lien debt claims, second lien notes claims and the PBGC in connection with the satisfaction of claims held by such parties.

 

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ITEM 1.A RISK FACTORS

Risks Related to Our Business

We face formidable competition from providers of unified communications and contact center products and related services. As these markets evolve, we expect competition to intensify and expand to include companies that do not currently compete directly against us.

Our unified communications products and services compete with companies such as Cisco, Microsoft, NEC Corporation, Unify GmbH & Co. Kg, Alcatel-Lucent (now Nokia), or Lucent, and Huawei, in the enterprise segment; with companies such as Mitel, in the midmarket; and with companies such as Cisco, Broadsoft, Microsoft, 8x8, RingCentral and Mitel in cloud products and services. Our video products and services compete with companies such as Cisco, Polycom, Huawei, ZTE Corporation, Vidyo, Blue Jeans and LifeSize (now a division of Logitech International S.A.).

Our contact center products and services compete with companies such as Genesys, Cisco, Huawei, Enghouse, Aspect Software and Mitel in the enterprise segment and with companies such as Cisco, Genesys, Enghouse and Aspect Software, in the midmarket and cloud products and services.

We face competition in certain geographies with companies that have a particular strength and focus in these regions, such as Huawei and ZTE in China, Intelbras in Latin America and Panasonic in Asia.

While we believe our global, in-house end-to-end services organization as well as our indirect channel provide us with a competitive advantage, we face competition from companies offering products and services directly or indirectly through their channel partners, as well as resellers, consulting and systems integration firms and network service providers.

In addition, because the business communications market continues to evolve and technology continues to develop rapidly, we may face competition in the future from companies that do not currently compete against us, but whose current business activities may bring them into competition with us in the future. In particular, this may be the case as business, information technology and communications applications deployed on converged networks become more integrated to support business communications. We may face increased competition from current leaders in IT infrastructure, IT, consumer products, personal and business applications and the software that connects the network infrastructure to those applications. With respect to services, we may also face competition from companies that seek to sell remotely hosted services or software as a service directly to the end customer. Competition from these potential market entrants may take many forms, including offering products and applications similar to those we offer as part of another offering. In addition, these technologies continue to move from a proprietary environment to an open standards-based environment.

Several of our existing competitors have, and many of our future competitors may have, greater financial, personnel, technical, R&D and other resources, more well-established brands or reputations and broader customer bases than we do and, as a result, these competitors may be in a stronger position to respond quickly to potential acquisitions and other market opportunities, new or emerging technologies and changes in customer requirements. Some of these competitors may have customer bases that are more geographically balanced than ours and, therefore, may be less affected by an economic downturn in a particular region. Other competitors may have deeper expertise in a particular stand-alone technology that develops more quickly than we anticipate. Competitors with greater resources also may be able to offer lower prices, additional products or services or other incentives that we cannot match or do not offer. Industry consolidations may also create competitors with broader and more geographic coverage and the ability to reach enterprises through communications service providers.

We cannot predict which competitors may enter our markets in the future, what form such competition may take or whether we will be able to respond effectively to the entry of new competitors into competition with us or

 

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the rapid evolution in technology and product development that has characterized our businesses. In addition, in order to effectively compete with any new market entrant, we may need to make additional investments in our business, use more capital resources than our business currently requires or reduce prices, any of which may materially and adversely affect our profitability.

The market opportunity for business communications products and services may not develop in the ways that we anticipate.

The demand for our products and services can change quickly and in ways that we may not anticipate because the market in which we operate is characterized by rapid, and sometimes disruptive, technological developments, evolving industry standards, frequent new product introductions and enhancements, changes in customer requirements and a limited ability to accurately forecast future customer orders. Our operating results may be adversely affected if the market opportunity for our products and services does not develop in the ways that we anticipate or if other technologies become more accepted or standard in our industry or disrupt our technology platforms.

Our strategy depends in part on our ability to rely on our indirect sales channel.

An important element of our go-to-market strategy to expand sales coverage and increase market absorption of new products is our global network of alliance partners, distributors, dealers, value-added resellers, telecommunications service providers and system integrators. Our financial results could be adversely affected if our relationships with channel partners were to deteriorate, if our support pricing or other services strategies conflict with those of our channel partners, if any of our competitors were to enter into strategic relationships with or acquire a significant channel partner, if channel partners do not become enabled to sell new products or if the financial condition of our channel partners were to weaken. In addition, we may expend time, money and other resources on developing and maintaining channel relationships that are ultimately unsuccessful. Furthermore, despite the benefits of a robust indirect channel, our channel partners have direct contact with our customers that may foster independent relationships between them and a loss of certain services agreements for us. There can be no assurance that we will be successful in maintaining, expanding or developing relationships with channel partners. If we are not successful, we may lose sales opportunities, customers or market share. Although the terms of individual channel partner agreements may deviate from our standard program terms, our standard program agreements for resellers generally provide for a term of one year with automatic renewal for successive one-year terms and generally may be terminated by either party for convenience upon 30 days prior written notice. Our standard program agreements for distributors generally may be terminated by either party for convenience upon 90 days prior written notice. Certain of our contractual agreements with our largest distributors and resellers, however, permit termination of the relationship by either party for convenience upon prior notice of 180 days. See “Item 1. Business—Alliances and Partnerships” for more information on our global business partner program and the standard terms of our program agreements.

Our products and services may fail to keep pace with rapidly changing technology and evolving industry standards.

The market in which we operate is characterized by rapid, and sometimes disruptive, technological developments, evolving industry standards, frequent new product introductions and enhancements and changes in customer requirements. In addition, both traditional and new competitors are investing heavily in this market and competing for customers. As next-generation business communications technology continues to evolve, we must keep pace in order to maintain or expand our market leading position. We recently introduced a significant number of new product offerings and are increasingly focused on new, high value software products, as a revenue driver. If we are not able to successfully develop and bring these new products to market in a timely manner, achieve market acceptance of our products and services or identify new market opportunities for our products and services, our business and results of operations may be materially and adversely affected.

 

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We rely on third-party contract manufacturers and component suppliers, some of which are sole source and limited source suppliers, as well as warehousing and distribution logistics providers.

We have outsourced substantially all of our manufacturing operations to several contract manufacturers. Our contract manufacturers produce the vast majority of products in facilities located in southern China, with other products manufactured in facilities located in Israel, Mexico, Taiwan, Germany, Ireland and the U.S. While we continued to pay our manufacturers during the pendency of our bankruptcy, not all vendors received 100% of their pre-petition invoices. As a result, our relationships with such manufacturers and suppliers may be adversely impacted, and we may not be able to maintain critical contracts on existing terms or at all. All manufacturing of our products is performed in accordance with detailed specifications and product designs furnished or approved by us and is subject to rigorous quality control standards. We periodically review our product manufacturing operations and consider changes we believe may be necessary or appropriate. Although we closely manage the transition process when manufacturing changes are required, we could experience disruption to our operations during any such transition. Any such disruption could negatively affect our reputation and our results of operations. We also purchase certain hardware components and license certain software components and resell them separately or as part of our products under the Avaya brand. In some cases, certain components are available only from a single source or from a limited source of suppliers. These sole source and limited source suppliers may stop selling their components at commercially reasonable prices or at all. Interruptions, delays or shortages associated with these components could cause significant disruption to our operations. We may not be able to make scheduled product deliveries to our customers in a timely fashion. We could incur significant costs to redesign our products or to qualify alternative suppliers, which would reduce our realized margins. We have also outsourced substantially all of our warehousing and distribution logistics operations to several providers of such services on a global basis, and any delays or material changes in such services could cause significant disruption to our operations.

Recently completed bankruptcy proceedings may adversely affect our operations in the future.

We emerged from bankruptcy on December 15, 2017. The full extent to which our bankruptcy will impact our business operations, reputation and relationships with our customers, employees, regulators and agents may not be known for some time, and any adverse consequences could have a material adverse effect on our business, financial condition and results of operations.

Our actual financial results may vary significantly from the financial projections filed with the Bankruptcy Court.

In connection with the Plan of Reorganization, we were required to prepare projected financial information to demonstrate to the Bankruptcy Court the feasibility of the Plan of Reorganization and the ability of the Debtors to continue operations upon emergence from bankruptcy. These projections are neither included nor incorporated by reference in this registration statement and should not be relied upon. At the time they were prepared, the projections reflected numerous assumptions concerning anticipated future performance and market and economic conditions that were and remain beyond our control and that may not materialize. Projections are inherently subject to uncertainties and to a wide variety of significant business, economic and competitive risks. Our actual results will vary from those contemplated by the projections and the variations may be material.

Our historical financial information may not be indicative of our future financial performance.

Our capital structure has been significantly altered by the Restructuring. Under fresh start accounting rules that apply to us beginning on the Emergence Date, our assets and liabilities will be adjusted to fair values and our accumulated deficit will be restated to zero. Accordingly, our financial condition and results of operations following the Restructuring will not be comparable to the financial condition and results of operations reflected in our historical consolidated financial statements. Further, the Restructuring materially changed the amounts and classifications reported in our historical consolidated financial statements.

 

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Our quarterly and annual revenues and operating results have historically fluctuated and the results of one period may not provide a reliable indicator of our future performance.

Our quarterly and annual revenues and operating results have historically fluctuated and are not necessarily indicative of results to be expected in future periods. Fluctuations in our financial results from period to period are caused by many factors, including, but not limited to, the size and timing of individual orders, changes in foreign currency exchange rates, the mix of products sold by us and general economic conditions.

It is also difficult to predict our revenue for a particular quarter, especially in light of the growing demand for IT purchases under a subscription-based operating expense model instead of a capital expense model and the increasing proportion of our revenue coming from software and services. Both of these trends delay the timing of our revenue recognition. In addition, execution of sales opportunities sometimes traverses from the intended fiscal quarter to the next. Moreover, our efforts to address the challenges facing our business could increase the level of variability in our financial results because the rate at which we are able to realize the benefits from those efforts may vary from period to period.

In addition, we experience some seasonal trends in the sale of our products that also may produce variations in quarterly results and financial condition. Typically, our second fiscal quarter is our weakest and our fourth fiscal quarter is our strongest. Many of the factors that create and affect seasonal trends are beyond our control.

As our business and operations relationships have expanded globally, certain operational and logistical challenges as well as changes in economic or political conditions, in a specific country or region, could negatively affect our revenue, costs, expenses and financial condition or those of our channel partners and distributors.

We conduct significant sales and customer support operations and significant amounts of our R&D activities in countries outside of the U.S. and also depend on non-U.S. operations of our contract manufacturers and our channel partners. For fiscal 2017, we derived 45% of our revenue from sales outside of the U.S. The vast majority of our contract manufacturing also takes place outside the U.S., primarily in southern China. The transition of even a portion of our operations or functions to a foreign country involves a number of logistical and technical challenges, including:

 

    challenges in effectively managing operations in jurisdictions with lower cost structures as a result of several factors, including time zone differences and regulatory, legal, employment, cultural and logistical issues;

 

    the potential negative impact on our existing employees as a result of the relocation of workforce resources;

 

    an inability to predict the extent of local government support;

 

    the availability of qualified workers and the level of competition in offshore markets for qualified employees, including skilled design and technical employees, as companies expand their operations offshore; and

 

    future political, monetary and economic conditions in any specific offshore location.

If we are unable to effectively manage our offshore operations, we may be unable to produce the expected cost savings from any shifts of operations to offshore jurisdictions and our business and results of operations could be adversely affected.

In addition, our future operating results, including our ability to import our products from, export our products to, or sell our products in, various countries, could be adversely affected by a variety of uncontrollable and changing global issues. Factors that could adversely affect us include:

 

    political conditions;

 

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    economic conditions, including trade sanctions or changes to significant trading relationships;

 

    legal and regulatory constraints;

 

    protectionist and local security legislation;

 

    difficulty in enforcing intellectual property rights, such as against counterfeiting of our products;

 

    relationships with employees and works councils;

 

    unfavorable tax and currency regulations;

 

    health pandemics or similar issues;

 

    natural disasters, such as an earthquake, a hurricane or a flood, anywhere we and/or our channel partners and distributors have business operations, including the Silicon Valley area of California, which is a seismically active region and where our corporate headquarters is located; and

 

    other matters in any of the countries or regions in which we and our contract manufacturers and business partners currently operate or intend to operate, in the future, including in the U.S.

Geopolitical trends toward protectionism and nationalism and the dissolution or weakening of international trade pacts may increase the cost of, or otherwise interfere with, our conduct of business. Uncertainty about current and future economic and political conditions which affect us, our customers and partners makes it difficult for us to forecast operating results and to make decisions about future investments. For instance, in June 2016, voters in the United Kingdom approved an advisory referendum to withdraw from the EU (commonly referred to as “Brexit”). The Brexit vote and the perceptions as to the impact of the withdrawal of the United Kingdom from the EU may adversely affect business activity, political stability and economic conditions in the United Kingdom, the EU and elsewhere. It is uncertain at this time how the policies of the current U.S. presidential administration and Congress will affect our business, including potentially through increased import tariffs and other influences on U.S. trade relations with other countries, such as Canada, Mexico and China. The imposition of tariffs or other trade barriers could increase our costs and reduce the competitiveness of our offerings in certain markets. In addition, other countries may change their own policies on business and foreign investment in companies in their respective countries. In addition, as discussed in more detail below, recently enacted U.S. tax reform legislation could have a material and adverse impact on our cash flows and financial condition. There may also be changes to, and introductions of, new tax laws in various foreign countries in which we do business or other future proposals to change U.S. or state or local tax law. Any of these proposals, changes or new tax laws could significantly and adversely impact how we are taxed on both U.S. and foreign earnings.

The various risks inherent in doing business in the U.S. generally also exist when doing business outside of the U.S., and may be exaggerated by the difficulty of doing business in numerous sovereign jurisdictions due to differences in culture, laws and regulations. Furthermore, our prospective effective tax rate could be adversely affected by, among others, changes in the mix of earnings in countries with differing statutory tax rates, changes in the valuation of our deferred tax assets and liabilities or changes in tax laws, regulations, accounting principles or interpretations thereof.

Our revenues are dependent on general economic conditions and the willingness of enterprises to invest in technology.

We believe there is a growing market trend around cloud consumption preferences with more customers exploring operating expense models as opposed to capital expense models for procuring technology, which trend delays the timing of our revenue recognition. We believe the market trend toward cloud models will continue as customers seek ways of reducing their overhead and other costs. In addition, the instability in the geopolitical environment in many parts of the world and other disruptions may continue to put pressure on global economic unrest and on political or social conditions. All of the foregoing may result in continued pressure on our ability to

 

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increase our revenue, as well as create competitive pricing pressures and price erosion. If these or other conditions limit our ability to grow revenue or cause our revenue to decline our operating results may be materially and adversely affected. In addition, in the past a portion of our revenues which come from the U.S. federal government sector were impacted because of government shutdowns. In the event of future shutdowns or uncertainties, there can be no assurance that that portion of our revenues will not be impacted.

We are dependent on our intellectual property. If we are not able to protect our proprietary rights or if those rights are invalidated or circumvented, our business may be adversely affected.

Our business is primarily concerned with technology and innovation in business communications, and we generally protect our intellectual property through patents, trademarks, trade secrets, copyrights, confidentiality and nondisclosure agreements and other measures to the extent our budget permits. There can be no assurance that patents will be issued from pending applications that we have filed or that our patents will be sufficient to protect our key technology from misappropriation or falling into the public domain, nor can assurances be made that any of our patents, patent applications, trademarks or our other intellectual property or proprietary rights will not be challenged, invalidated or circumvented. For example, our business is global and the level of protection of our proprietary technology will vary by country and may be particularly uncertain in countries that do not have well developed judicial systems or laws that adequately protect intellectual property rights. Patent litigation and other challenges to our patents and other proprietary rights are costly and unpredictable and may prevent us from marketing and selling a product in a particular geographic area. Financial considerations also preclude us from seeking patent protection in every country where infringement litigation could arise. Our inability to predict our intellectual property requirements in all geographies and affordability constraints also impact our intellectual property protection investment decisions. If we are unable to protect our proprietary rights, we may be at a disadvantage to others who do not incur the substantial time and expense we incur to create our products.

Certain software we use is from open source code sources, which, under certain circumstances, may lead to unintended consequences and, therefore, could materially adversely affect our business, financial condition, operating results and cash flow.

Some of our products contain software from open source code sources. The use of such open source code may subject us to certain conditions, including the obligation to offer our products that use open source code to third parties for no cost. We monitor our use of such open source code to avoid subjecting our products to conditions we do not intend. However, the use of such open source code may ultimately subject some of our products to unintended conditions, which could require us to take remedial action that may divert resources away from our development efforts and, therefore, could materially adversely affect our business, financial condition, operating results and cash flow.

The Company could be subject to changes in its tax rates, the adoption of new U.S. or international tax legislation or exposure to additional tax liabilities, which could have a material and adverse impact on the Company’s operating results, cash flows and financial condition.

The Company is subject to taxes in the U.S. and numerous foreign jurisdictions, where a number of the Company’s subsidiaries are organized. Due to economic and political conditions, tax rates in various jurisdictions including the U.S. may be subject to change. The Company’s future effective tax rates could be affected by changes in the mix of earnings in countries with differing statutory tax rates, changes in the valuation of deferred tax assets and liabilities and changes in tax laws or their interpretation, such as interpretations as to the legality of tax advantages granted under the EU state aid rules.

Recently enacted U.S. tax reform legislation known colloquially as the “Tax Cuts and Jobs Act,” among other things, makes significant changes to the rules applicable to the taxation of corporations, such as changing the corporate tax rate to a flat 21% rate, modifying the rules regarding limitations on certain deductions for

 

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executive compensation, introducing a capital investment deduction in certain circumstances, placing certain limitations on the interest deduction, modifying the rules regarding the usability of certain net operating losses, implementing a minimum tax on the “global intangible low-taxed income” of a “United States shareholder” of a “controlled foreign corporation,” modifying certain rules applicable to United States shareholders of controlled foreign corporations, imposing a deemed repatriation tax on certain earnings and adding certain anti-base erosion rules. The Company is currently in the process of analyzing the effects of this new legislation on the Company and at this time the ultimate outcome of the new legislation on our business and financial condition is uncertain. It is possible that the application of these new rules may have a material and adverse impact on our operating results, cash flows and financial condition.

Cancellation of indebtedness income realized as a result of the Restructuring is expected to result in material reductions in, or elimination of, tax attributes which could have a material and adverse impact on the Company’s cash flows and financial condition.

Certain debt obligations of Avaya Inc. and claims against the Company were extinguished in the Restructuring. Absent an exception, a debtor generally recognizes cancellation of debt income, or “CODI,” upon discharge of its outstanding indebtedness for total consideration less than its adjusted issue price. The Internal Revenue Code of 1986, as amended (the “Code”) generally provides that a debtor in a bankruptcy case may exclude CODI from taxable income but must reduce certain of its tax attributes by the amount of the CODI realized as a result of the consummation of a plan of reorganization. In the context of a consolidated group of corporations, the tax rules provide for a complex ordering mechanism in determining how the tax attributes of one member can be reduced by the CODI of another member. Under the relevant Treasury Regulations, the tax attributes of each member of an affiliated group of corporations that is excluding CODI is first subject to reduction. To the extent the debtor member’s tax basis in stock of a lower-tier member of the affiliated group is reduced, a “look through rule” requires that a corresponding reduction be made to the tax attributes of the lower-tier member. If a debtor member’s excluded CODI exceeds its tax attributes, the excess CODI is applied to reduce certain remaining consolidated tax attributes of the affiliated group. The Company expects that the amount of such CODI realized as a result of the Restructuring is significant and that there will be material reductions in, or elimination of, certain tax attributes (including net operating losses, credits and possibly certain of the Company’s tax basis in assets) of the Company. In particular, this attribute reduction is expected to result in a reduction or elimination of our remaining federal net operating losses that would otherwise be available to be utilized in the future subject to the limitations pursuant to Section 382 of the Code. Any required attribute reduction could have a material and adverse impact on the Company’s cash flows and financial conditions. Any net operating losses, tax credit carryforwards or capital loss carryforwards that survive attribute reduction would be subject to the applicable limitations of Sections 382 and 383 of the Code, including the limitations that arose from the “ownership change” that occurred in connection with our emergence from bankruptcy (as described in more detail below).

Tax examinations and audits could have a material and adverse impact on the Company’s cash flows and financial condition.

The Company is subject to the examination of its tax returns and other tax matters by the U.S. Internal Revenue Service and other tax authorities and governmental bodies. The Company regularly assesses the likelihood of an adverse outcome resulting from such examinations to determine the adequacy of its provision for taxes. There can be no assurance as to the outcome of any such examinations.

If the Company’s effective tax rates were to increase, or if the ultimate determination of the Company’s taxes owed were for an amount in excess of amounts previously accrued, the Company’s operating results, cash flows and financial condition could be materially and adversely affected.

 

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Transfers or issuances of our equity may impair or reduce our ability to utilize our net operating loss carryforwards and certain other tax attributes in the future.

Section 382 of the Code contains rules that limit the ability of a company that undergoes an “ownership change” to utilize its net operating loss and tax credit carry forwards and certain built-in losses recognized in years after the ownership change. An “ownership change” is generally defined as an increase in ownership of a corporation’s stock by more than 50 percentage points over a rolling three-year period by stockholders that own (directly or indirectly), or are treated as owning, 5% or more of the stock of a corporation at any time during the relevant rolling three-year period. If an ownership change occurs, Section 382 imposes an annual limitation on the use of pre-ownership change net operating losses, credits and certain other tax attributes to offset taxable income earned after the ownership change. The annual limitation is equal to the product of the applicable long-term tax exempt rate in effect for the month in which the ownership change occurs and the value of the company’s stock immediately before the ownership change (with some adjustments). For example, this annual limitation may be adjusted to reflect any unused annual limitation for prior years and certain recognized (or treated as recognized) built-in gains and losses for the year. In addition, Section 383 generally limits the amount of tax liability in any post-ownership change year that can be reduced by pre-ownership change tax credit carryforwards or capital loss carryforwards. In connection with our emergence from bankruptcy, we underwent an ownership change. Any subsequent ownership change can reduce, but not increase, the annual limitation under Section 382 that applies to any remaining net operating losses, credits and certain other tax attributes that are attributable to the period prior to the Emergence Date.

No assurance can be given that subsequent transactions (including an issuance of additional shares of our common stock) will not result in an ownership change. Even if a subsequent transaction does not result in another ownership change, it may materially increase the likelihood that we will undergo an ownership change in the future. Also, sales of stock by stockholders, whose interests may differ from our interests, may increase the likelihood that we undergo, or may cause, an ownership change. If we were to undergo another “ownership change,” it could have a material adverse effect on our business, financial condition, results of operations and cash flows.

Fluctuations in foreign currency exchange rates could negatively impact our operating results.

We are a global company with significant international operations and transact business in many currencies. As such, we are exposed to adverse movements in foreign currency exchange rates. The majority of our revenues and expenses are denominated in U.S. dollars. However, we are exposed to foreign currency exchange rate fluctuations related to certain revenues and expenses denominated in foreign currencies. Our primary currency exposures relate to net operating expenses denominated in euro, Indian rupee and British pound. These exposures may change over time as business practices evolve and the geographic mix of our business changes. From time to time, we enter into foreign exchange forward contracts to hedge fluctuations associated with certain monetary assets and liabilities, primarily accounts receivable, accounts payable and certain intercompany obligations. However any attempts to hedge against foreign currency exchange rate fluctuation risk may be unsuccessful and result in an adverse impact to our operating results.

Business communications products are complex, and design defects, errors, failures or “bugs” may be difficult to detect and correct.

Business communications products are complex, integrating hardware, software and many elements of a customer’s existing network and communications infrastructure. Despite testing conducted prior to the release of products to the market and quality assurance programs, hardware may malfunction and software may contain “bugs” that are difficult to detect and fix. Any such issues could interfere with the expected operation of a product, which might negatively impact customer satisfaction, reduce sales opportunities or affect gross margins.

Depending upon the size and scope of any such issue, remediation may have a material impact on our business. Our inability to cure an application or product defect, should one occur, could result in the failure of an

 

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application or product line, the temporary or permanent withdrawal from an application, product or market, damage to our reputation, inventory costs, an increase in warranty claims, lawsuits by customers or customers’ or channel partners’ end users, or application or product reengineering expenses. Our insurance may not cover or may be insufficient to cover claims that are successfully asserted against us.

If we are unable to integrate acquired businesses effectively, our operating results may be adversely affected.

From time to time, we seek to expand our business through acquisitions. We may not be able to successfully integrate acquired businesses and, where desired, their product portfolios into ours, and therefore we may not be able to realize the intended benefits. If we fail to successfully integrate acquisitions or product portfolios, or if they fail to perform as we anticipate, our existing businesses and our revenue and operating results could be adversely affected. If the due diligence of the operations of acquired businesses performed by us and by third parties on our behalf is inadequate or flawed, or if we later discover unforeseen financial or business liabilities, acquired businesses and their assets may not perform as expected. Additionally, acquisitions could result in difficulties assimilating acquired operations and, where deemed desirable, transitioning overlapping products into a single product line and the diversion of capital and management’s attention away from other business issues and opportunities. We may fail to retain employees acquired through acquisitions, which may negatively impact the integration efforts. The failure to integrate acquired businesses effectively may adversely impact our business, results of operations or financial condition.

We may not realize the benefits we expect from our cost-reduction initiatives.

As discussed in “Item 2. Financial Information—Management’s Discussion & Analysis of Financial Condition and Results of Operations—Continued Focus on Cost Structure,” we have initiated cost savings programs designed to streamline operations and we continue to evaluate additional similar opportunities. These types of cost-reduction activities are complex. Even if we carry out these strategies in the manner we expect, we may not be able to achieve the efficiencies or savings we anticipate, or on the timetable we anticipate, and any expected efficiencies and benefits might be delayed or not realized, and our operations and business could be disrupted. Our ability to realize the gross margin improvements and other efficiencies expected to result from these initiatives is subject to many risks, including delays in the anticipated timing of activities related to these initiatives, lack of sustainability in cost savings over time and unexpected costs associated with operating our business, our success in reinvesting the savings arising from these initiatives, time required to complete planned actions, absence of material issues associated with workforce reductions and avoidance of unexpected disruptions in service. A failure to implement our initiatives or realize expected benefits could have an adverse effect on our financial condition that could be material.

We may incur liabilities as a result of our obligation to indemnify, and to share certain liabilities with, Lucent in connection with our spin-off from Lucent in September 2000.

Pursuant to the Contribution and Distribution Agreement between Avaya Inc. and Lucent, Lucent contributed to Avaya Inc. substantially all of the assets, liabilities and operations associated with its enterprise networking businesses and distributed all of the outstanding shares of Avaya Inc.’s common stock to its stockholders. The Contribution and Distribution Agreement, among other things, provides that, in general, Avaya Inc. will indemnify Lucent for all liabilities including certain environmental and pre-distribution tax obligations of Lucent relating to our businesses and all contingent liabilities accruing pre-distribution primarily relating to Avaya Inc.’s businesses or otherwise assigned to Avaya Inc. In addition, the Contribution and Distribution Agreement provides that certain contingent liabilities not directly identifiable with one of the parties accruing pre-distribution will be shared in the proportion of 90% by Lucent and 10% by Avaya Inc. The Contribution and Distribution Agreement also provides that contingent liabilities accruing pre-distribution in excess of $50 million that are primarily related to Lucent’s businesses shall be borne 90% by Lucent and 10% by Avaya Inc. and contingent liabilities accruing pre-distribution in excess of $50 million that are primarily related to Avaya Inc.’s businesses shall be borne equally by the parties. There can be no assurance that Lucent will not submit a claim

 

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for indemnification or cost sharing to us in connection with any future matter. In addition, our ability to assess the impact of matters for which Avaya Inc. may have to indemnify or share the cost with Lucent is made more difficult by the fact that we do not control the defense of these matters.

In addition, in connection with the distribution, Avaya Inc. and Lucent entered into a Tax Sharing Agreement that governs the parties’ respective rights, responsibilities and obligations after the distribution with respect to taxes for the periods ending on or before (or deemed to be ending on or before) the distribution. Generally, pre-distribution taxes that are clearly attributable to the business of one party will be borne solely by that party, and other pre-distribution taxes will be shared by the parties based on a formula set forth in the Tax Sharing Agreement. In addition, pursuant to the Tax Sharing Agreement, Avaya could be responsible for all or a portion of certain other taxes such as taxes arising from the restructuring activities undertaken to implement the distribution. Any taxes or other costs borne by Avaya Inc. under the Tax Sharing Agreement could have an adverse impact on our business, results of operations or financial condition.

Transfers or issuances of our equity may impair or reduce our ability to utilize our net operating loss carryforwards and certain other tax attributes in the future.

Section 382 of the Code contains rules that limit the ability of a company that undergoes an “ownership change” to utilize its net operating loss and tax credit carry forwards and certain built-in losses recognized in years after the ownership change. An “ownership change” is generally defined as an increase in ownership of a corporation’s stock by more than 50 percentage points over a rolling three-year period by stockholders that own (directly or indirectly), or are treated as owning, 5% or more of the stock of a corporation at any time during the relevant rolling three-year period. If an ownership change occurs, Section 382 imposes an annual limitation on the use of pre-ownership change net operating losses, credits and certain other tax attributes to offset taxable income earned after the ownership change. The annual limitation is equal to the product of the applicable long-term tax exempt rate in effect for the month in which the ownership change occurs and the value of the company’s stock immediately before the ownership change (with some adjustments). For example, this annual limitation may be adjusted to reflect any unused annual limitation for prior years and certain recognized (or treated as recognized) built-in gains and losses for the year. In addition, Section 383 generally limits the amount of tax liability in any post-ownership change year that can be reduced by pre-ownership change tax credit carryforwards or capital loss carryforwards. In connection with our emergence from bankruptcy, we underwent an ownership change. Any subsequent ownership change can reduce, but not increase, the annual limitation under Section 382 that applies to any remaining net operating losses, credits and certain other tax attributes that are attributable to the period prior to the Emergence Date.

No assurance can be given that subsequent transactions (including an issuance of additional shares of our common stock) will not result in an ownership change. Even if a subsequent transaction does not result in another ownership change, it may materially increase the likelihood that we will undergo an ownership change in the future. Also, sales of stock by stockholders, whose interests may differ from our interests, may increase the likelihood that we undergo, or may cause, an ownership change. If we were to undergo another “ownership change,” it could have a material adverse effect on our business, financial condition, results of operations and cash flows.

The ability to retain and attract key personnel is critical to the success of our business and may be impacted by our Restructuring.

The success of our business depends on the skill, experience and dedication of our employee base. If we are unable to retain and recruit sufficiently experienced and capable employees, our business and financial results may suffer. In connection with the uncertainties relating to our Restructuring, we have experienced significant attrition at both senior levels and throughout the Company. Experienced and capable employees in the technology industry remain in high demand, and there is continual competition for their talents. The uncertainties facing our business related to our Restructuring and changes we may make to the organizational structure to

 

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adjust to our changing circumstances may make it more difficult to compete and to attract and retain key employees. If executives, managers or other key personnel resign, retire or are terminated, or their service is otherwise interrupted, we may not be able to replace them in a timely manner and we could experience significant declines in productivity and/or errors due to insufficient staffing or managerial oversight. Moreover, turnover of senior management and other key personnel can adversely impact, among other things, our results of operations, our customer relationships and lead us to incur significant expenses related to executive transition costs that may impact our operating results. In addition, our ability to adequately staff our R&D efforts in the U.S. may be inhibited by changes to U.S. immigration policies that restrain the flow of professional and technical talent. While we strive to maintain our competitiveness in the marketplace, there can be no assurance that we will be able to successfully retain and attract the employees that we need to achieve our business objectives.

If we fail to establish and maintain proper and effective internal control over financial reporting, our operating results and our ability to operate our business could be harmed.

Section 404 of the Sarbanes-Oxley Act of 2002 requires that we establish and maintain internal control over financial reporting and disclosure controls and procedures. An effective internal control environment is necessary to enable us to produce reliable financial reports and is an important component of our efforts to prevent and detect financial reporting errors and fraud. Beginning with the second annual report that we will be required to file with the SEC, management will be required to provide an annual assessment on the effectiveness of our internal control over financial reporting and our independent registered public accounting firm will also be required to attest to the effectiveness of our internal control over financial reporting. Our and our auditor’s testing may reveal significant deficiencies in our internal control over financial reporting that are deemed to be material weaknesses and render our internal control over financial reporting ineffective. We have incurred and we expect to continue to incur substantial accounting and auditing expense and expend significant management time in complying with the requirements of Section 404.

While an effective internal control environment is necessary to enable us to produce reliable financial reports and is an important component of our efforts to prevent and detect financial reporting errors and fraud, disclosure controls and internal control over financial reporting are generally not capable of preventing or detecting all financial reporting errors and all fraud. A control system, no matter how well-designed and operated, is designed to reduce rather than eliminate financial statement risk. There are inherent limitations on the effectiveness of internal controls, including collusion, management override and failure in human judgment. A control system can provide only reasonable, not absolute, assurance of achieving the desired control objectives and the design of a control system must reflect the fact that resource constraints exist. Accordingly, our and our auditor’s testing may reveal significant deficiencies in our internal control over financial reporting that are deemed to be material weaknesses and render our internal control over financial reporting ineffective.

If we are not able to comply with the requirements of Section 404, or if we or our independent registered public accounting firm identify deficiencies in our internal control over financial reporting that are deemed to be material weaknesses:

 

    we could fail to meet our financial reporting obligations;

 

    our reputation may be adversely affected and our business and operating results could be harmed;

 

    the market price of our stock could decline; and

 

    we could be subject to litigation and/or investigations or sanctions by the SEC, the New York Stock Exchange or other regulatory authorities.

 

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We have identified material weaknesses in our internal control over financial reporting. If we do not adequately remediate these material weaknesses, or if we experience additional material weaknesses in the future or otherwise fail to maintain an effective system of internal controls, we may not be able to accurately or timely report our financial condition or results of operations, or comply with the accounting and reporting requirements applicable to public companies, which may adversely affect investor confidence in us and, as a result, the value of our common stock.

A material weakness is a deficiency, or combination of deficiencies, in internal control over financial reporting such that there is a reasonable possibility that a material misstatement of our annual or interim consolidated financial statements will not be prevented or detected on a timely basis.

In connection with the preparation of our consolidated financial statements for the quarter ended June 30, 2017, we identified control deficiencies that constituted material weaknesses in our internal control over financial reporting as of June 30, 2017. Specifically, we did not maintain the appropriate complement of resources in our tax department commensurate with the volume and complexity of accounting for income taxes subsequent to our voluntary filing of chapter 11 bankruptcy protection. This material weakness contributed to the following control deficiencies, which are individually considered to be material weaknesses, relating to the completeness and accuracy of our accounting for income taxes, including the related tax assets and liabilities:

 

    Control activities over the completeness and accuracy of interim forecasts by tax jurisdiction used in accounting for our interim income tax provision were not performed at the appropriate level of precision. This control deficiency resulted in an adjustment to our income tax provision for the quarter ended June 30, 2017.

 

    Control activities over the completeness and accuracy of the allocation of the tax provision calculations (the “intraperiod allocation”) were insufficient to ensure that the intraperiod allocation balances were accurately determined. This control deficiency resulted in an adjustment to our income tax provision for the quarter ended June 30, 2017.

Although we are in the process of carrying out remediation activities, we cannot provide any assurance that the measures we have taken to date, together with any measures we may take in the future, will be sufficient to remediate our material weaknesses in our internal control over financial reporting or to avoid potential future material weaknesses. If the steps we take do not correct the material weaknesses in a timely manner, we will be unable to conclude that we maintain effective internal control over financial reporting. Accordingly, this could result in a material misstatement of our financial statements that would not be prevented or detected on a timely basis and we may be unable to maintain compliance with securities law requirements regarding timely filing of periodic reports in addition to the listing requirements of the New York Stock Exchange. Consequently, investors may lose confidence in our financial reporting and our stock price, to the extent it is listed, may decline as a result. We could also become subject to investigations by the New York Stock Exchange, the SEC or other regulatory authorities, and become subject to litigation from investors and stockholders, which could harm our reputation, business and financial condition and divert financial and management resources from our business operations.

We may be subject to litigation in connection with our emergence from bankruptcy.

In connection with our emergence from bankruptcy, additional claims have been, or may be, asserted against us. While the provisions of the Plan of Reorganization constitute a good faith compromise or settlement, or resolution of, substantially all claims that arose against us prior to our emergence from bankruptcy, additional claims may be brought against us. Any litigation now or in the future related to the consummation of the Plan of Reorganization may also require managerial involvement and oversight, which could divert executive attention away from other business matters. The effects of any litigation related to the consummation of the Plan of Reorganization could have a material adverse effect on our business, financial condition and results of operations.

 

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A breach of the security of our information systems, products or services or of the information systems of our third-party providers could adversely affect our operating results.

We rely on the security of our information systems and, in certain circumstances, those of our third-party providers, such as vendors, consultants and contract manufacturers, to protect our proprietary information and information of our customers. In addition, the growth of BYOD programs has heightened the need for enhanced security measures. IT system failures, including a breach of our or our third-party providers’ data security, could disrupt our ability to function in the normal course of business by potentially causing, among other things, delays in the fulfillment or cancellation of customer orders, disruptions in the manufacture or shipment of products or, delivery of services or an unintentional disclosure of customer, employee or our information. Additionally, despite our security procedures or those of our third-party providers, information systems and our products and services may be vulnerable to threats such as computer hacking, cyber-terrorism or other unauthorized attempts by third parties to access, modify or delete our or our customers’ proprietary information.

We take cybersecurity seriously and devote significant resources and tools to protect our systems, products and data and to prevent unwanted intrusions. However, these security efforts may be costly to implement and may not be successful. We cannot be assured that we will be able to prevent, detect and adequately address or mitigate such cyber-attacks or security breaches. Any such breach could have a material adverse effect on our operating results and our reputation as a provider of business communications products and services and could cause irreparable damage to us or our systems regardless of whether we or our third-party providers are able to adequately recover critical systems following a systems failure. In addition, regulatory or legislative action related to cybersecurity, privacy and data protection worldwide, such as the European Union, or EU, General Data Protection Regulation, which is expected to go into effect in May 2018, may increase the costs to develop, implement or secure our products and services. If we violate or fail to comply with such regulatory or legislative requirements, we could be fined or otherwise sanctioned and such fines or penalties could have a material adverse effect on our business and operations.

Business interruptions, whether due to catastrophic disasters or other events, could adversely affect our operations.

Our operations and those of our contract manufacturers and outsourced service providers are vulnerable to interruption by fire, earthquake, hurricane, flood or other natural disaster, power loss, computer viruses, computer systems failure, telecommunications failure, quarantines, national catastrophe, terrorist activities, war and other events beyond our control. For instance, our corporate headquarters, which are in the Silicon Valley area of California near known earthquake fault zones, are vulnerable to damage from earthquakes. Our disaster recovery plans may not be sufficient to address these interruptions. If any disaster were to occur, our ability and the ability of our contract manufacturers and outsourced service providers to operate could be seriously impaired and we could experience material harm to our business, operating results and financial condition. In addition, the coverage or limits of our business interruption insurance may not be sufficient to compensate for any losses or damages that may occur.

We may be subject to claims that were not discharged in the Plan of Reorganization, which could have a material adverse effect on our results of operations and profitability.

Substantially all of the claims against us that arose prior to our emergence from bankruptcy were resolved in the Plan of Reorganization or are in the process of being resolved in the Bankruptcy Court as part of the claims reconciliation process. Although we anticipate that the remaining claims will be handled in due course with no material adverse effect to our business, financial operations or financial conditions, there can be no assurance that this will be the case or that the resolution of such claims will occur in a timely manner or at all. Subject to certain exceptions under applicable law, including the Bankruptcy Code and/or as set forth in the Plan of Reorganization, all claims against and interests in us and our subsidiaries that filed for Chapter 11 and which arose prior to our emergence from bankruptcy are (1) subject to the compromise and/or treatment provided for in

 

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the Plan of Reorganization and/or (2) discharged in accordance with the Bankruptcy Code, the terms of the Plan of Reorganization and the Bankruptcy Court’s order confirming the Plan of Reorganization, or the Confirmation Order. Pursuant to the terms of the Plan of Reorganization, the provisions of the Plan of Reorganization constitute a good faith compromise or settlement, or resolution of, all such claims and the Confirmation Order, as well as other orders resolving objections to claims, constitute the Bankruptcy Court’s approval of the compromise, settlement or resolution arrived at with respect to all such claims. Circumstances in which claims and other obligations that arose prior to our emergence from bankruptcy may not have been discharged include instances where the Plan of Reorganization provides for reinstatement of such claims, or where a claimant had inadequate notice of the Bankruptcy Filing. As such, some parties whose claims were expunged during the bankruptcy or discharged by the Plan of Reorganization and Confirmation Order may seek to re-assert their claims in state or federal court. While the terms of the Plan of Reorganization and the Bankruptcy Court’s orders generally foreclose that reassertion, there are limited instances, such as where a court finds an insufficient notice of the bankruptcy, in which a plaintiff may be able to proceed despite an expungement or discharge. In that event, the continuation of such a lawsuit could have a material adverse effect on us.

We may be subject to litigation and infringement claims, which could cause us to incur significant expenses or prevent us from selling our products or services.

From time to time, we receive notices and claims from third parties asserting that our proprietary or licensed products, systems and software infringe their intellectual property rights. There can be no assurance that the number of these notices and claims will not increase in the future or that we do not in fact infringe those intellectual property rights. Irrespective of the merits of these claims, any resulting litigation could be costly and time consuming and could divert the attention of management and key personnel from other business issues. The complexity of the technology involved and the uncertainty of intellectual property litigation increase these risks. These matters may result in any number of outcomes for us, including entering into licensing agreements, redesigning our products to avoid infringement, being enjoined from selling products that are found to infringe, paying damages if products are found to infringe and indemnifying customers from infringement claims as part of our contractual obligations. Royalty or license agreements may be very costly and we may be unable to obtain royalty or license agreements on terms acceptable to us or at all. Such agreements may cause operating margins to decline.

In addition, some of our employees previously have been employed at other companies that provide similar products and services. We may be subject to claims that these employees or we have inadvertently or otherwise used or disclosed trade secrets or other proprietary information of their former employers. These claims and other claims of patent or other intellectual property infringement against us could materially adversely affect our operating results.

We have made and will likely continue to make investments to license and/or acquire the use of third-party intellectual property rights and technology as part of our strategy to manage this risk, but there can be no assurance that we will be successful or that any costs relating to such activity will not be material. We may also be subject to additional notice, attribution and other compliance requirements to the extent we incorporate open source software into our applications. In addition, third parties have claimed, and may in the future claim, that a customer’s use of our products, systems or software infringes the third-party’s intellectual property rights. Under certain circumstances, we may be required to indemnify our customers for some of the costs and damages related to such an infringement claim. Any indemnification requirement could have a material adverse effect on our business and our operating results.

Upon our emergence from bankruptcy, the composition of our board of directors and management has changed significantly.

Pursuant to the Plan of Reorganization, the composition of our board of directors changed significantly. As of the Emergence Date, our new board of directors is composed of seven directors, five of whom were selected

 

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by the holders of our first lien debt, one of whom is our CEO, James M. Chirico, Jr., and one of whom was selected by Mr. Chirico. Only one member of the board of directors, Ronald A. Rittenmeyer, served on our board of directors prior to our emergence from bankruptcy. The Company’s management team has also changed significantly. The new directors and officers have different backgrounds, experiences and perspectives from those individuals who previously served on the board of directors and management team and they may have different views on the issues that will determine the future of the Company. As a result, the future strategy and plans of the Company may differ materially from those of the past.

Additionally, the ability of our new directors and officers to quickly expand their knowledge of our business plans, operations, strategies and our technologies will be critical to their ability to make informed decisions about our strategy and operations, particularly given the competitive environment in which our business operates. If our board of directors and management is not sufficiently informed to make such decisions, our ability to compete effectively and profitably could be adversely affected.

We have a significant number of foreign subsidiaries with whom we have entered into many related party transactions. Our relationship with these entities could adversely affect us in the event of their bankruptcy or similar insolvency proceeding.

We have historically entered into many transactions with our affiliates. These transactions include financial guarantees and other credit support arrangements, including letters of comfort to such affiliates pursuant to which we undertake to provide financial support to these affiliates and adequate resources as required to ensure that they are able to meet certain liabilities and local solvency requirements. We are currently party to many such affiliate transactions, and it is likely we will enter into new and similar affiliate transactions in the future.

In the event that any of these affiliates become bankrupt or insolvent, there can be no assurance that a court or other foreign tribunal, liquidator, monitor, trustee or similar party would not seek to enforce these intercompany arrangements and guarantees or otherwise seek relief against us and our other affiliates. If any of our material foreign subsidiaries (e.g., subsidiaries that hold a significant number of our customer contracts, or that are the parent company of other material subsidiaries) becomes subject to a bankruptcy, liquidation or similar insolvency proceeding, such proceeding could have a material adverse effect on our business and results of operations.

We may be adversely affected by environmental, health and safety, laws, regulations, costs and other liabilities.

We are subject to a wide range of federal, state, local, and international governmental requirements relating to the discharge of substances into the environment, protection of the environment and worker health and safety. If we violate or fail to comply with these requirements, we could be fined or otherwise sanctioned by regulators, lose customers and damage our reputation, which could have an adverse effect on our business. The Federal Comprehensive Environmental Response, Compensation, and Liability Act, or CERCLA, and comparable state statutes impose liability, without regard to fault or legality of the original conduct, on classes of persons that are considered to have contributed to the release of a hazardous substance into the environment. Such classes of persons include the current and past owners or operators of sites where a hazardous substance was released, and companies that disposed or arranged for disposal of hazardous substances at off-site locations such as landfills. Under CERCLA, these persons may be subject to strict, joint and several liability for the costs of cleaning up the hazardous substances that have been released into the environment and for damages to natural resources, and it is not uncommon for neighboring landowners and other third parties to file claims for personal injury and property damage allegedly caused by the hazardous substances released into the environment. We currently own or formerly owned several properties or facilities that for many years were used for industrial activities, including the manufacture of electronics equipment. These properties and the substances disposed or released on them may be subject to CERCLA, the Resource Conservation and Recovery Act and analogous state or foreign laws. For example, we are presently involved in remediation efforts at several currently or formerly owned sites related to

 

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historical site use which we do not believe will have a material impact on our business or operations. We are also subject to various local, federal and international laws and regulations regarding the materials content and electrical design of our products that require us to be financially responsible for the collection, treatment, recycling and disposal of those products. For example, the EU has adopted the Restriction on Hazardous Substances and Waste Electrical and Electronic Equipment Directive, with similar laws and regulations being enacted in other regions. Effective in May 2014, the United States requires companies to begin publicly disclosing their use of conflict minerals that originated in the Democratic Republic of the Congo, or an adjoining country. Additionally, requirements such as the EU Energy Labelling Directive, impose requirements relating to the energy efficiency of our products. Our failure or the undetected failure of our supply chain to comply with existing or future environmental, health and safety requirements could subject us to liabilities exceeding our reserves or adversely affect our business, operations or financial condition.

In addition, a number of climate change regulations and initiatives are either in force or pending at the local, federal and international levels. Although it is not possible at this time to predict how legislation or new regulations that may be adopted to address greenhouse emissions would impact our business, our operations and our supply chain could face increased climate change-related regulations, modifications to transportation to meet lower emission requirements and changes to types of materials used for products and packaging to reduce emissions, increased utility costs to address cleaner energy technologies, increased costs related to severe weather events and emissions reductions associated with operations, business travel or products. These yet-to-be defined costs and changes to operations could have a financial impact on our business and result in an adverse impact on our operating results.

Risks Related to Our Indebtedness

We may not be able to generate sufficient cash to service all of our indebtedness and our other ongoing liquidity needs, and we may be forced to take other actions to satisfy our obligations under our indebtedness, which may not be successful.

Our ability to make scheduled payments on or to refinance our debt obligations and to fund our planned capital expenditures, acquisitions and other ongoing liquidity needs depends on our financial condition and operating performance, which are subject to prevailing economic and competitive conditions and to certain financial, business and other factors beyond our control. There can be no assurance that we will maintain a level of cash flow from operating activities in an amount sufficient to permit us to pay the principal, premium, if any, and interest on our indebtedness. If our cash flow and capital resources are insufficient to fund our debt service obligations, we may be forced to reduce or delay investments and capital expenditures, or to seek additional capital or restructure or refinance our indebtedness. These alternative measures may not be successful and may not permit us to meet our scheduled debt service obligations. In the absence of such operating results and resources, we could face substantial liquidity problems and might be required to dispose of material assets or operations to meet our debt service and other obligations. Avaya Inc.’s credit facilities restrict the ability of Avaya Inc. and its restricted subsidiaries to dispose of assets and use the proceeds from the disposition. Accordingly, we may not be able to consummate those dispositions or to obtain any proceeds on terms acceptable to us or at all, and any such proceeds may not be adequate to meet any debt service obligations when due.

Our degree of leverage could adversely affect our ability to raise additional capital to fund our operations, limit our ability to react to changes in the economy or our industry, expose us to interest rate risk on our variable rate debt and prevent us from meeting obligations on our indebtedness.

In connection with the Restructuring, we entered into various exit financing arrangements which impact our degree of leverage.

Our degree of leverage could have consequences, including:

 

    making it more difficult for us to make payments on our indebtedness;

 

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    increasing our vulnerability to general economic and industry conditions;

 

    requiring a substantial portion of cash flow from operations to be dedicated to the payment of principal and interest on our indebtedness, thereby reducing our ability to use our cash flow to fund our operations, capital expenditures and future business opportunities;

 

    exposing us to the risk of increased interest rates as borrowings under Avaya Inc.’s credit facilities and certain of our foreign subsidiaries’ credit facilities to the extent such facilities have variable rates of interest;

 

    limiting our ability to make strategic acquisitions and investments;

 

    limiting our ability to obtain additional financing for working capital, capital expenditures, debt service requirements, acquisitions and general corporate or other purposes;

 

    limiting our ability to refinance our indebtedness as it becomes due; and

 

    limiting our ability to adjust to changing market conditions and placing us at a competitive disadvantage compared to our competitors who are less highly leveraged.

Our ability to continue to fund our obligations and to reduce debt may be affected by general economic, financial market, competitive, legislative and regulatory factors, among other things. An inability to fund our debt requirements or reduce debt could have a material adverse effect on our business, financial condition, results of operations and cash flows.

Despite our level of indebtedness, we and our subsidiaries may be able to incur additional indebtedness. This could further exacerbate the risks associated with our degree of leverage.

We and our subsidiaries may be able to incur additional indebtedness in the future. Although the credit facilities contain restrictions on the incurrence of additional indebtedness, these restrictions are subject to a number of significant qualifications and exceptions, and any indebtedness incurred in compliance with these restrictions could be substantial. To the extent new debt is added to our and our subsidiaries’ currently anticipated debt levels, the related risks that we and our subsidiaries face could intensify.

Our exit financing agreements contain restrictions that limit in certain respects our flexibility in operating our business.

Our exit financing contain various covenants that limit our ability to engage in specific types of transactions. These covenants limit our and our restricted subsidiaries’ ability to:

 

    incur or guarantee additional debt and issue or sell certain preferred stock;

 

    pay dividends on, redeem or repurchase our capital stock;

 

    make certain acquisitions or investments;

 

    incur or assume certain liens;

 

    enter into transactions with affiliates; and

 

    sell assets to, or merge or consolidate with, another company.

A breach of any of these covenants could result in a default under our debt instruments.

There is no assurance we will be able to repay or refinance all or any portion of our or our subsidiaries’ debt in the future. If we were unable to repay or otherwise refinance these borrowings and loans when due, the applicable secured lenders could proceed against the collateral granted to them to secure that indebtedness, which could force us into bankruptcy or liquidation. In the event our lenders accelerate the repayment of our or our subsidiaries’ borrowings, we and our subsidiaries may not have sufficient assets to repay that indebtedness.

 

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A ratings downgrade or other negative action by a ratings organization could adversely affect our cost of capital.

Credit rating agencies continually revise their ratings for companies they follow. The condition of the financial and credit markets and prevailing interest rates have been, and will continue to be, subject to fluctuation. In addition, developments in our business and operations could lead to a ratings downgrade for Avaya Inc. Any such fluctuation in our credit rating may impact our ability to access debt markets in the future or increase our cost of future debt which could have a material adverse effect on our operations and financial condition, which in return may adversely affect the trading price of shares of our common stock.

Risks Related to Ownership of Our Common Stock

An active trading market for our common stock may not develop.

Our common stock is currently quoted on the OTCQX marketplace, and there is currently a very limited trading market for our shares. Although we intend to list our common stock on the New York Stock Exchange, an active trading market for our common stock may never develop or be sustained following this registration statement. If the market does not develop or is not sustained, it may be difficult for shareholders to sell shares of common stock at a price that is attractive or at all. In addition, an inactive market may impair our ability to raise capital by selling shares and may impair our ability to acquire other companies by using our shares as consideration, which, in turn, could materially adversely affect our business.

The price of our common stock may be volatile and fluctuate substantially.

We expect to list our common stock on the New York Stock Exchange. If and when listed on the New York Stock Exchange, the market price of our common stock is likely to be highly volatile and may fluctuate substantially due to the following factors (in addition to the other risk factors described in this section):

 

    actual or anticipated fluctuations in our results of operations;

 

    variance in our financial performance from the expectations of equity research analysts;

 

    conditions and trends in the markets we serve;

 

    announcements of significant new services or products by us or our competitors;

 

    additions of or changes to key employees;

 

    changes in market valuations or earnings of our competitors;

 

    the trading volume of our common stock;

 

    future sales of our equity securities;

 

    changes in the estimation of the future sizes and growth rates of our markets;

 

    legislation or regulatory policies, practices or actions; and

 

    general economic conditions.

In addition, the stock markets in general have experienced extreme price and volume fluctuations that have at times been unrelated or disproportionate to the operating performance of the particular companies affected. These market and industry factors may materially harm the market price of our common stock irrespective of our operating performance.

We are a holding company and rely on dividends, distributions and other payments, advances and transfers of funds from our subsidiaries to meet our obligations.

We have no direct operations and derive all of our cash flow from our subsidiaries. Because we conduct our operations through our subsidiaries, we depend on those entities for dividends and other payments or

 

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distributions to meet our obligations. The deterioration of the earnings from, or other available assets of, our subsidiaries for any reason could limit or impair their ability to pay dividends or other distributions to us.

We currently do not intend to pay dividends on our common stock.

Following the completion of this registration, we do not anticipate that we will pay any cash dividends on shares of our common stock for the foreseeable future. Any determination to pay dividends in the future will be at the discretion of our board of directors and will depend on results of operations, financial condition, contractual restrictions, restrictions imposed by applicable law and other factors our board of directors deems relevant.

If securities or industry analysts do not publish research or reports or publish unfavorable research or reports about our business, our stock price and trading volume could decline.

The trading market for our common stock will depend in part on the research and reports that securities or industry analysts publish about us, our business, our market or our competitors. We may not obtain research coverage by securities and industry analysts. If no securities or industry analysts commence coverage of our company, the trading price for our stock could be negatively impacted. In the event we obtain securities or industry analyst coverage, if one or more of the analysts who covers us publishes unfavorable research or reports or downgrades our stock, our stock price would likely decline. If one or more of these analysts ceases to cover us or fails to regularly publish reports on us, interest in our stock could decrease, which could cause our stock price or trading volume to decline.

 

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ITEM 2. FINANCIAL INFORMATION

SELECTED HISTORICAL CONSOLIDATED FINANCIAL DATA

The Company is a holding company and has no material assets or stand-alone operations other than its ownership in Avaya Inc. and its subsidiaries. See discussion in Note 1, “Background and Basis of Presentation,” to our audited Consolidated Financial Statements included elsewhere in this registration statement for further details.

The selected historical consolidated financial data set forth below as of September 30, 2017 and 2016 and for the fiscal years ended September 30, 2017, 2016 and 2015 have been derived from our audited Consolidated Financial Statements and related notes included elsewhere in this registration statement. The selected historical consolidated financial data set forth below as of September 30, 2015 and as of and for the fiscal years ended September 30, 2014 and 2013 has been derived from our Consolidated Financial Statements that are not included in this report.

This information does not reflect any adjustments required upon emergence from bankruptcy.

 

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The selected historical consolidated financial data set forth below should be read in conjunction with our audited Consolidated Financial Statements and related notes and “Management’s Discussion and Analysis of Financial Condition and Results of Operations.” Our financial information may not be indicative of future performance.

 

     Fiscal years ended September 30,  
(In millions, except per share amounts)    2017     2016     2015     2014     2013  

STATEMENT OF OPERATIONS DATA:

          

REVENUE

          

Products

   $ 1,437     $ 1,755     $ 2,029     $ 2,196     $ 2,337  

Services

     1,835       1,947       2,052       2,175       2,241  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 
     3,272       3,702       4,081       4,371       4,578  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

COSTS

          

Products:

          

Costs

     500       630       744       854       963  

Amortization of acquired technology intangible assets

     20       30       35       56       63  

Services

     753       797       872       962       1,022  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 
     1,273       1,457       1,651       1,872       2,048  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

GROSS PROFIT

     1,999       2,245       2,430       2,499       2,530  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

OPERATING EXPENSES

          

Selling, general and administrative

     1,282       1,413       1,432       1,531       1,512  

Research and development

     229       275       338       379       445  

Amortization of acquired intangible assets

     204       226       226       227       228  

Impairment of indefinite-lived intangible assets

     65       100       —         —         —    

Goodwill impairment

     52       442       —         —         —    

Restructuring and impairment charges, net

     30       105       62       165       200  

Acquisition-related costs

     —         —         1       —         1  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 
     1,862       2,561       2,059       2,302       2,386  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

OPERATING INCOME (LOSS)

     137       (316     371       197       144  

Interest expense

     (246     (471     (452     (459     (467

Loss on extinguishment of debt

     —         —         (6     (5     (6

Other income (expense), net

     9       68       (11     3       (25

Reorganization items, net

     (98     —         —         —         —    
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

LOSS FROM CONTINUING OPERATIONS BEFORE INCOME TAXES

     (198     (719     (98     (264     (354

Benefit from (provision for) income taxes of continuing operations

     16       (11     (70     (51     35  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

LOSS FROM CONTINUING OPERATIONS

     (182     (730     (168     (315     (319

Income (loss) from discontinued operations, net of income taxes

     —         —         —         62       (57
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

NET LOSS

     (182     (730     (168     (253     (376

Less: accretion and accrued dividends on Series A and Series B preferred stock

     (31     (41     (46     (45     (43
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

NET LOSS ATTRIBUTABLE TO COMMON STOCKHOLDERS

   $ (213   $ (771   $ (214   $ (298   $ (419
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Basic and diluted earnings per share attributable to common stockholders:

          

Loss from continuing operations per common share

   $ (0.43   $ (1.54   $ (0.43   $ (0.73   $ (0.74

Income (loss) from discontinued operations per common share

     —         —         —         0.13       (0.12
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net loss per common share

   $ (0.43   $ (1.54   $ (0.43   $ (0.60   $ (0.86
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Weighted average common shares

     497.1       500.7       499.7       495.4       489.8  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

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     Fiscal years ended September 30,  
(In millions, except per share amounts)    2017     2016     2015     2014     2013  

BALANCE SHEET DATA (at end of period):

          

Cash and cash equivalents

   $ 876     $ 336     $ 323     $ 322     $ 289  

Acquired intangible assets, net

     311       617       970       1,224       1,497  

Goodwill

     3,542       3,629       4,074       4,047       4,048  

Total assets

     5,898       5,821       6,836       7,179       7,577  

Total debt (excluding capital lease obligations)(1)

     725       6,018       5,967       5,968       6,014  

Liabilities subject to compromise

     7,705       —         —         —         —    

Equity awards on redeemable shares

     7       6       19       21       5  

Preferred stock, Series B

     393       371       338       300       263  

Preferred stock, Series A

     184       175       167       159       151  

Total stockholders’ deficiency

     (5,013     (5,023     (4,001     (3,621     (3,138

STATEMENT OF CASH FLOWS DATA:

          

Net cash provided by (used in) continuing:

          

Operating activities

   $ 291     $ 113     $ 215     $ 35     $ 131  

Investing activities

     (70     (100     (129     (33     (113

Financing activities

     314       9       (53     (60     (79

OTHER FINANCIAL DATA:

          

EBITDA

   $ 370     $ 125     $ 724     $ 627     $ 566  

Adjusted EBITDA(2)

     866       940       900       898       922  

Capital expenditures

     57       94       124       134       110  

Capitalized software development costs

     2       2       —         1       14  

 

(1) Unamortized debt issuance costs originally presented within other current assets and other assets, were reclassified as a reduction of debt maturing within one year and long-term debt, respectively, upon adoption of ASU 2013-3, Imputation of Interest (Subtopic 835-30): Simplifying the Presentation of Debt Issuance Costs”, in the second quarter of fiscal 2015.
(2)  Adjusted EBITDA is calculated as disclosed herein. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations—EBITDA and Adjusted EBITDA” for a definition and explanation of Adjusted EBITDA and reconciliation of loss from continuing operations to Adjusted EBITDA.

The following are the significant items affecting the comparability of the selected historical consolidated financial data for the periods presented:

Reorganization items, net—Reorganization items, net represent amounts incurred subsequent to the Bankruptcy Filing as a direct result of the Bankruptcy Filing and are comprised of professional fees, contract rejection fees and DIP Credit Agreement financing costs.

Goodwill impairment—The Company tests goodwill for impairment at the reporting unit level annually each July 1st and more frequently if events occur or circumstances change that indicate that the fair value of a reporting unit may be below its carrying value. If the fair value of a reporting unit is below its carrying value, the implied fair value of the reporting unit is compared to the carrying value of that goodwill and a loss is recognized to the extent the carrying amount of the reporting unit’s goodwill exceeds the implied fair value of the goodwill.

 

  (a) As a result of the sale of certain assets and liabilities of the Company’s Networking segment in July 2017 to Extreme Networks, Inc. (“Extreme”), it was determined that the fair value of the Networking services component of the Global Support Services reporting unit was $80 million, which was less than its carrying value of $132 million. Accordingly, the Company recorded an impairment to goodwill of $52 million associated with the Networking services component of the Global Support Services reporting unit for fiscal 2017.

 

  (b)

Goodwill impairment in fiscal 2016 was $442 million associated with the Unified Communication reporting unit. At July 1, 2016, the Company performed its annual goodwill impairment test and determined that the carrying amount of the reporting unit’s goodwill exceeded its implied fair value

 

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  resulting in an impairment to goodwill of $442 million. The impairment was primarily the result of the continued customer cutbacks in investments in unified communication products. The reduced valuation of the reporting unit reflects additional market risks and lower sales forecasts for the reporting unit, which is consistent with the lack of customers’ willingness to spend on unified communication products such as endpoints, gateways, Nortel and Tenovis Telecom Frankfurt GmbH & Co. KG (“Tenovis”) products, servers and SME Telephony products.

Divestitures—In order to remain focused on our business objectives, we have divested ourselves of three businesses, of which two were obtained as part of larger acquisitions and were not considered core to our ongoing operations or the needs of our primary-customer base.

 

    On July 14, 2017, we consummated the sale of the Company’s Networking business to Extreme, and Extreme paid the Company $70 million, deposited $10 million in an indemnity escrow account and assumed certain liabilities of $20 million, primarily lease obligations. The sale enables the Company to focus on its core higher margin Unified Communications and Contact Center solutions. The Networking business is comprised of certain assets of our Networking segment, along with the maintenance and professional services of the Networking business, which are part of the AGS segment. Accordingly, the historical results of the Company, which include the results of operations related to the Networking business, may not be reflective of the Company’s business going forward.

 

    On July 31, 2014, we sold the Technology Business Unit (“TBU”), which we acquired as part of our acquisition of RADVISION Ltd. (“Radvision”), and recognized a $14 million gain on the sale, which is included in other (expense) income, net. TBU is a software development business that licenses technologies to developers for their use and integration into their own products and includes protocol stacks, client framework solutions and network testing and monitoring tools.

 

    On March 31, 2014, we completed the sale of our IT Professional Services (“ITPS”), business for a final sales price of $101 million, inclusive of $3 million of working capital adjustments and net of $2 million in costs to sell. As a result of the divestiture of the ITPS business, the results of operations, cash flows, and assets and liabilities of this business have been classified as discontinued operations in all periods presented. Income from discontinued operations for fiscal 2014 includes the gain on the sale of the ITPS business of $52 million. Loss from discontinued operations for fiscal 2013 includes an $89 million impairment charge to the goodwill of the ITPS business.

Costs in connection with certain legal matters—Costs in connection with certain legal matters include reserves and settlements, as well as associated legal costs. Costs in connection with certain legal matters were $64 million, $106 million, $0 million, $8 million and $10 million for fiscal 2017, 2016, 2015, 2014 and 2013, respectively, and were primarily recorded as selling, general and administrative expense.

Refinancing, Interest Expense, and Loss on Extinguishment of Debt—During fiscal 2015, 2014 and 2013, we completed a series of transactions, which allowed us to refinance certain of our debt arrangements under our senior secured credit facility dated October 27, 2007 (“Senior Secured Credit Agreement”) and our senior secured asset-based revolving credit facility (“Domestic ABL”). These transactions included:

 

   

On May 29, 2015, Avaya Inc. completed an amendment to the Senior Secured Credit Agreement pursuant to which Avaya Inc. refinanced a portion of its outstanding term B-3, term B-4 and term B-6 loans in exchange for and with the proceeds from the issuance of $2,125 million in principal amount of senior secured term B-7 loans (“term B-7 loans”) maturing May 29, 2020. On June 4, 2015, Avaya Inc. completed an amendment to the Domestic ABL, which, among other things: (i) extended the stated maturity of the facility from October 26, 2016 to June 4, 2020 (subject to certain conditions specified in the Domestic ABL), (ii) increased the sublimit for letter of credit issuances under the Domestic ABL from $150 million to $200 million, and (iii) amended certain covenants and other provisions of the existing agreement. At the same time, certain foreign subsidiaries of the Company (the “Foreign Borrowers”), Citibank and the lenders party thereto entered into a new senior secured foreign

 

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asset-based revolving credit facility (the “Foreign ABL”), which matures June 4, 2020 (subject to certain conditions specified in the Foreign ABL). On June 5, 2015, Avaya Inc. permanently reduced the revolving credit commitments under the Senior Secured Credit Agreement from $200 million to $18 million and all letters of credit outstanding under the Senior Secured Credit Agreement were transferred to the Domestic ABL.

 

    During fiscal 2014, Avaya Inc. entered into refinancing transactions, which lowered the interest rate of certain debt. On February 5, 2014, Avaya Inc. completed an amendment to the Senior Secured Credit Agreement pursuant to which it refinanced $1,138 million aggregate principal amount of senior secured term B-5 loans (“term B-5 loans”) with the cash proceeds from the issuance of senior secured term B-6 loans (“term B-6 loans”). On May 15, 2014, Avaya Inc. redeemed 100% of the remaining aggregate principal amount of its 9.75% senior unsecured cash-pay notes due 2015 and 10.125%/10.875% senior unsecured paid-in-kind (“PIK”) toggle notes due 2015 at a redemption price of 100% of the principal amount thereof, plus accrued and unpaid interest, or $92 million and $58 million, respectively. The redemption price was funded through cash on-hand of $10 million and borrowings of $140 million under Avaya Inc.’s revolving credit facilities.

 

    During fiscal 2013, Avaya Inc. completed a series of transactions, which allowed Avaya Inc. to refinance (1) all of Avaya Inc.’s senior secured term B-1 loans (“term B-1 loans”) outstanding under its Senior Secured Credit Agreement originally due October 26, 2014, and (2) $642 million of Avaya Inc’s 9.75% senior unsecured cash-pay notes and $742 million of Avaya Inc.’s senior unsecured PIK toggle notes each originally due November 1, 2015. These transactions extended the maturity date of the $2.8 billion of refinanced debt by an additional three to six years and increased the associated interest rate.

 

    In connection with the refinancing transactions referenced above, we recognized a loss on extinguishment of debt of $6 million, $5 million and $6 million in fiscal 2015, 2014 and 2013, respectively.

 

    These refinancing transactions impacted the interest we pay on the related debt. As of September 30, 2017, 2016, 2015, 2014 and 2013, the weighted average interest rate of the Company’s outstanding debt was 7.7%, 7.3%, 7.3%, 6.9% and 7.4%, respectively.

 

    Effective January 19, 2017, the Company ceased recording interest expense on outstanding pre-petition debt classified as liabilities subject to compromise. Contractual interest expense represents amounts due under the contractual terms of outstanding debt, including debt subject to compromise. For the period from January 19, 2017 through September 30, 2017, contractual interest expense related to debt subject to compromise of $316 million was not recorded, as it was not expected to be an allowed claim under the Bankruptcy Filing.

Restructuring Charges and Cost Saving Initiatives—We have maintained our focus on profitability levels and investing in our future results. In connection with certain acquisitions and in response to global economic conditions, the Company initiated cost savings programs designed to streamline its operations, generate cost savings, and eliminate overlapping processes and expenses. These cost savings programs have included: (1) reducing headcount, (2) relocating certain job functions to lower cost geographies, including service delivery, customer care, research and development, human resources and finance, (3) eliminating real estate costs associated with unused or under-utilized facilities and (4) implementing gross margin improvement and other cost reduction initiatives. Restructuring charges include employee separation charges such as, but not limited to, severance and employment benefit payments, social pension fund payments, and healthcare and unemployment insurance costs to be paid to or on behalf of the affected employees. The related restructuring costs also include the contractual future lease payments and payments made under lease termination agreements associated with vacated facilities. As of September 30, 2017, the remaining liability associated with these actions is $80 million, including amounts reported within liabilities subject to compromise in the audited Consolidated Financial Statements. The Company continues to evaluate opportunities to streamline its operations and identify cost

 

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savings globally and may take additional restructuring actions in the future, the costs of which could be material. See Note 10, “Business Restructuring Reserves and Programs,” to our audited Consolidated Financial Statements included elsewhere in this registration statement for further details.

HP Capital Lease—On August 20, 2014, we signed an agreement with HP Enterprise Services, LLC (“HP”), pursuant to which the Company outsources to HP certain delivery services in order to scale our operational capacity to serve cloud demand of customers. In connection with that agreement, in fiscal 2014, HP acquired specified assets owned by the Company for $40 million, which are being leased-back by Avaya under a capital lease. During fiscal 2016 and 2015, the Company received $14 million and $22 million, respectively in cash proceeds in connection with the sale of equipment used in the performance of services under this agreement, which are being leased-back by Avaya under a capital lease. As of September 30, 2017, our capital lease obligations associated with this agreement were $24 million, of which $10 million was included in liabilities subject to compromise.

Amortization of Acquired Intangible Assets—Amortization of acquired intangible assets represents the amortization of acquired technologies, customer relationships and other intangibles.

Impairment of Indefinite-lived Intangible Assets—The impairment of indefinite-lived intangible assets recorded during fiscal 2017 and 2016 was related to the Company’s trademarks and trade names. The impairment charges were primarily the result of the continued customer cutbacks in current and expected future investments in products, specifically relating to unified communications. The reduced valuation reflects additional market risks and lower sales forecasts for the Company, which is consistent with the lack of customers’ willingness to spend on products.

Changes in Estimated Lives and Salvage Value of Property—In addition to the restructuring charges associated with vacated facilities under operating leases discussed above, the Company also sold four Company-owned and under-utilized facilities in order to reduce its real estate costs. During fiscal 2014, in anticipation of selling a Company-owned facility, additional depreciation of $6 million, $24 million and $5 million was recognized and included in cost of revenue; selling, general and administrative expense; and research and development, respectively. During fiscal 2013, in anticipation of selling a Company-owned facility, additional depreciation of $21 million was recognized and included in selling, general and administrative expense. The additional depreciation was the result of changes to the estimated salvage value and useful life of the respective facility made to be consistent with the estimated proceeds and timing of the contemplated sale of the facility.

Other Income (Expense), net—Other income (expense), net for fiscal 2017, 2016, 2015, 2014 and 2013 includes the change in fair value of Preferred B embedded derivative of $0 million, $73 million, $(24) million, $(22) million and $(11) million, respectively, and net foreign currency transaction gains of $2 million, $10 million, $14 million, $18 million and $5 million, respectively. Other (expense) income, net for fiscal 2016 included an $11 million loss on an equity investment, for fiscal 2015 included $9 million associated with the release of a reserve related to a tax indemnification liability and for fiscal 2014 a gain on the sale of the TBU business of $14 million. Other (expense) income, net for fiscal 2015, 2014 and 2013 also includes $8 million, $2 million and $18 million, respectively, of third-party fees incurred in connection with the debt modifications referenced above.

Income Taxes—The effective income tax rate differed from the U.S. federal statutory rate for the periods presented due to the following significant items:

 

    Changes in Valuation Allowance of Deferred Tax Assets—The Company, in assessing the requirement for a valuation allowance against its U.S. deferred tax assets determined that it was not more likely than not that our U.S. net deferred tax assets would be realized. Accordingly, we recorded a valuation allowance against our U.S. net deferred tax assets. Each fiscal year, additional valuation allowances were provided against the net increase in the Company’s deferred tax asset balance in the U.S. and certain foreign jurisdictions. Net operating losses comprised the most significant increase in net deferred tax assets.

 

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    Effect of Changes in Other Comprehensive Income—During fiscal 2017 and 2013, we recognized tax charges to other comprehensive income of $19 million and $126 million, respectively. As a result of the tax charges recognized in other comprehensive income, we recognized a corresponding income tax benefit in the Consolidated Statements of Operations.

Total Debt (excluding Capital Lease)—In connection with the Bankruptcy Filing on January 19, 2017, the Company entered into the DIP Credit Agreement, which provided a $725 million term loan facility due January 2018 and a cash collateralized letter of credit facility in an aggregate amount equal to $150 million. Accordingly, this amount is included in current liabilities as of September 30, 2017.

Liabilities Subject to Compromise—Liabilities subject to compromise are pre-petition obligations that are not fully secured and that have at least a possibility of not being repaid at the full claim amount. See Note 4, “Liabilities Subject to Compromise,” to our audited Consolidated Financial Statements for details regarding our liabilities subject to compromise.

 

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UNAUDITED PRO FORMA CONSOLIDATED FINANCIAL STATEMENTS

The following presents the unaudited pro forma consolidated balance sheet as of September 30, 2017, and the unaudited pro forma consolidated statements of operations for the fiscal years ended September 30, 2017.

The unaudited pro forma consolidated financial statements have been developed by applying pro forma adjustments to the historical Consolidated Balance Sheet and Consolidated Statement of Operations of Avaya Holdings Corp. appearing elsewhere in this registration statement. The unaudited pro forma Consolidated Balance Sheet as of September 30, 2017 gives effect to the Restructuring approved by the Bankruptcy Court on November 28, 2017, the effective emergence from chapter 11 cases on December 15, 2017 and the application of fresh start accounting as if it had occurred on September 30, 2017. The unaudited pro forma Consolidated Statement of Operations for the fiscal year ended September 30, 2017 gives effect to the Restructuring as contemplated by the Plan of Reorganization approved by the Bankruptcy Court on November 28, 2017 and the effective emergence from chapter 11 cases and the application of fresh start accounting as if it had occurred on October 1, 2016. All pro forma adjustments and underlying assumptions are described more fully in the notes to the unaudited pro forma consolidated financial statements.

The pro forma information presented is for illustrative purposes only and is not necessarily indicative of the financial position or results of operations that would have been realized if the Restructuring had been completed on the dates indicated, nor is it indicative of future operating results. The pro forma adjustments are based upon available information and certain assumptions that management believes to be reasonable. The actual amounts to be recorded as of the effective date of emergence may be materially different from these estimates. In addition, the historical consolidated financial statements will not be comparable to the financial statements following the effective emergence from chapter 11 cases due to the effects of the consummation of the Plan of Reorganization as well as adjustments for fresh start accounting.

The Plan of Reorganization provides for the following treatments for certain creditor and equity classes:

 

    First lien debt claims: pro rata share of (i) new secured debt (or cash to the extent such debt is partially or fully syndicated) to be issued in connection with the Restructuring and (ii) 90.5% of the reorganized Avaya Holdings’ common stock (subject to dilution by the issuance of warrants for second lien notes claims and by the post-Emergence Date Equity Incentive Plan less the General Unsecured Recovery Cash Pool and the General Unsecured Recovery Equity Reserve.

 

    Second lien notes claims: pro rata share of 4.0% of the reorganized Avaya Holdings’ common stock and warrants to purchase additional common stock (the common stock subject to dilution by the issuance of such warrants and by the post-Emergence Date Equity Incentive Plan).

 

    General unsecured claims: pro rata share of the $58 million general unsecured recovery cash pool, which the general unsecured creditors may irrevocably elect to receive as reorganized Avaya Holdings’ common stock (subject to dilution by the issuance of warrants for second lien notes claims and by the post-Emergence Date Equity Incentive Plan) or cash proceeds (pursuant to an election submitted prior to the applicable voting deadline).

 

    Claims of the PBGC in connection with the termination of the APPSE: (i) $340 million in cash and (ii) 5.5% of the reorganized Avaya Holdings’ common stock (subject to dilution by the issuance of warrants for the second lien notes claims and by the post-Emergence Date Equity Incentive Plan).

 

    Pre-emergence equity interests in Avaya Holdings: cancelled.

Upon emergence from bankruptcy, on December 15, 2017, the Company entered into (i) a term loan credit agreement between Avaya Inc., as borrower, Avaya Holdings, the lending institutions from time to time party thereto, and Goldman Sachs Bank USA, as administrative agent and collateral agent, which provided a $2,925 million term loan facility due December 15, 2024 (the “Term Loan Credit Agreement”) and (ii) an ABL credit

 

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agreement among Avaya Holdings, Avaya Inc., as borrower, the several borrowers party thereto, the several lenders from time to time party thereto, and Citibank, N.A., as administrative agent and collateral agent, which provided a revolving credit facility consisting of a U.S. tranche and a foreign tranche in an aggregate principal amount of $300 million, subject to borrowing base availability (the “ABL Credit Agreement”, and together with the Term Loan Credit Agreement, the “Credit Agreements”). The Term Loan Credit Agreement, in the case of ABR Loans, bears interest at a rate per annum equal to 3.75% plus the highest of (i) the Federal Funds Rate plus 0.50%, (ii) the U.S. prime rate as publicly announced in the Wall Street Journal and (iii) the LIBOR Rate for an interest period of one month, subject to a 1% floor and in the case of LIBOR Loans, bears interest at a rate per annum equal to 4.75% plus the applicable LIBOR Rate, subject to a 1% floor. The ABL Credit Agreement bears interest:

 

  1. In the case of Base Rate Loans, at a rate per annum equal to 0.75% (subject to a step-up or step-down based on availability) plus the highest of (i) the Federal Funds Rate plus 0.50%, (ii) the prime rate as publicly announced by Citibank, N.A. and (iii) the LIBOR Rate for an interest period of one month, subject to a 1% floor;

 

  2. In the case of Canadian Prime Rate Loans, at a rate per annum equal to 0.75% (subject to a step-up or step-down based on availability) plus the highest of (i) the “Base Rate” as publicly announced by Citibank, N.A., Canadian branch and (ii) the CDOR Rate for an interest period of 30 days, subject to a 1% floor;

 

  3. In the case of LIBOR Rate Loans, at a rate per annum equal to 1.75% (subject to a step-up or stepdown based on availability) plus the applicable LIBOR Rate, subject to a 0% floor;

 

  4. In the case of CDOR Rate Loans, at a rate per annum equal to 1.75% (subject to a step-up or step-down based on availability) plus the applicable CDOR Rate, subject to a 0% floor; and

 

  5. In the case of Overnight LIBOR Rate Loans, at a rate per annum equal to 1.75% (subject to a step-up or step-down based on availability) plus the applicable Overnight LIBOR Rate.

The Credit Agreements limit, among other things, Avaya Inc.’s ability to (i) incur indebtedness, (ii) incur or create liens, (iii) dispose of assets, (iv) prepay subordinated indebtedness and make other restricted payments, (v) enter into sale and leaseback transactions, (vi) make dividends, redemptions and repurchases of capital stock, (vii) enter into transactions with affiliates and (viii) modify the terms of any organizational documents and certain material contracts of Avaya Inc.

 

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UNAUDITED PRO FORMA CONSOLIDATED BALANCE SHEET

AS OF SEPTEMBER 30, 2017

(in millions, except per share amounts)

 

    Historical
Avaya
Holdings
Corp.
    Reorganization
Adjustments
        Fresh Start
Adjustments
        Pro Forma
Avaya
Holdings
Corp.
 

ASSETS

           

Current assets:

           

Cash and cash equivalents

  $ 876     $ (526   (1c)   $ —         $ 350  

Accounts receivable, net

    536       —           —           536  

Inventory

    96       —           34     (2c)     130  

Other current assets

    269       (73   (1c)     —           196  
 

 

 

   

 

 

     

 

 

     

 

 

 

TOTAL CURRENT ASSETS

    1,777       (599       34         1,212  

Property, plant and equipment, net

    200       —           —           200  

Intangible assets, net

    311       —           3,049     (2a)     3,360  

Goodwill

    3,542       —           (349   (2a)     3,193  

Other assets

    68       5     (1a)     —           73  
 

 

 

   

 

 

     

 

 

     

 

 

 

TOTAL ASSETS

  $ 5,898     $ (594     $ 2,734       $ 8,038  
 

 

 

   

 

 

     

 

 

     

 

 

 

LIABILITIES

           

Current liabilities:

           

Current portion of long-term debt

  $ 725     $ (725   (1c)   $ —         $ —    

Accounts payable

    282       (29   (1c)     —           253  

Payroll and benefit obligations

    127       14     (1f)     —           141  

Deferred revenue

    614       55     (1f)     (227   (2b)     442  

Business restructuring reserve, current portion

    35       4     (1f)     —           39  

Other current liabilities

    90       —           —           90  
 

 

 

   

 

 

     

 

 

     

 

 

 

TOTAL CURRENT LIABILITIES

    1,873       (681       (227       965  
 

 

 

   

 

 

     

 

 

     

 

 

 

Non-current liabilities:

           

Long-term debt

    —         2,813     (1a)     —           2,813  

Pension obligations

    513       261     (1f)     —           774  

Other postretirement obligations

    —         226     (1f)     —           226  

Deferred income taxes, net

    32       (223   (3)     884     (3)     693  

Business restructuring reserve, non-current portion

    34       —           —           34  

Other liabilities

    170       234     (1f)     (25   (2b)     379  
 

 

 

   

 

 

     

 

 

     

 

 

 

TOTAL NON-CURRENT LIABILITIES

    749       3,311         859         4,919  

LIABILITIES SUBJECT TO COMPROMISE

    7,705       (7,705   (1f)     —           —    
 

 

 

   

 

 

     

 

 

     

 

 

 

TOTAL LIABILITIES

    10,327       (5,075       632         5,884  

Commitments and contingencies

           

Equity awards on redeemable shares

    7       (7   (1e)     —           —    

Preferred stock:

           

Series B

    393       (393   (1e)     —           —    

Series A

    184       (184   (1e)     —           —    

STOCKHOLDERS’ DEFICIENCY

           

Common stock

    —         —           —           —    

Additional paid-in capital

    2,389       (235   (1b,d,e)     —           2,154  

Accumulated deficit

    (5,954     5,300     (1)     654     (2)     —    

Accumulated other comprehensive loss

    (1,448     —           1,448     (2)     —    
 

 

 

   

 

 

     

 

 

     

 

 

 

TOTAL STOCKHOLDERS’ DEFICIENCY

    (5,013     5,065         2,102         2,154  
 

 

 

   

 

 

     

 

 

     

 

 

 

TOTAL LIABILITIES AND STOCKHOLDERS’ DEFICIENCY

  $ 5,898     $ (594     $ 2,734       $ 8,038  
 

 

 

   

 

 

     

 

 

     

 

 

 

 

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UNAUDITED PRO FORMA CONSOLIDATED STATEMENT OF OPERATIONS

FISCAL YEAR ENDED SEPTEMBER 30, 2017

(in millions, except per share amounts)

 

     Historical
Avaya
Holdings
Corp.
    Reorganization
Adjustments
          Fresh Start
Adjustments
          Pro Forma
Avaya
Holdings
Corp.
       

REVENUE

              

Products

   $ 1,437     $ —         $ (32     (2f   $ 1,405    

Services

     1,835       —           (232     (2f     1,603    
  

 

 

   

 

 

     

 

 

     

 

 

   
     3,272       —           (264       3,008    
  

 

 

   

 

 

     

 

 

     

 

 

   

COSTS

       —              

Products:

              

Costs

     500       (1     (1g     36       (2e     535    

Amortization of acquired technology intangible assets

     20       —           157       (2d     177    

Services

     753       (10     (1g     —           743    
  

 

 

   

 

 

     

 

 

     

 

 

   
     1,273       (11       193         1,455    
  

 

 

   

 

 

     

 

 

     

 

 

   

GROSS PROFIT

     1,999       11         (457       1,553    
  

 

 

   

 

 

     

 

 

     

 

 

   

OPERATING EXPENSES:

              

Selling, general and administrative

     1,282       (23     (1g     —           1,259    

Research and development

     229       (4     (1g     —           225    

Amortization of intangible assets

     204       —           (44     (2d     160    

Impairment of indefinite-lived intangible assets

     65       —           —           65    

Goodwill impairment

     52       —           —           52    

Restructuring charges, net

     30       —           —           30    
  

 

 

   

 

 

     

 

 

     

 

 

   
     1,862       (27       (44       1,791    
  

 

 

   

 

 

     

 

 

     

 

 

   

OPERATING INCOME

     137       38         (413       (238  

Interest expense

     (246     50       (1i     —           (196  

Other income, net

     9       —           —           9    

Reorganization items, net

     (98     98       (1k     —           —      
  

 

 

   

 

 

     

 

 

     

 

 

   

LOSS BEFORE INCOME TAXES

     (198     186         (413       (425  

Benefit from income taxes

     16       (36     (3     121       (3     101    
  

 

 

   

 

 

     

 

 

     

 

 

   

NET LOSS

     (182     150         (292       (324  

Less: Accretion and accrued dividends on Series A and Series B preferred stock

     (31     31       (1h     —           —      
  

 

 

   

 

 

     

 

 

     

 

 

   

NET LOSS ATTRIBUTABLE TO COMMON STOCKHOLDERS

   $ (213   $ 181       $ (292     $ (324  
  

 

 

   

 

 

     

 

 

     

 

 

   

Basic and diluted earnings per share attributable to common stockholders:

              

Net loss per share—basic and diluted.

   $ (0.43           $ (2.95  
  

 

 

           

 

 

   

Weighted average shares outstanding—basic and diluted

     497.1               110.0       (1d
  

 

 

           

 

 

   

 

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NOTES TO THE UNAUDITED PRO FORMA CONSOLIDATED FINANCIAL STATEMENTS

We were required to apply Financial Accounting Standards Board Accounting Standards Codification (“ASC”) 852, “Reorganizations,” effective on January 19, 2017, which is applicable to companies under bankruptcy protection, and requires amendments to the presentation of certain financial statement line items. It requires that the balance sheet distinguish pre-petition liabilities subject to compromise from both (i) pre-petition liabilities not subject to compromise and (ii) post-petition liabilities. Liabilities that may be affected by a plan of reorganization must be reported at the amounts expected to be allowed by the Bankruptcy Court, even if they may be settled for lesser amounts as a result of the plan of reorganization or negotiations with creditors.

At the effective date of our emergence, we anticipate meeting the requirements under ASC 852 for fresh start accounting. Fresh start accounting requires the debtor to use current fair values in its balance sheet for both assets and liabilities upon emergence and to eliminate all prior earnings or deficits if both of the following conditions are met:

 

  i. The reorganization value of the assets of the emerging entity immediately before the date of confirmation of the plan of reorganization is less than the total of all post-petition liabilities and allowed claims; and

 

  ii. The holders of existing voting shares immediately before confirmation of the plan of reorganization receive less than 50% of the voting shares of the emerging entity.

Note 1—Plan of Reorganization

The following are adjustments to reflect the proposed transactions in the Plan of Reorganization. The difference between the settled amount of a liability and its recorded amount is reflected in accumulated deficit.

a) Exit Financing

The exit financing consists of a senior secured term loan of $2,925 million, maturing 7 years from the date of issuance and a $300 million undrawn senior secured asset-based revolving credit facility (“ABL”).

The net cash proceeds from the exit financing are as follows (in millions):

 

Senior secured term loan

   $ 2,925  

Less:

  

Discount on senior secured term loan

     (34

Upfront and underwriting fees

     (78
  

 

 

 

Anticipated net proceeds from issuance of senior secured term loan and second lien note

     2,813  

Upfront fees associated with ABL

     (5
  

 

 

 

Pro forma net proceeds from exit financing

   $ 2,808  
  

 

 

 

Deferred financing costs related to the senior secured term loan along with the discount on the senior secured term loan will be presented on the balance sheet as a reduction of the carrying amount of debt. The net borrowings, discount and deferred financing costs of $2,813 million related to the senior secured term loan will be included in long-term debt. The $5 million for upfront fees associated with the ABL are considered deferred financing costs and will be included in other assets. Deferred financing costs and debt discount will be amortized as interest expense using the effective interest rate method over the contractual life of the related credit facility.

b) Avaya Pension Plan for Salaried Employees

As part of the Plan of Reorganization, Avaya will complete a distress termination of the APPSE in accordance with the Stipulation of Settlement with the PBGC. The PBGC received $340 million in cash and

 

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5.5% of the common stock in the successor company (estimated value $117 million) for full and final satisfaction, settlement, release and compromise of each allowed claim. Therefore, we eliminated the $634 million liability included in liabilities subject to compromise as of September 30, 2017 for the APPSE.

c) Sources and Uses of Cash (in millions)

 

Historical cash at September 30, 2017

   $ 876  

Net cash received from exit financing

     2,808  

Repayment of debtor in possession financing

     (725

Cash paid to predecessor debt-holders

     (2,176

Payment to the PBGC

     (340

Payment for professional fees contingent upon emergence

     (24

Release of restricted cash (other current assets)

     73  

Funding payment for Avaya pension plan for represented employees

     (39

Payment of accrued professional fees (accounts payable)

     (29

Payments to cure contracts (liabilities subject to compromise)

     (16

Payments for general unsecured claims (liabilities subject to compromise)

     (58
  

 

 

 

Pro forma cash upon emergence

   $ 350  
  

 

 

 

Restricted cash of $73 million related to letters of credit and included in other current assets will be released upon repayment of the debtor in possession financing.

d) Settlement of Debt and Issuance of New Common Shares

In settlement of the Company’s $5,832 million first and second lien debt, the first lien debt-holders will receive a total of $2,176 million in cash and 90.5% of the common stock of the successor company (estimated value $1,924 million) and the second lien debt-holders will receive 4.0% of the common stock of the successor company and 5.6 million of warrants to purchase additional common shares (combined estimated value $113 million). The common stock is subject to dilution by the issuance of warrants.

Upon emergence, the Company issued 110 million shares of common stock.

e) Cancellation of Predecessor Preferred and Common Stock

Per the terms of the Plan of Reorganization, on the effective date all pre-emergence common stock, preferred stock, and equity awards were cancelled without any distribution.

f) Liabilities Subject to Compromise and Settlement of General Unsecured Claims

As part of the Plan of Reorganization, the Bankruptcy Court approved the settlement of certain claims reported within liabilities subject to compromise in our Consolidated Balance Sheet at allowed claim amounts. The total claims submitted to the Bankruptcy Court amounted to $19.6 billion.

 

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The table below details the disposition of certain proofs of claim through which the Company calculates its liabilities subject to compromise (in millions):

 

Proofs of claim

   $ 19,624  

Less:

  

Expunged claims

     (7,340

Duplicate guarantor claims

     (1,165

Duplicate claims

     (1,397

Claims assessed as invalid and not reserved

     (1,310

Union contract claims

     (503

Other

     (204
  

 

 

 

Liabilities subject to compromise

   $ 7,705  
  

 

 

 

The Bankruptcy Court’s final determination with respect to these proofs of claim may differ from the estimates presented above, but, as noted above, the Company does not expect that the resolution of these proofs of claim will have a material effect on either the completion of its restructuring or its future results of operations post-emergence.

The table below details the disposition of liabilities subject to compromise (in millions):

 

Liabilities subject to compromise pre-emergence

   $ 7,705  

To be reinstated:

  

Avaya pension plan for represented employees

     (261

Postretirement benefit obligations

     (226

Deferred taxes

     (113

Deferred revenue

     (91

Payroll and benefit obligations

     (14

Other post employment benefits

     (111

Other

     (91

Settlement of first and second lien debt

     (5,832

Termination of APPSE

     (634

Contribution to Avaya pension plan for represented employees

     (39

Payments to cure contracts

     (16

Settlement of general unsecured claims

     (277
  

 

 

 

Liabilities subject to compromise post-emergence

   $ —    
  

 

 

 

In settlement of allowed general unsecured claims, each claimant will receive a pro-rata distribution of $58 million in cash paid for all general unsecured claims.

g) Pension Adjustments

In connection with the termination of the APPSE and the Avaya Supplemental Pension Plan, the Company reversed associated expenses of $38 million for the fiscal year ended September 30, 2017. This included $27 million within operating expenses and $11 million within cost of sales. These expenses are primarily related to certain components of net periodic benefit cost for these plans, that the Company will no longer incur, including interest cost, amortization of actuarial gains (losses) and amortization of prior service costs.

 

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h) Accretion and Dividends on Preferred Stock

For the fiscal year ended September 30, 2017, accrued dividends on preferred Series A and B stock was $31 million. These amounts included the following (in millions):

 

     Fiscal Year
Ended

September 30,
2017
 

Dividends on preferred Series A stock

   $ (9

Dividends on preferred Series B stock

     (22
  

 

 

 
   $ (31
  

 

 

 

i) Interest Expense

 

  1) For the fiscal year ended September 30, 2017, the Company reversed interest expense of $242 million on its pre-emergence related debt.

 

  2) For the fiscal year ended September 30, 2017, the Company’s interest expense related to its post-emergence debt was $192 million.

k) Reorganization Expenses

Reorganization items, net represent amounts incurred subsequent to the Bankruptcy Filing, which were a direct result of the Bankruptcy Filing and were comprised of the following for the fiscal year ended September 30, 2017: professional fees of $66 million, DIP Credit Agreement financing costs of $14 million and contract rejection fees of $18 million.

Note 2—Fresh Start Adjustments

At the Emergence Date, we met the requirements under ASC 852 for fresh start accounting. Fresh start accounting requires the revaluation of our tangible and intangible assets to fair value, resulting in a higher fair value of our existing tangible assets and the recognition of new intangible, amortizable assets namely developed technology, customer relationships and trade names. The effect of these fair value adjustments is primarily to increase the depreciation and amortization charge relating to these intangible assets in reporting periods subsequent to the Emergence Date, which will primarily increase our costs of goods sold and decrease gross profits and operating margins in future periods. Fresh start accounting also requires the debtor to eliminate all predecessor earnings or deficits in accumulated deficit and accumulated other comprehensive loss. These adjustments reflect preliminary estimates and actual amounts recorded as of the Emergence Date may be materially different from these estimates.

a) Goodwill and Acquired Intangibles

We have eliminated historical goodwill and other intangible assets and in accordance with ASC 852 determined the estimated current fair value of identifiable acquired intangible assets using the income approach. These estimates are based on a preliminary valuation and are subject to change.

 

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The following table sets forth the components of these intangible assets (in millions) and their estimated useful lives:

 

     Preliminary
Fair Value
     Estimated useful life  

Customer relationships

   $ 2,000        6-19 years  

Developed technology and patents

     1,020        6 years  

Trademarks and trade names

     340        10 years—indefinite lived  
  

 

 

    

Total pro forma intangible assets upon emergence

     3,360     

Elimination of historical acquired intangible assets

     (311   
  

 

 

    

Fresh start adjustment to acquired intangibles assets

   $ 3,049     
  

 

 

    

The Company expects to record material customer-related and developed technology-related intangible assets as part of fresh start accounting and the application of ASC 852. Such assets were not recognized on historical financial statements. We also expect to record marketing-related intangible assets, including the Avaya trade name.

The following table sets forth the estimated adjustments to goodwill (in millions):

 

Pro forma reorganization value

   $ 8,038  

Less: Fair value of pro forma assets (excluding goodwill)

     (4,845
  

 

 

 

Total pro forma goodwill upon emergence

     3,193  

Elimination of historical goodwill

     (3,542
  

 

 

 

Fresh start adjustment to goodwill

   $ (349
  

 

 

 

As set forth in the Plan of Reorganization, which was confirmed by the Bankruptcy Court on November 28, 2017, the agreed upon enterprise value of the Company is $5.721 billion. This value is within the initial range of approximately $5.1 billion to approximately $7.1 billion using the income approach. The $5.721 billion enterprise value was selected as it was the transaction price agreed to in the global settlement agreement with the Company’s creditor constituencies, including the PBGC.

The reorganization value was then determined by adding back liabilities other than interest bearing debt.

While the reorganization value approximates the amount a willing buyer would pay for the assets of the Company immediately before the restructuring, it is derived from estimated amounts that may have materially changed as a result of confirmation of the Plan of Reorganization by the Bankruptcy Court.

b) Deferred Revenue

The fair value of a deferred revenue liability typically reflects how much an acquirer would be required to pay a third-party to assume the remaining performance obligations. We have estimated the fair value of deferred revenue to be $490 million, a decrease of $252 million, of which $442 million is a component of total current liabilities and $48 million is included in other liabilities.

c) Inventory

The fair value of inventory is generally measured at estimated selling prices of the inventory, less the sum of (1) costs of disposal and (2) a reasonable profit allowance for the selling effort as this represents an exit price. We have determined the estimated fair value of our inventory to be $130 million, an increase of $34 million.

 

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d) Amortization of Intangible Assets

 

  1) For the fiscal year ended September 30, 2017, the Company reversed historical amortization of acquired intangible assets of $224 million. This included $204 million within operating expenses and $20 million included within cost of sales for the amortization of acquired technology intangible assets.

 

  2) The Company’s pro forma other intangible assets include customer relationships, developed technology and trade names. For the fiscal year ended September 30, 2017, the Company recorded amortization of intangible assets of $337 million. This included amortization of $160 million included within operating expenses related to our customer relationship intangible assets and $177 million included within cost of sales related to our technology and trade name intangible assets.

e) Inventory Write-up

For the fiscal year ended September 30, 2017, the Company recorded additional cost of products of $36 million as a result of the write-up of inventory to its estimated fair value upon emergence. This adjustment primarily relates to our Unified Communications reporting unit.

f) Deferred Revenue Write-down

For the fiscal year ended September 30, 2017, the Company recorded a decrease to revenue of $264 million, which included $232 million related to services and $32 million related to products. These adjustments result from the write-down of deferred revenue to its estimated fair value upon emergence.

Note 3—Income Tax

a) Adjustments Related to the Tax Effects of the Pro Forma Adjustments

Upon emergence, the Company’s U.S. federal net operating losses (NOL) will be reduced in accordance with IRC Section 108 due to cancellation of debt income, which is not includable in U.S. federal taxable income. The estimated U.S. federal NOL upon emergence is zero.

The opening balance of the valuation allowance on deferred tax assets has been removed as a pro forma adjustment because, based on information currently available, the Company believes it is more likely than not that such deferred assets will be realized. Realization of deferred tax assets is based on income from reversing deferred tax liabilities. These reversing deferred tax liabilities are principally attributable to the amortization of intangible assets. Because the pro forma adjustment for intangible assets has no tax basis, a pro forma adjustment was made to establish a deferred tax liability on the book/tax basis difference for the September 30, 2017 unaudited pro forma Consolidated Balance Sheet. On a pro forma basis, the Company has a net deferred tax liability as of September 30, 2017.

The reduction in the NOL and the removal of the opening balance of the valuation allowance on deferred tax assets is reflected as a pro forma adjustment to the deferred tax balance in the unaudited Consolidated Balance Sheet as of September 30, 2017. The effect on income and loss for the reduction in the NOL and the opening balance of the valuation allowance is not included in the unaudited pro forma Consolidated Statement of Operations for the periods presented because the item is non-recurring in nature.

Pro forma tax adjustments have been made to the Consolidated Statement of Operations to reflect tax benefits on losses generated in the fiscal year ended September 30, 2017. As originally filed, such tax benefits were reversed through a current period increase in the valuation allowance. The amount of this pro forma tax benefit is $14 million.

Pro forma adjustments made to the Consolidated Statement of Operations and the Consolidated Balance Sheet have been tax-effected based upon the statutory tax rate for the applicable jurisdiction. Because the Company conducts operations in several jurisdictions, there is a difference between the federal statutory tax rate of 35% and the net rate at which the pro forma adjustments are tax-effected.

 

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The tax effect of the pro forma adjustments made to the unaudited pro forma Consolidated Statement of Operations is a $85 million benefit for the fiscal year ended September 30, 2017. Of this amount, $71 million of benefit is attributable to the tax effect of the pro forma book adjustments.

The September 30, 2017 deferred tax balance has been adjusted to reflect the reduction in the NOL, the reversal of the valuation allowance and the tax effect of the pro forma adjustments.

 

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MANAGEMENT’S DISCUSSION AND ANALYSIS OF

FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following is a discussion and analysis of our financial condition and results of operations for the fiscal years ended September 30, 2017, 2016 and 2015. You should read this discussion and analysis together with our Consolidated Financial Statements and related notes and the other financial information included elsewhere in this registration statement. This discussion contains forward-looking statements that involve significant risks and uncertainties. As a result of many factors, such as those set forth under “Item 1.A. Risk Factors” and elsewhere in this registration statement, our actual results may differ materially from those anticipated in these forward-looking statements.

Overview

Avaya is a leading global business communications company, providing an expansive portfolio of software and services for contact center and unified communications, offered on-premises, in the cloud or as a hybrid solution. We provide our solutions to a broad range of companies, from small businesses to large multinational enterprises and government organizations. Our products and services portfolio spans software, hardware, professional and support services and cloud services. These fall under the following reporting segments:

 

    GCS encompasses our contact center and unified communications solutions and our real-time collaboration software and hardware products, all of which target small and medium to very large enterprise businesses and are delivered through a hybrid cloud environment. Our omnichannel contact center applications offer highly reliable, scalable communications-centric solutions including voice, email, chat, social media, video, performance management and ease of third-party integration that can improve customer service and help companies compete more effectively. Our unified communications solutions help companies increase employee productivity, improve customer service and reduce costs by integrating multiple forms of communications, including telephony, e-mail, instant messaging and video. Avaya embeds communications directly into the applications, browsers and devices employees use every day to create a single, powerful gateway for voice, video, messaging, conferencing and collaboration. We free people from their desktop and give them a more natural and efficient way to connect, communicate and share—when, where and how they want. This reporting segment also includes an open, extensible development platform, which allows our customers and third parties to adapt our technology by creating custom applications and automated workflows for their unique needs and allows them to integrate Avaya’s capabilities into their existing infrastructure and business applications.

 

    Avaya Networking includes advanced fabric networking technology, which offers a unique end-to-end virtualized architecture network designed to be simple to deploy, agile and resilient. This reporting segment also includes software and hardware products such as Ethernet switches, wireless networking, access control, and unified management and orchestration solutions, which provide network and device management.

On July 14, 2017, the Company sold the Avaya Networking business to Extreme Networks, Inc. (“Extreme”). The Networking business is comprised of certain assets of the Company’s Networking segment, along with the maintenance and professional services of the Networking business, which are part of the AGS segment.

 

    AGS includes professional and support services designed to help our customers maximize the benefits of using our products and technology. Our services include support for implementation, deployment, training, monitoring, troubleshooting and optimization, among others. This reporting segment also includes our private cloud and managed services, which enable customers to take advantage of our technology on-premises or in a private, public or hybrid (i.e., mix of on-premises, private and/or public) cloud environment, depending on our solution and customer needs. The majority of our revenue in this reporting segment is recurring in nature and based on multi-year services contracts.

 

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Emergence from Chapter 11

On December 15, 2017, the Debtors, including the Company, completed the Restructuring and emerged from chapter 11 proceedings. This followed the Bankruptcy Court’s entry of an order confirming the Debtors’ Plan of Reorganization on November 28, 2017.

History

The Company was formed by affiliates of the Sponsors as a Delaware corporation in 2007 under the name Sierra Holdings Corp. The Sponsors, through the Company, acquired Avaya Inc. in a transaction that was completed on October 26, 2007. The Sponsors no longer hold a controlling interest in the Company following our emergence from bankruptcy.

Chapter 11 Filing

On January 19, 2017 (the “Petition Date”), the Debtors filed the Bankruptcy Filing under the Bankruptcy Code in the Bankruptcy Court, case number 17-10089 (SMB). The Debtors continued to operate their business as debtors-in-possession (“DIP”) under the jurisdiction of the Bankruptcy Court and in accordance with the applicable provisions of the Bankruptcy Code and the orders of the Bankruptcy Court. All other subsidiaries of Avaya Inc. that were not part of the Bankruptcy Filing continued to operate in the ordinary course of business.

On the date of the Bankruptcy Filing, the capital structure of the Company, Avaya Inc. and the Debtor Affiliates and non-Debtor Affiliates (collectively, the “Avaya Enterprise”) included $6.0 billion in funded debt. The majority of this funded debt was a legacy of the 2007 transaction in which the Avaya Enterprise was taken private. The remainder of the funded debt originated as part of the Avaya Enterprise’s 2009 acquisition of Nortel Enterprise Systems. In addition to this indebtedness, the following challenges led the Debtors to commence the chapter 11 cases in January 2017:

 

    Business model shift: The decline in economic activity between 2008 and 2010, together with the market trends away from hardware-based business communications under the capital expenditure model towards software and services offerings under the operating expense model, had a substantial impact on the Avaya Enterprise’s operations. The Avaya Enterprise also faced ongoing competition to its core Unified Communications Product and Service offerings from numerous competitors such as Cisco and Microsoft. In light of these factors, the Avaya Enterprise experienced significant revenue declines over the past several years.

 

    Substantial annual cash requirements: The Avaya Enterprise’s cash flow profile was negatively impacted by the substantial costs associated with its debt load, which increased over the last decade. Annual cash interest payments averaged approximately $440 million since fiscal 2014, with a corresponding impact on cash flow available to fund the research, development and other investments required to remain competitive in the market. From fiscal 2014 to fiscal 2016, annual cash requirements averaged approximately $900 million, including: (a) approximately $440 million in cash interest payments and (b) annual pension and other post-retirement employment benefits funding of approximately $180 million, as well as ongoing cash needs related to restructuring costs, capital expenditures and cash taxes.

 

    October 2017 debt maturities: Debtors’ indebtedness of $617 million was scheduled to mature in October 2017.

The Bankruptcy Filing permitted the Company to reorganize, thereby increasing liquidity in the U.S. and abroad. Implementation of the Plan of Reorganization will materially alter the classifications and amounts reported in the Consolidated Financial Statements. The Consolidated Financial Statements as of and for the fiscal year ended September 30, 2017 do not give effect to any adjustments to certain carrying values of assets and/or amounts of liabilities that are necessary as a consequence of our emergence from bankruptcy, or the effect of any operational changes that may be implemented.

 

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The Bankruptcy Filing constituted an event of default that accelerated the Company’s payment obligations under (i) its senior secured credit facility dated October 27, 2007 (as amended and restated and further amended to date, the “Senior Secured Credit Agreement”), (ii) the Domestic ABL, (iii) the Foreign ABL and, together with the Senior Secured Credit Agreement and Domestic ABL, the “Credit Facilities”), (iv) 10.5% Senior Secured notes due 2021 (the “10.5% Senior Secured Notes”), (v) 9% Senior Secured notes due 2019 (the “9% Senior Secured Notes”), and (vi) 7% Senior Secured Notes due 2019 (the “7% Senior Secured Notes” and, together with the 10.5% Senior Secured Notes and 9% Senior Secured Notes, the “Senior Secured Notes”). As a result of the Bankruptcy Filing, the principal and interest due under our debt agreements became due and payable, except as agreed in the Forbearance Agreement described below.

Contemporaneously with the Bankruptcy Filing, certain affiliates of the Company, namely Avaya Canada Corp., Avaya UK, Avaya International Sales Limited, Avaya Deutschland GmbH, Avaya GmbH & Co. KG, Avaya UK Holdings Limited, Avaya Holdings Limited, Avaya Germany GmbH, Tenovis and Avaya Verwaltungs GmbH (collectively, the “Foreign ABL Borrowers”) entered into a Forbearance Agreement (the “Forbearance Agreement”) pursuant to which, among other things, the Foreign ABL lenders agreed to forbear from exercising certain rights as a result of the Debtors filing voluntary petitions for relief under the Bankruptcy Code, which constituted events of default under the Foreign ABL. The Forbearance Agreement also provided for, among other things, entry into a payoff letter, which contemplated that all loans and other obligations that were accrued and payable under the Foreign ABL and the corresponding loan documents were required to be paid in full within eight business days after January 19, 2017. The Foreign ABL and Domestic ABL were repaid in full on January 24, 2017 in the amount of $50 million and $55 million, respectively, inclusive of accrued interest.

The Senior Secured Credit Agreement, the Domestic ABL, the Foreign ABL and the indentures governing the Senior Secured Notes provide that as a result of the Bankruptcy Filing, the principal and interest due thereunder became due and payable, except as described in the Forbearance Agreement above. However, any efforts to enforce such payment obligations under the credit agreements and indentures governing the Senior Secured Notes were automatically stayed as a result of the Bankruptcy Filing, and the creditors’ rights of enforcement in respect of the credit agreements and indentures governing the Senior Secured Notes were subject to the applicable provisions of the Bankruptcy Code and orders of the Bankruptcy Court.

Subsequent to the Petition Date, the Company received approval from the Bankruptcy Court to pay or otherwise honor certain pre-petition obligations to stabilize the Company’s operations. These obligations related to certain employee wages, salaries and benefits, taxes, insurance, customer programs and the payment of critical vendors in the ordinary course for goods and services, and legal and financial professionals to advise the Company in connection with the Bankruptcy Filing and other professionals to provide services and advice in the ordinary course of business.

The Debtors filed a proposed plan of reorganization and related disclosure statement with the Bankruptcy Court on April 13, 2017. The Debtors subsequently filed the First Amended Plan of Reorganization and disclosure statement on August 7, 2017. In addition, on August 6, 2017, the Debtors entered into the First Lien PSA with holders of more than 50% of first lien debt of the Company, pursuant to which such holders, when solicited, voted in favor of and in support of the Plan of Reorganization. The First Lien PSA was subsequently amended on August 23, 2017 and October 23, 2017. Also in connection with the Plan of Reorganization, the Debtors entered into the Crossover PSA, dated as of October 23, 2017, among the Debtors and the Ad Hoc Crossover Group. The Bankruptcy Court approved the amended disclosure statement on August 25, 2017, and allowed the Debtors to commence solicitation on their First Amended Plan of Reorganization, which solicitation began on September 8, 2017. Additionally, on August 25, 2017, the Bankruptcy Court approved the First Lien PSA, which became effective and binding upon court approval. Together, the holders of approximately over two-thirds of the total amount of first lien debt and holders of approximately over two-thirds of the total amount of second lien notes were party to the PSAs. On September 8, 2017, the Debtors filed the solicitation versions of the First Amended Plan of Reorganization and Amended Disclosure Statement. On September 9, 2017, the Bankruptcy Court assigned the Debtors and their major stakeholder constituencies to mediation. The mediation

 

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resulted in a resolution between these constituencies, and, as a result, the Debtors filed a further amended Plan of Reorganization and a Disclosure Statement Supplement on October 24, 2017.

The Company was required to apply Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) 852, Reorganizations, on the Petition Date, which is applicable to companies under bankruptcy protection, and requires amendments to the presentation of key financial statement line items. It requires that the financial statements for periods subsequent to the Bankruptcy Filing distinguish transactions and events that are directly associated with the reorganization from the ongoing operations of the business. Revenues, expenses, realized gains and losses, and provisions for losses that can be directly associated with the reorganization and restructuring of the business must be reported separately as Reorganization items, net in the Consolidated Statements of Operations. The balance sheet must distinguish pre-petition liabilities subject to compromise from both those pre-petition liabilities that are not subject to compromise and from post-petition liabilities. Based upon the uncertainty surrounding the ultimate treatment of the Senior Secured Credit Agreement and the Senior Secured Notes, the instruments are classified as liabilities subject to compromise on the Company’s Consolidated Balance Sheet. The Company evaluated creditors’ claims relative to priority over other unsecured creditors. Liabilities that are affected by a plan of reorganization are reported at the amounts expected to be approved by the Bankruptcy Court, even if they may be settled for lesser amounts as a result of the Plan of Reorganization or negotiations with creditors. In addition, cash used by reorganization items are disclosed separately in the Consolidated Statements of Cash Flow.

Business Trends

There are a number of trends and uncertainties affecting our business. For example, we are dependent on general economic conditions and the willingness of our customers to invest in technology. In addition, instability in the geopolitical environment of our customers, instability in the global credit markets, current economic challenges in Europe, including uncertainties associated with Brexit and other disruptions put pressure on the global economy causing uncertainties. We are also affected by the impact of foreign currency exchange rates on our business. We believe these uncertainties have impacted our customers’ willingness to spend on IT and the manner in which they procure such technologies and services. This includes delays or rejection of capital projects, including the implementation of our products and services. In addition, we believe there is a growing market trend around cloud consumption preferences with more customers exploring operating expense models as opposed to capital expenditure (“CapEx”) models for procuring technology. We believe the market trend toward cloud models will continue as customers seek ways of reducing their fixed overhead and other costs.

In fiscal 2017, we continued to drive Avaya’s transformation to a software and service-led organization and focused our go-to-market efforts by introducing 70 new products and related services, including new innovations focused particularly on workflow automation, multichannel customer engagement and cloud-enabled communications applications such as Avaya Oceana, Avaya Oceanalytics, Avaya Equinox, Avaya Enterprise Private Cloud and Zang Cloud. We also launched a next-generation desktop device, Avaya Vantage.

Sales decreased in fiscal 2017 primarily as the result of lower demand for products and services due to extended procurement cycles resulting from the chapter 11 filing and the sale of the Networking business in July 2017. The lower demand for our unified communications, contact center and networking products has contributed, in part, to lower maintenance services revenue and private cloud and managed services.

As a result of a growing market trend preferring cloud consumption, more customers are exploring subscription and pay-per-use based models, rather than CapEx models, for procuring technology. The shift to subscription and pay-per-use models enables customers to manage costs and efficiencies by paying a subscription or per minute or per message fee for business communications services rather than purchasing the underlying products and services, infrastructure and personnel, which are owned and managed by the equipment vendor or a private cloud and managed services provider. We believe the market trend toward these flexible consumption models will continue as we see an increasing number of opportunities and requests for proposal based on

 

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subscription and pay-per-use models. This trend has driven an increase in the proportion of total Company revenues attributable to software and services. As of September 30, 2017, we anticipated the total future revenues for these contracts to be in excess of $650 million. The values for these contracts are usually larger than contracts under a CapEx model, but the associated revenues are recognized over a period of time, typically three to seven years.

During fiscal 2015, we acquired Knoahsoft, Inc., a provider of work force optimization technology, and Esna Technologies Inc., a provider of browser integrated, unified communications capabilities. We believe the investments in Knoahsoft, Inc., Esna Technologies Inc. and other acquisitions, as well as our ongoing investments in research and development, are helping us to capitalize on the increasing focus of enterprises on deploying collaboration products to increase productivity, reduce costs and complexity and gain competitive advantages, which is being further accelerated by a trend toward a more mobile workforce and the associated proliferation of devices.

We are continuing to expand our indirect channel to meet the growing demand of our customers, as well as adding new partners in underserved geographies to support our go-to-market strategy within our enterprise and midmarket customer bases. We believe this expansion of our indirect channel favorably impacts our financial results by reducing selling expenses and allowing us to reach more end users and grow our business, although sales through the indirect channel generally generate lower profits than direct sales due to higher discounts. In furtherance of our effort to maintain an effective business partner program, we continue to refine and expand our global coverage while better aligning our go-to-market strategy for our products and services with our enterprise and midmarket customer bases. We have been deploying new customer segmentation and enhanced geographic emphasis. For the midmarket, which we view as companies with 100 to 2,000 employees, we have engaged a set of partners with threshold commitments specific to the midmarket. The program provides these partners with tightly integrated, bundled product offerings, which include third-party hosted cloud instances, as well as premises-based appliances, with the same software used in all deployments. We also implemented new sales compensation structures to better align compensation with a software and services model and to reflect our increasing orientation to the cloud. In addition, we have aligned our partner support structure to drive future growth.

In addition, customers are moving away from owned and operated infrastructure, preferring cloud offerings and virtualized server defined networks, which provide us with reduced associated maintenance support opportunities. Despite the benefits of a robust indirect channel, which include expanding our sales reach, our channel partners have direct contact with our customers that may foster independent relationships between them and a loss of certain services agreements for us. We have been able to offset these impacts by focusing on utilizing partners in a sales agent relationship, whereby partners perform selling activities but the contract remains with Avaya, and offering higher value services in support of our software offerings, which are not traditionally provided by our channel partners, such as professional services and cloud and managed services.

For fiscal 2017, 2016 and 2015, revenue outside of the U.S. represented 45%, 44% and 46% of total revenue, respectively. Further, foreign currency exchange rate fluctuations have had an impact on our revenue, costs and cash flows from our international operations. Our primary currency exposures are to the euro, Indian rupee and British pound. These exposures may change over time as business practices evolve and as the geographic mix of our business changes and we are not able to predict the impact that foreign currency fluctuations will have on future periods.

Debt Financing

On December 15, 2017, the Company entered into (i) a term loan credit agreement between Avaya Inc., as borrower, Avaya Holdings, the lending institutions from time to time party thereto, and Goldman Sachs Bank USA, as administrative agent and collateral agent, which provided a $2,925 million term loan facility due December 15, 2024 (the “Term Loan Credit Agreement”) and (ii) an ABL credit agreement among Avaya

 

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Holdings, Avaya Inc., as borrower, the several borrowers party thereto, the several lenders from time to time party thereto, and Citibank, N.A., as administrative agent and collateral agent, which provided a revolving credit facility consisting of a U.S. tranche and a foreign tranche in an aggregate principal amount of $300 million, subject to borrowing base availability (the “ABL Credit Agreement”, and together with the Term Loan Credit Agreement, the “Credit Agreements”). The Term Loan Credit Agreement, in the case of ABR Loans, bears interest at a rate per annum equal to 3.75% plus the highest of (i) the Federal Funds Rate plus 0.50%, (ii) the U.S. prime rate as publicly announced in the Wall Street Journal and (iii) the LIBOR Rate for an interest period of one month, subject to a 1% floor and in the case of LIBOR Loans, bears interest at a rate per annum equal to 4.75% plus the applicable LIBOR Rate, subject to a 1% floor. The ABL Credit Agreement bears interest:

 

  1. In the case of Base Rate Loans, at a rate per annum equal to 0.75% (subject to a step-up or step-down based on availability) plus the highest of (i) the Federal Funds Rate plus 0.50%, (ii) the prime rate as publicly announced by Citibank, N.A. and (iii) the LIBOR Rate for an interest period of one month, subject to a 1% floor;

 

  2. In the case of Canadian Prime Rate Loans, at a rate per annum equal to 0.75% (subject to a step-up or step-down based on availability) plus the highest of (i) the “Base Rate” as publicly announced by Citibank, N.A., Canadian branch and (ii) the CDOR Rate for an interest period of 30 days, subject to a 1% floor;

 

  3. In the case of LIBOR Rate Loans, at a rate per annum equal to 1.75% (subject to a step-up or step-down based on availability) plus the applicable LIBOR Rate, subject to a 0% floor;

 

  4. In the case of CDOR Rate Loans, at a rate per annum equal to 1.75% (subject to a step-up or step-down based on availability) plus the applicable CDOR Rate, subject to a 0% floor; and

 

  5. In the case of Overnight LIBOR Rate Loans, at a rate per annum equal to 1.75% (subject to a step-up or step-down based on availability) plus the applicable Overnight LIBOR Rate.

The Credit Agreements limit, among other things, Avaya Inc.’s ability to (i) incur indebtedness, (ii) incur or create liens, (iii) dispose of assets, (iv) prepay subordinated indebtedness and make other restricted payments, (v) enter into sale and leaseback transactions, (vi) make dividends, redemptions and repurchases of capital stock, (vii) enter into transactions with affiliates and (viii) modify the terms of any organizational documents and certain material contracts of Avaya Inc.

The Debtor-in-Possession Credit Agreement was repaid in full on December 15, 2017.

Continued Focus on Cost Structure

The Company has maintained its focus on profitability levels and investing in future results. As the Company continues its transformation to a software and service-led organization, it has implemented programs designed to streamline its operations, generate cost savings and eliminate overlapping processes and resources. These cost savings programs include: (1) reducing headcount, (2) relocating certain job functions to lower cost geographies, including service delivery, customer care, research and development, human resources and finance, (3) eliminating real estate costs associated with unused or under-utilized facilities and (4) implementing gross margin improvement and other cost reduction initiatives. The Company continues to evaluate opportunities to streamline its operations and identify cost savings globally and may take additional restructuring actions in the future. The costs of those actions could be material.

We have executed on several gross margin improvements and other cost reduction initiatives and have extended the multi-year positive trend in gross margin. These initiatives included obtaining better pricing from our contract manufacturers and transportation vendors, which has improved our product gross margins. In addition, we have streamlined our operations by redesigning the Avaya support website and continue to transition our customers from an agent-based support model to a self-service/web-based support model. These improvements have allowed us to reduce the workforce and relocate positions to lower-cost geographies and improve our services gross margins.

 

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We expect our gross margin to continue to improve in the foreseeable future as we continue to implement additional initiatives such as increasing our focus on sales of higher margin software, working with our contract manufacturers and transportation vendors to secure more favorable pricing, optimizing the design of products and services delivery to drive efficiencies and achieving greater economies of scale.

In addition to the improvements in gross margin, we have successfully reduced our operating expenses through these cost savings programs, primarily through reducing our labor and real estate costs.

Reductions in labor costs have been achieved through the elimination of redundancies by redefining and consolidating job functions, reductions in management and in back-office headcount of our sales organization, reduced headcount in our services business, the use of remote monitoring of customer systems as discussed above and a shift in the mix of the Company’s distribution channels toward the indirect channel, which reduced our personnel needs. We were also able to attain additional savings as the Company placed greater emphasis on shifting job functions to its shared service centers in India and Argentina, as well as the automation of customer service.

During fiscal 2017, 2016 and 2015, the Company initiated cost savings programs to reduce headcount that included reaching agreements with the works council representing employees of certain of the Company’s German and French subsidiaries for the elimination of positions, offering enhanced separation plans to certain management employees in the U.S., and other actions primarily focused in the U.S. and in Europe, Middle East and Africa (“EMEA”). As a result of these programs and the divestiture of two non-core businesses discussed below, the Company’s workforce at September 30, 2017, 2016 and 2015 was approximately 8,700, 10,100 and 11,700, respectively.

The Company’s restructuring charges include employee separation charges such as, but not limited to, severance and employment benefit payments, social pension fund payments, and healthcare and unemployment insurance costs to be paid to or on behalf of the affected employees. The aggregate restructuring charges also include the future lease payments and payments made under lease termination agreements associated with vacated facilities. As of September 30, 2017, the remaining liability associated with these actions was $80 million. This liability includes $55 million related to employee separations, of which $26 million are scheduled to be paid in fiscal 2018 and the balance through fiscal 2023, and $25 million related to lease obligations of vacated facilities, of which $13 million are scheduled to be paid in fiscal 2018 and the balance through fiscal 2022.

The Company continues to evaluate opportunities to streamline its operations and identify additional cost savings globally. Although a specific plan does not exist at this time, the Company may take additional restructuring actions in the future, the costs of which could be material.

Divestitures

In July 2017, we consummated the sale of the Company’s Networking business to Extreme and Extreme paid the Company $70 million and deposited $10 million in an indemnity escrow account. The sale enables the company to focus on its core higher margin Unified Communications and Contact Center solutions. The Networking business was comprised of certain assets of our Networking segment, along with the maintenance and professional services of the Networking business, which are part of the AGS segment. Accordingly, the historical results of the Company, which include the results of operations related to the Networking business, may not be reflective of the Company’s business going forward.

Financial Operations Overview

The audited Consolidated Financial Statements have been prepared on a basis that assumes that the Company will continue as a going concern and contemplates the realization of assets and the satisfaction of liabilities and commitments in the normal course of business.

 

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The following describes certain components of our statement of operations and considerations impacting those results.

Revenue. We derive our revenue primarily from the sale and service of business communications systems and applications. Our product revenue includes the sales of unified communications, contact center, midmarket enterprise communications and video. Product revenue accounted for 44%, 47% and 50% of our total revenue for fiscal 2017, 2016 and 2015, respectively. Our services revenue includes product maintenance and support, professional services, including design and integration, and private cloud and managed services.

We employ a flexible go-to-market strategy with direct and indirect presence worldwide and as of September 30, 2017, we had approximately 6,300 channel partners. For fiscal 2017, 2016 and 2015, our product revenue from indirect sales represented 73%, 74% and 75% of our total product revenue, respectively.

Because we sell our products to end-users in a wide range of industries and geographies, demand for our products is generally driven more by the level of general economic activity than by conditions in one particular industry or geographic region.

Cost of Revenue. Cost of product revenue consists primarily of hardware costs, royalties and license fees for third-party software included in our systems, personnel and related overhead costs of operation including but not limited to current engineering, freight, warranty costs, amortization of acquired technology intangible assets and provisions for excess inventory. We outsource substantially all of our manufacturing operations to several contract manufacturers. Our contract manufacturers produce the vast majority of our products in facilities located in southern China, with other products produced in facilities located in Israel, Mexico, Taiwan, Germany, Ireland and the U.S. The majority of these costs vary with the unit volumes of product sold. We expect over time to increase the software content of our products, decrease our product costs and improve product gross margins. Cost of services revenue consists of salaries and related overhead costs of personnel engaged in support and services. As we continue to realize the benefit of cost saving initiatives, which include productivity improvements from automation of customer service, reducing the workforce and relocating positions to lower cost geographies, we expect our cost of services revenue will decrease as a percentage of services revenue.

Selling, General and Administrative Expenses. Sales and marketing expenses primarily include personnel costs, sales commissions, travel, marketing promotional and lead generation programs, trade shows, professional services fees and related overhead expenses. We plan to continue to invest in development of our distribution channels by increasing the size of our field sales force and continue to develop the capabilities of our channel partners to enable us to expand into new geographies and further increase our sales to the midmarket across the world.

General and administrative expenses consist primarily of salary and benefit costs for executive and administrative staff, the use and maintenance of administrative offices, including depreciation expense, logistics, information systems and legal, financial, human resources and other corporate functions. Administrative expenses generally do not increase or decrease directly with changes in sales volume.

Research and Development Expenses. Research and development expenses primarily include personnel costs, outside engineering costs, professional services, prototype costs, test equipment, software usage fees and related overhead expenses. Research and development expenses are recognized when incurred. The level of research and development expense is related to the number of products in development, the stage of development, the complexity of the underlying technology, the potential scale of the product upon successful commercialization and the level of our exploratory research. We conduct such activities in areas we believe will accelerate our longer term net revenue growth.

We are devoting substantial resources to the development of additional functionality for existing products and the development of new products and related software applications. We intend to continue to invest in our

 

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research and development efforts because we believe they are essential to maintaining and improving our competitive position.

Amortization of Acquired Intangible Assets. Acquired intangible assets include acquired technology and patents, customer relationships, and trademarks and tradenames. The fair value of these intangible assets was estimated at the time of the business acquisitions and is amortized into our costs and expenses over their estimated useful lives.

Goodwill and Indefinite-Lived Asset Impairment. The Company tests goodwill for impairment at the reporting unit level annually each July 1st and more frequently if events occur or circumstances change that indicate that the fair value of a reporting unit may be below its carrying value. If the fair value of a reporting unit is below its carrying value, the implied fair value of the reporting unit is compared to the carrying value of that goodwill and a loss is recognized to the extent the carrying amount of the reporting unit’s goodwill exceeds the implied fair value of the goodwill. Indefinite-lived intangibles are not amortized but reviewed for impairment annually, each July 1st and more frequently if events occur or circumstances change that indicate that the fair value of the intangible asset may be below its carrying value. In situations where the carrying value exceeds the fair value of the intangible asset, an impairment loss equal to the difference is recognized.

Restructuring Charges, net. In response to the global economic climate and the Company’s commitment to control costs, the Company implemented initiatives designed to streamline the operations of the Company and generate cost savings. The Company exited and consolidated facilities and terminated or relocated certain job functions. The expenses associated with these actions are reflected in our operating results. As the Company continues to evaluate and identify additional operational synergies, additional cost saving opportunities may be identified and future restructuring charges may be incurred.

Interest Expense. Interest expense consists primarily of interest on indebtedness under our credit facilities and our notes. Interest expense also includes the amortization of deferred financing costs, the amortization of debt discount and the expense associated with interest rate derivative instruments that we may use, from time to time, to minimize our exposure to variable rate interest payments associated with our debt. We regularly evaluate market conditions, our liquidity profile and various financing alternatives for opportunities to enhance our capital structure. If market conditions are favorable, we may refinance existing debt or issue additional debt securities.

Loss on Extinguishment of Debt. The Company completed a series of transactions, which allowed us to refinance certain of our debt arrangements. The Company was required to account for certain of these transactions as an extinguishment of debt. A loss representing the difference between the reacquisition price of the original debt (including consent fees paid by Avaya to the holders of the original debt that consented to the transaction) and the carrying value of the old debt (including unamortized debt discount and debt issue costs) was recognized.

Other Income (Expense), net. Other income (expense), net consists primarily of gains and losses on change in the fair value of the Preferred B embedded derivative, foreign currency transactions and foreign currency forward contracts, third-party fees incurred in connection with certain debt modifications, changes to the reserves of certain tax indemnifications, interest income and other gains and losses that are not considered part of the Company’s ongoing major or central operations.

Income Taxes. Income taxes are accounted for under the asset and liability method. Under this method, deferred tax assets and liabilities are recognized for the estimated future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases, operating losses and tax credit carryforwards. Deferred tax assets and liabilities are measured using enacted tax rates in effect for the year in which those temporary differences are expected to be recovered or settled.

 

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Our audited Consolidated Financial Statements and related notes and other financial information included elsewhere in this registration statement were prepared in accordance with applicable tax law in effect for fiscal years ended September 30, 2017, 2016 and 2015. As discussed above under “Item 1.A. Risk Factors,” the Tax Cuts and Jobs Act could have a material and adverse impact on our operating results, cash flows and financial condition.

Selected Segment Information

Avaya conducted its business operations in three segments. Two of those segments, GCS and Networking, make up the Company’s Enterprise Collaboration Services (“ECS”) product portfolio. The third segment contains the Company’s services portfolio and is called AGS. On July 14, 2017, the Company sold its Networking business to Extreme.

In GCS, we deliver business communications products primarily for IT infrastructure, unified communications and contact centers. Our infrastructure and unified communications application products are designed to promote collaboration, innovation, productivity and real-time decision-making by providing business users a highly intuitive and personalized user experience that enables them to collaborate seamlessly across various modes of communication, including voice, video, email, instant messaging, text messaging, web conferencing, voicemail and social networking. Our contact center applications are highly reliable, scalable communications-centric applications suites designed to optimize customer service.

Our Networking segment provided a broad range of internet protocol networking infrastructure products including ethernet switches, routers and Virtual Private Network, or VPN, appliances, wireless networking routers, access control products, unified management products and end-to-end virtualization strategies and architectures.

Through our AGS segment we help our customers evaluate, plan, design, implement, support, manage and optimize their enterprise communications networks to help them achieve enhanced business results. Our award-winning service portfolio includes product support, integration and professional services and private cloud and managed services that enable customers to optimize and manage their converged communications networks worldwide.

On March 7, 2017, the Company entered into an agreement with Extreme and the sale closed on July 14, 2017. The Company’s Networking business was comprised of certain assets of the Company’s Networking segment, along with the maintenance and professional services of the Networking business, which are part of the AGS segment.

 

     Fiscal Year Ended September 30, 2017     Fiscal Year Ended September 30, 2016  
     Revenues     Gross Profit     Revenues     Gross Profit  
(In millions)    Dollar
Amount
     Percent
of Total
Revenue
    Dollar
Amount
    Percent
of
Revenue
    Dollar
Amount
     Percent
of Total
Revenue
    Dollar
Amount
    Percent
of
Revenue
 

Global Communications Solutions

   $ 1,297        40   $ 889       68.5   $ 1,536        41   $ 1,046       68.1

Networking(2)

     140        4     48       34.3     219        6     80       36.5
  

 

 

    

 

 

   

 

 

     

 

 

    

 

 

   

 

 

   

Enterprise Collaboration Systems

     1,437        44     937       65.2     1,755        47     1,126       64.2

Avaya Global Services

     1,835        56     1,083       59.0     1,947        53     1,148       59.0

Unallocated Amounts

     —          —       (21          (1)      —          —       (29          (1) 
  

 

 

    

 

 

   

 

 

     

 

 

    

 

 

   

 

 

   
   $ 3,272        100   $ 1,999       61.1   $ 3,702        100   $ 2,245       60.6
  

 

 

    

 

 

   

 

 

     

 

 

    

 

 

   

 

 

   

 

(1)  Not meaningful
(2)  Networking business was sold on July 14, 2017, therefore, the Company recognized no revenue after the date of sale.

 

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Financial Results Summary

The following table sets forth for fiscal 2017, 2016 and 2015, our results of operations as reported in our audited Consolidated Financial Statements in accordance with accounting principles generally accepted in the United States of America (“GAAP”).

 

     Fiscal years ended
September 30,
 
(In millions, except per share amounts)    2017     2016     2015  

STATEMENTS OF OPERATIONS DATA:

      

REVENUE

      

Products

   $ 1,437     $ 1,755     $ 2,029  

Services

     1,835       1,947       2,052  
  

 

 

   

 

 

   

 

 

 
     3,272       3,702       4,081  
  

 

 

   

 

 

   

 

 

 

COSTS

      

Products:

      

Costs

     500       630       744  

Amortization of acquired technology intangible assets

     20       30       35  

Services

     753       797       872  
  

 

 

   

 

 

   

 

 

 
     1,273       1,457       1,651  
  

 

 

   

 

 

   

 

 

 

GROSS PROFIT

     1,999       2,245       2,430  
  

 

 

   

 

 

   

 

 

 

OPERATING EXPENSES

      

Selling, general and administrative

     1,282       1,413       1,432  

Research and development

     229       275       338  

Amortization of acquired intangible assets

     204       226       226  

Impairment of indefinite-lived intangible assets

     65       100       —    

Goodwill impairment

     52       442       —    

Restructuring charges, net

     30       105       62  

Acquisition-related costs

     —         —         1  
  

 

 

   

 

 

   

 

 

 
     1,862       2,561       2,059  
  

 

 

   

 

 

   

 

 

 

OPERATING INCOME (LOSS)

     137       (316     371  

Interest expense

     (246     (471     (452

Loss on extinguishment of debt

     —         —         (6

Other income (expense), net

     9       68       (11

Reorganization items, net

     (98     —         —    
  

 

 

   

 

 

   

 

 

 

LOSS BEFORE INCOME TAXES

     (198     (719     (98

Benefit from (provision for) income taxes

     16       (11     (70
  

 

 

   

 

 

   

 

 

 

NET LOSS

     (182     (730     (168

Less: Accretion and accrued dividends on Series A and Series B preferred stock

     (31     (41     (46
  

 

 

   

 

 

   

 

 

 

NET LOSS ATTRIBUTABLE TO COMMON STOCKHOLDERS

   $ (213   $ (771   $ (214
  

 

 

   

 

 

   

 

 

 

Basic and diluted earnings per share attributable to common stockholders:

      

Net loss per share—basic and diluted

   $ (0.43   $ (1.54   $ (0.43
  

 

 

   

 

 

   

 

 

 

Weighted average shares outstanding—basic and diluted

     497.1       500.7       499.7  
  

 

 

   

 

 

   

 

 

 

 

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Results of Operations

Fiscal Year Ended September 30, 2017 Compared with Fiscal Year Ended September 30, 2016

Revenue

Our revenue for fiscal 2017 and 2016 was $3,272 million and $3,702 million, respectively, a decrease of $430 million or 12%. The following table sets forth a comparison of revenue by portfolio:

 

     Fiscal years ended September 30,  
                   Percentage of
Total Revenue
    Yr. to Yr.
Percent
Change
    Yr. to Yr.
Percent

Change, net of
Foreign

Currency
Impact
 
(In millions)    2017      2016      2017     2016      

GCS

   $ 1,297      $ 1,536        40     41     (16 )%      (15 )% 

Networking(1)

     140        219        4     6     (36 )%      (36 )% 
  

 

 

    

 

 

    

 

 

   

 

 

     

Total product revenue

     1,437        1,755        44     47     (18 )%      (18 )% 

AGS

     1,835        1,947        56     53     (6 )%      (6 )% 
  

 

 

    

 

 

    

 

 

   

 

 

     

Total revenue

   $ 3,272      $ 3,702        100     100     (12 )%      (11 )% 
  

 

 

    

 

 

    

 

 

   

 

 

     

 

(1) Networking business was sold on July 14, 2017, therefore, the Company recognized no revenue after the date of sale.

GCS revenue for fiscal 2017 and 2016 was $1,297 million and $1,536 million, respectively, a decrease of $239 million or 16%. The decrease in GCS revenue was primarily attributable to uncertainties that had an impact and will continue to impact our customers’ buying decisions in the foreseeable future as we saw ongoing procurement slowdowns and extended procurement cycles resulting from the Bankruptcy Filing. As a result, there was a lower demand for endpoints, gateways, Nortel and Tenovis products, SME Telephony products and servers.

Networking revenue for fiscal 2017 and 2016 was $140 million and $219 million, respectively, a decrease of $79 million or 36%. The decrease in Networking revenue is primarily attributable to the sale of certain assets and liabilities of the Company’s Networking segment in July 2017 to Extreme. Prior to the sale, there was a lower demand for our products in the U.S., partially offset by greater demand for our products in EMEA.

AGS revenue for fiscal 2017 and 2016 was $1,835 million and $1,947 million, respectively, a decrease of $112 million or 6%. The decrease in AGS revenue was primarily due to lower maintenance services revenues as a result of the lower product sales discussed above and lower professional services revenue.

 

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The following table sets forth a comparison of revenue by location:

 

     Fiscal years ended September 30,  
                   Percentage of
Total Revenue
    Yr. to Yr.
Percentage
Change
    Yr. to Yr.
Percentage
Change, net of
Foreign

Currency
Impact
 
(In millions)    2017      2016      2017     2016      

U.S.

   $ 1,798      $ 2,072        55     56     (13 )%      (13 )% 
  

 

 

    

 

 

    

 

 

   

 

 

     

International:

              

EMEA

     834        880        26     24     (5 )%      (4 )% 

APAC—Asia Pacific

     334        416        10     11     (20 )%      (20 )% 

Americas International—Canada and Latin America

     306        334        9     9     (8 )%      (9 )% 
  

 

 

    

 

 

    

 

 

   

 

 

     

Total international

     1,474        1,630        45     44     (10 )%      (9 )% 
  

 

 

    

 

 

    

 

 

   

 

 

     

Total revenue

   $ 3,272      $ 3,702        100     100     (12 )%      (11 )% 
  

 

 

    

 

 

    

 

 

   

 

 

     

Revenue in the U.S. for fiscal 2017 and 2016 was $1,798 million and $2,072 million, respectively, a decrease of $274 million or 13%. This decrease was primarily attributable to lower sales of unified communications products—endpoints, SME Telephony, and gateways; networking products; and contact center products; in addition to decreased global shared services revenues. Revenue in EMEA for fiscal 2017 and 2016 was $834 million and $880 million, respectively, a decrease of $46 million or 5%. The decrease in EMEA revenue was primarily attributable to lower sales of unified communication and networking products, and an unfavorable impact of foreign currency. Revenue in APAC for fiscal 2017 and 2016 was $334 million and $416 million, respectively, a decrease of $82 million or 20%. The decrease in APAC revenue was primarily attributable to lower sales of unified communications, principally endpoints, gateways, Aura CM, video and SME Telephony, and contact center products. Revenue in Americas International for fiscal 2017 and 2016 was $306 million and $334 million, respectively, a decrease of $28 million or 8%. The decrease in Americas International revenue was primarily attributable to lower sales of endpoints and gateways, and contact center and networking products, partially offset by increased demand for APCS and the favorable impact of foreign currency.

We sell our products both directly and through an indirect sales channel. The following table sets forth a comparison of revenue from sales of products by channel:

 

     Fiscal years ended September 30,  
            Percentage of
ECS Product Revenue
    Yr. to Yr.
Percentage
Change
    Yr. to Yr.
Percentage
Change, net of
Foreign

Currency
Impact
 
(In millions)    2017      2016      2017     2016      

Direct

   $ 382      $ 453        27     26     (16 )%      (15 )% 

Indirect

     1,055        1,302        73     74     (19 )%      (19 )% 
  

 

 

    

 

 

    

 

 

   

 

 

     

Total ECS product revenue

   $ 1,437      $ 1,755        100     100     (18 )%      (18 )% 
  

 

 

    

 

 

    

 

 

   

 

 

     

 

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Gross Profit

The following table sets forth a comparison of gross profit by segment:

 

     Fiscal years ended September 30,  
     Gross Profit     Gross Margin     Change  
(In millions)    2017     2016     2017     2016     Amount     Percentage  

GCS

   $ 889     $ 1,046       68.5     68.1   $ (157     (15 )% 

Networking(2)

     48       80       34.3     36.5     (32     (40 )% 
  

 

 

   

 

 

       

 

 

   

ECS

     937       1,126       65.2     64.2     (189     (17 )% 

AGS

     1,083       1,148       59.0     59.0     (65     (6 )% 

Unallocated amounts

     (21     (29          (1)           (1)      8            (1) 
  

 

 

   

 

 

       

 

 

   

Total

   $ 1,999     $ 2,245       61.1     60.6   $ (246     (11 )% 
  

 

 

   

 

 

       

 

 

   

 

(1) Not meaningful
(2) Networking business was sold on July 14, 2017, therefore, the Company recognized no revenue after the date of sale.

Gross profit for fiscal 2017 and 2016 was $1,999 million and $2,245 million, respectively, a decrease of $246 million or 11%. The decrease was attributable to the decrease in sales volume. The decrease in gross profit was partially offset by the success of our gross margin improvement initiatives and favorable pricing. Our gross margin improvement initiatives included exiting facilities, reducing the workforce, productivity improvements and obtaining better pricing from our contract manufacturers and transportation vendors. Gross margin increased to 61.1% for fiscal 2017 from 60.6% for fiscal 2016 primarily as a result of our gross margin improvement initiatives, favorable pricing and higher software sales as a percentage of revenues, which have higher margins.

GCS gross profit for fiscal 2017 and 2016 was $889 million and $1,046 million, respectively, a decrease of $157 million or 15%. The decrease in GCS gross profit was primarily attributable to lower sales volume. The decrease was partially offset by the success of our gross margin improvement initiatives and favorable pricing. GCS gross margin increased to 68.5% for fiscal 2017 compared to 68.1% for fiscal 2016 primarily as a result of favorable pricing.

Networking gross profit for fiscal 2017 and 2016 was $48 million and $80 million, respectively, a decrease of $32 million or 40%. Networking gross margin decreased to 34.3% for fiscal 2017 from 36.5% for fiscal 2016. The decrease in Networking gross profit is primarily attributable to lower sales volume as a result of the sale of the Company’s Networking business to Extreme.

AGS gross profit for fiscal 2017 and 2016 was $1,083 million and $1,148 million, respectively, a decrease of $65 million or 6%. The decrease in AGS gross profit was due to lower revenue. AGS gross margin was 59.0% for fiscal 2017 and 2016.

Unallocated amounts for fiscal 2017 and 2016 included the effect of the amortization of acquired technology intangibles and costs that are not core to the measurement of segment performance, but rather are controlled at the corporate level.

 

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Operating Expenses

The following table sets forth a comparison of operating expenses:

 

     Fiscal years ended September 30,  
            Percentage of Revenue     Change  
(In millions)    2017      2016      2017     2016     Amount     Percentage  

Selling, general and administrative

   $ 1,282      $ 1,413        39.2     38.2   $ (131     (9 )% 

Research and development

     229        275        7.0     7.4     (46     (17 )% 

Amortization of acquired intangible assets

     204        226        6.2     6.1     (22     (10 )% 

Impairment of indefinite-lived intangible assets

     65        100        2.0     2.7     (35     (35 )% 

Goodwill impairment

     52        442        1.6     12.0     (390     (88 )% 

Restructuring charges, net

     30        105        0.9     2.8     (75     (71 )% 
  

 

 

    

 

 

    

 

 

   

 

 

   

 

 

   

Total operating expenses

   $ 1,862      $ 2,561        56.9     69.2   $ (699     (27 )% 
  

 

 

    

 

 

    

 

 

   

 

 

   

 

 

   

Selling, general and administrative expenses for fiscal 2017 and 2016 were $1,282 million and $1,413 million, respectively, a decrease of $131 million. The decrease was primarily attributable to lower costs incurred in connection with certain legal matters period over period, lower payroll and payroll related expenses realized from the success of cost savings initiatives executed in prior periods, lower selling expenses and the favorable impact of foreign currency, partially offset by advisory fees incurred to assist in the assessment of strategic and financial alternatives to improve the Company’s capital structure. Our cost savings initiatives included reductions to the workforce, exiting and consolidating facilities and relocating positions to lower-cost geographies.

Research and development expenses for fiscal 2017 and 2016 were $229 million and $275 million, respectively, a decrease of $46 million. The decrease was primarily due to lower payroll and payroll related expenses realized as a result of cost savings initiatives executed in prior periods.

Impairment of indefinite-lived intangible assets in fiscal 2017 was $65 million. The Company filed for bankruptcy and also experienced a decline in revenues, which led to a revision of its five year forecast in the quarter ended June 30, 2017. Due to the decline in revenue in the five year forecast, the Company tested its intangible assets with indefinite lives and other long-lived assets. The Company estimated the fair values of its indefinite-lived intangible assets using the royalty savings method, which values an asset by estimating the royalties saved through ownership of the asset. As a result of the impairment test, the Company estimated the fair value of its trademarks and trade names to be $190 million as compared to a carrying amount of $255 million and recorded an impairment charge of $65 million. Impairment of indefinite-lived intangible assets in fiscal 2016 was $100 million. The impairment recorded in fiscal 2016 related to the Company’s trademarks and trade names and was primarily the result of continued customer cutbacks in current and expected future investments in products, specifically relating to unified communications. The reduced valuation reflects additional market risks and lower sales forecasts for the Company, which is consistent with the lack of customers’ willingness to spend on products, specifically relating to unified communications, such as endpoints, gateways, Nortel and Tenovis products, servers and SME Telephony products.

Goodwill impairment in fiscal 2017 was $52 million associated with the Unified Communication reporting unit. As a result of the sale of certain assets and liabilities of the Company’s Networking segment in July 2017 to Extreme, it was determined that the fair value of the Networking services component of the Global Support Services reporting unit was less than its carrying value. As a result, the Company recorded a goodwill impairment charge of $52 million associated with the Networking services component of the Global Support Services reporting unit. If market conditions deteriorate, it may be necessary to record impairment charges in the future. Goodwill impairment in fiscal 2016 was $442 million associated with the Unified Communication reporting unit. At July 1, 2016, the Company performed step one of the goodwill impairment test for all of its reporting units, which indicated the estimated fair value of the Unified Communication reporting unit was less

 

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than the carrying amount of its net assets (including goodwill). Therefore, the Company performed step two of its annual goodwill impairment test and determined that the carrying amount of the reporting unit’s goodwill exceeded its implied fair value resulting in an impairment to goodwill of $442 million. The impairment was primarily the result of the continued customer cutbacks in investments in unified communication products. The reduced valuation of the reporting unit reflects additional market risks and lower sales forecasts for the reporting unit, which is consistent with the lack of customers’ willingness to spend on unified communication products such as endpoints, gateways, Nortel and Tenovis products, servers and SME Telephony products. At July 1, 2016, the Company determined that the respective carrying amounts of the Company’s other reporting units did not exceed their estimated fair values and therefore no impairment of the goodwill for these reporting units existed.

Restructuring charges, net, for fiscal 2017 and 2016 were $30 million and $105 million, respectively, a decrease of $75 million. As Avaya continued its transformation to a software and service-led organization, it has implemented programs designed to streamline its operations, generate cost savings and eliminate overlapping processes and resources. Restructuring charges recorded during fiscal 2017 include employee separation costs of $21 million primarily associated with employee severance actions in the U.S. and EMEA and lease obligations of $9 million primarily in EMEA. Restructuring charges recorded during fiscal 2016 include employee separation costs of $101 million primarily associated with employee severance actions in EMEA and Canada, and a voluntary plan initiated in the U.S. as the Company continues its transformation to a software and service-led organization, as well as lease obligations of $4 million.

Operating Income (Loss)

Fiscal 2017 had operating income of $137 million compared to an operating loss of $316 million for fiscal 2016.

Operating (loss) income for fiscal 2017 and 2016 includes impairments of goodwill and indefinite-lived intangible assets of $117 million and $542 million, depreciation and amortization of $326 million and $374 million and share-based compensation of $11 million and $16 million, respectively.

Interest Expense

Interest expense for fiscal 2017 and 2016 was $246 million and $471 million, respectively, and includes non-cash interest expense of $61 million and $20 million, respectively. Non-cash interest expense is amortization of debt issuance costs and accretion of debt discount. The increase in non-cash interest is a result of accelerated amortization of debt issuance costs and accretion of debt discounts due to our Bankruptcy filing. The Bankruptcy Filing constituted an event of default under our Credit Facilities and Senior Secured Notes that accelerated the Company’s payment obligations. Consequently, all debt outstanding under the Credit Facilities and Senior Secured Notes have been classified as liabilities subject to compromise and related unamortized deferred financing costs and debt discounts in the amount of $61 million were expensed during fiscal 2017. Effective January 19, 2017, the Company ceased recording interest expense on outstanding pre-petition debt classified as liabilities subject to compromise. Contractual interest expense represents amounts due under the contractual terms of outstanding debt, including debt subject to compromise. For the period from January 19, 2017 through September 30, 2017, contractual interest expense related to debt subject to compromise of $316 million has not been recorded, as it is not expected to be an allowed claim under the Bankruptcy Filing. Cash interest expense for fiscal 2017 and 2016 was $185 million and $451 million, respectively, a decrease of $266 million.

Other Income, Net

Other income, net for fiscal 2017 was $9 million compared with $68 million in fiscal 2016. Other income, net for fiscal 2017 includes interest income of $4 million, income from Transition Services Agreement, net of $3 million, a gain on the sale of certain assets and liabilities of the Networking business of $2 million and net

 

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foreign currency transaction gains of $2 million. Other income, net for fiscal 2016 includes $73 million from changes in the fair value of the Series B preferred stock embedded derivative, net foreign currency transaction gains of $10 million and loss on an equity investment of $11 million.

Benefit from (Provision for) Income Taxes

The benefit from income taxes was $16 million for fiscal 2017 compared with a provision for income taxes of $11 million for fiscal 2016.

The Company’s effective income tax rate for fiscal 2017 differs from the U.S. federal tax rate primarily due to (1) the effect of tax rate differentials on foreign income/loss, (2) changes in the valuation allowance established against the Company’s deferred tax assets, (3) tax positions taken during the current period offset by reductions for unrecognized tax benefits resulting from the lapse of statute of limitations and the completion of income tax examinations, (4) the non-deductible portion of goodwill impairment, (5) the non-deductible portion of the loss on the sale of Networking business assets, (6) the non-deductible portion of reorganization items, (7) the effect of enacted changes in tax laws, and (8) the recognition of income tax benefits as a result of net gains in other comprehensive income.

The Company’s effective income tax rate for fiscal 2016 differs from the U.S. federal tax rate primarily due to (1) the effect of tax rate differentials on foreign income/loss, (2) changes in the valuation allowance established against the Company’s deferred tax assets, (3) tax positions taken during the current period offset by reductions for unrecognized tax benefits resulting from the lapse of statute of limitations, (4) the non-deductible portion of goodwill impairment, (5) the effect of enacted changes in tax laws, and (6) a $5 million income tax provision related to the change in the indefinite reinvestment assertion.

At September 30, 2017, the Company’s book basis exceeded the tax basis it had in certain foreign subsidiaries, creating an outside basis difference for which the Company provided a deferred tax liability. During fiscal 2016, the Company could no longer assert that it had the intent to indefinitely reinvest the portion of the outside basis difference related to items other than the earnings and profits of the foreign subsidiaries. Accordingly, the Company was required to adjust its deferred tax liability for the effects of this change in assertion, which increased the fiscal 2016 provision for income taxes of continuing operations by $5 million.

Fiscal Year Ended September 30, 2016 Compared with Fiscal Year Ended September 30, 2015

Revenue

Our revenue for fiscal 2016 and 2015 was $3,702 million and $4,081 million, respectively, a decrease of $379 million or 9%. The following table sets forth a comparison of revenue by portfolio:

 

     Fiscal years ended September 30,  
                  

 

Percentage of
Total Revenue

    Yr. to Yr.
Percent
Change
    Yr. to Yr.
Percent
Change, net of
Foreign
Currency
Impact
 
(In millions)    2016      2015      2016     2015      

GCS

   $ 1,536      $ 1,796        41     44     (14 )%      (13 )% 

Networking

     219        233        6     6     (6 )%      (5 )% 
  

 

 

    

 

 

    

 

 

   

 

 

     

Total product revenue

     1,755        2,029        47     50     (14 )%      (12 )% 

AGS

     1,947        2,052        53     50     (5 )%      (3 )% 
  

 

 

    

 

 

    

 

 

   

 

 

     

Total revenue

   $ 3,702      $ 4,081        100     100     (9 )%      (8 )% 
  

 

 

    

 

 

    

 

 

   

 

 

     

GCS revenue for fiscal 2016 and 2015 was $1,536 million and $1,796 million, respectively, a decrease of $260 million or 14%. The decrease in GCS revenue was primarily attributable to lower demand for endpoints,

 

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gateways, Nortel and Tenovis products, servers and SME Telephony products, and the unfavorable impact of foreign currency. These decreases in GCS revenue were partially offset by higher revenues associated with our contact center products.

Networking revenue for fiscal 2016 and 2015 was $219 million and $233 million, respectively, a decrease of $14 million or 6%. The decrease in Networking revenue is primarily attributable to lower sales of ethernet switches, higher revenues in fiscal 2015 associated with new product releases and the unfavorable impact of foreign currency.

AGS revenue for fiscal 2016 and 2015 was $1,947 million and $2,052 million, respectively, a decrease of $105 million or 5%. The decrease in AGS revenue was primarily due to lower maintenance services revenues as a result of the lower product sales discussed above, lower professional services revenue and the unfavorable impact of foreign currency. These decreases in AGS revenue were partially offset by higher revenue from APCS. As previously discussed, revenues associated with APCS contracts are recognized over a longer period of time, typically three to seven years.

The following table sets forth a comparison of revenue by location:

 

     Fiscal years ended September 30,  
                  

 

Percentage of
Total Revenue

    Yr. to Yr.
Percentage
Change
    Yr. to Yr.
Percentage
Change, net of
Foreign

Currency
Impact
 
(In millions)    2016      2015      2016     2015      

U.S.

   $ 2,072      $ 2,203        56     54     (6 )%      (6 )% 
  

 

 

    

 

 

    

 

 

   

 

 

     

International:

              

EMEA

     880        1,073        24     26     (18 )%      (16 )% 

APAC—Asia Pacific

     416        425        11     11     (2 )%      (1 )% 

Americas International—Canada and Latin America

     334        380        9     9     (12 )%      (5 )% 
  

 

 

    

 

 

    

 

 

   

 

 

     

Total international

     1,630        1,878        44     46     (13 )%      (10 )% 
  

 

 

    

 

 

    

 

 

   

 

 

     

Total revenue

   $ 3,702      $ 4,081        100     100     (9 )%      (8 )% 
  

 

 

    

 

 

    

 

 

   

 

 

     

Revenue in the U.S. for fiscal 2016 and 2015 was $2,072 million and $2,203 million, respectively, a decrease of $131 million or 6%. The decrease in U.S. revenue was primarily attributable to lower maintenance services revenue, lower sales of endpoints, gateways, Nortel and Tenovis products and lower professional services revenue. These decreases in U.S. revenues were partially offset by higher sales of our contact center and networking products and higher revenue attributable to APCS. Revenue in EMEA for fiscal 2016 and 2015 was $880 million and $1,073 million, respectively, a decrease of $193 million or 18%. The decrease in EMEA revenue was primarily attributable to lower demand and unfavorable pricing for our products and associated maintenance services, lower professional services revenue and the unfavorable impact of foreign currency. Revenue in APAC for fiscal 2016 and 2015 was $416 million and $425 million, respectively, a decrease of $9 million or 2%. The decrease in APAC revenue was primarily attributable to unfavorable impact of foreign currency and lower sales of unified communications and networking products. These decreases in APAC revenue were partially offset by higher APCS revenue and higher sales of contact center products. Revenue in Americas International for fiscal 2016 and 2015 was $334 million and $380 million, respectively, a decrease of $46 million or 12%. The decrease in Americas International revenue was primarily attributable to the unfavorable impact of foreign currency and lower sales of endpoints partially offset by higher sales of networking products and professional services.

 

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We sell our products both directly and through an indirect sales channel. The following table sets forth a comparison of revenue from sales of products by channel:

 

     Fiscal years ended September 30,  
           

 

Percentage of

ECS Product Revenue

    Yr. to Yr.
Percentage
Change
    Yr. to Yr.
Percentage
Change, net of
Foreign
Currency
Impact
 
(In millions)    2016      2015      2016     2015      

Direct

   $ 453      $ 501        26     25     (10 )%      (8 )% 

Indirect

     1,302        1,528        74     75     (15 )%      (14 )% 
  

 

 

    

 

 

    

 

 

   

 

 

     

Total ECS product revenue

   $ 1,755      $ 2,029        100     100     (14 )%      (12 )% 
  

 

 

    

 

 

    

 

 

   

 

 

     

Gross Profit

The following table sets forth a comparison of gross profit by segment:

 

     Fiscal years ended September 30,  
     Gross Profit     Gross Margin     Change  
(In millions)    2016     2015     2016     2015     Amount     Percentage  

GCS

   $ 1,046     $ 1,189       68.1     66.2   $ (143     (12 )% 

Networking

     80       97       36.5     41.6     (17     (18 )% 
  

 

 

   

 

 

       

 

 

   

ECS

     1,126       1,286       64.2     63.4     (160     (12 )% 

AGS

     1,148       1,180       59.0     57.5     (32     (3 )% 

Unallocated amounts

     (29     (36          (1)           (1)      7            (1) 
  

 

 

   

 

 

       

 

 

   

Total

   $ 2,245     $ 2,430       60.6     59.5   $ (185     (8 )% 
  

 

 

   

 

 

       

 

 

   

 

(1) Not meaningful

Gross profit for fiscal 2016 and 2015 was $2,245 million and $2,430 million, respectively, a decrease of $185 million or 8%. The decrease is primarily attributable to the decrease in sales volume, unfavorable pricing, particularly in Europe, and the unfavorable impact of foreign currency. The decrease in gross profit was partially offset by the success of our gross margin improvement initiatives and lower pension and postretirement expenses. Our gross margin improvement initiatives included exiting facilities, reducing the workforce, relocating positions to lower-cost geographies, productivity improvements and obtaining better pricing from our contract manufacturers and transportation vendors. Effective October 1, 2015 the Company changed its estimates of the service and interest components of net periodic benefit costs associated with our U.S. pension and postretirement plans, which lowered pension and postretirement expenses recognized. Gross margin increased to 60.6% for fiscal 2016 from 59.5% for fiscal 2015 primarily as a result of higher software sales as a percentage of revenues, which have higher margins, our gross margin improvement initiatives and lower pension and postretirement expenses.

GCS gross profit for fiscal 2016 and 2015 was $1,046 million and $1,189 million, respectively, a decrease of $143 million or 12%. The decrease in GCS gross profit is primarily attributable to lower sales volume, the unfavorable impact of foreign currency and unfavorable pricing, particularly in Europe. These decreases were partially offset by higher software sales as a percentage of revenues, which have higher margins, the success of our gross margin improvement initiatives and lower pension and postretirement expenses discussed above. As a result of our gross margin improvement initiatives and lower pension and postretirement expenses, GCS gross margin increased to 68.1% for fiscal 2016 compared to 66.2% for fiscal 2015.

 

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Networking gross profit for fiscal 2016 and 2015 was $80 million and $97 million, respectively, a decrease of $17 million or 18%. Networking gross margin decreased to 36.5% for fiscal 2016 from 41.6% for fiscal 2015. The decrease in Networking gross profit and gross margin is primarily attributable to lower sales volume.

AGS gross profit for fiscal 2016 and 2015 was $1,148 million and $1,180 million, respectively, a decrease of $32 million or 3%. The decrease in AGS gross profit is primarily due to lower services revenue and the unfavorable impact of foreign currency. These decreases in AGS gross profit were partially offset by the continued benefit from our gross margin improvement initiatives and lower pension and postretirement expenses. Our gross margin improvement initiatives have enabled us to reduce the workforce and relocate positions to lower-cost geographies. As a result of our gross margin improvement initiatives, AGS gross margin increased to 59.0% for fiscal 2016 compared to 57.5% for fiscal 2015.

Unallocated amounts for fiscal 2016 and 2015 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. The decrease in unallocated amounts was primarily attributable to lower amortization associated with technology intangible assets acquired in prior periods.

Operating Expenses

The following table sets forth a comparison of operating expenses:

 

     Fiscal years ended September 30,  
                   Percentage of Revenue     Change  
(In millions)    2016      2015      2016     2015     Amount     Percentage  

Selling, general and administrative

   $ 1,413      $ 1,432        38.2     35.1   $ (19     (1 )% 

Research and development

     275        338        7.4     8.3     (63     (19 )% 

Amortization of acquired intangible assets

     226        226        6.1     5.5     —         —  

Impairment of indefinite-lived intangible assets

     100        —          2.7     —       100            (1) 

Goodwill impairment

     442        —          12.0     —       442            (1) 

Restructuring charges, net

     105        62        2.8     1.5     43       69

Acquisition-related costs

     —          1        —       —       (1          (1) 
  

 

 

    

 

 

    

 

 

   

 

 

   

 

 

   

Total operating expenses

   $ 2,561      $ 2,059        69.2     50.4   $ 502       24
  

 

 

    

 

 

    

 

 

   

 

 

   

 

 

   

 

(1) Not meaningful

Selling general and administrative expenses for fiscal 2016 and 2015 were $1,413 million and $1,432 million, respectively, a decrease of $19 million. The decrease was primarily attributable to the favorable impact of foreign currency, lower selling expenses, lower payroll and payroll related expenses realized from the success of our cost savings initiatives executed in the prior periods, and lower pension and postretirement expenses as discussed above. Our cost savings initiatives include reductions to the workforce, exiting and consolidating facilities, and relocating positions to lower-cost geographies. These decreases were partially offset by the resolution of certain legal matters, advisory fees incurred to assist in the assessment of strategic and financial alternatives to improve the Company’s capital structure, and third-party sales transformation costs.

Research and development expenses for fiscal 2016 and 2015 were $275 million and $338 million, respectively, a decrease of $63 million. The decrease was primarily due to lower payroll and payroll related expenses realized from the success of cost savings initiatives executed in prior periods and the favorable impact of foreign currency.

Amortization of acquired intangible assets was $226 million for each of fiscal 2016 and 2015.

Impairment of indefinite-lived intangible assets in fiscal 2016 was $100 million. The impairment related to the Company’s trademarks and trade names and was primarily the result of continued customer cutbacks in

 

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current and expected future investments in products, specifically relating to unified communications. The reduced valuation reflects additional market risks and lower sales forecasts for the Company, which is consistent with the lack of customers’ willingness to spend on products, specifically relating to unified communications, such as endpoints, gateways, Nortel and Tenovis products, servers and SME Telephony products.

Goodwill impairment in fiscal 2016 was $442 million associated with the Unified Communication reporting unit. At July 1, 2016, the Company performed step one of the goodwill impairment test for all of its reporting units, which indicated the estimated fair value of the Unified Communication reporting unit was less than the carrying amount of its net assets (including goodwill). Therefore, the Company performed step two of its annual goodwill impairment test and determined that the carrying amount of the reporting unit’s goodwill exceeded its implied fair value resulting in an impairment to goodwill of $442 million. The impairment was primarily the result of the continued customer cutbacks in investments in unified communication products. The reduced valuation of the reporting unit reflects additional market risks and lower sales forecasts for the reporting unit, which is consistent with the lack of customers’ willingness to spend on unified communication products such as endpoints, gateways, Nortel and Tenovis products, servers and SME Telephony products. At July 1, 2016, the Company determined that the respective carrying amounts of the Company’s other reporting units did not exceed their estimated fair values and therefore no impairment of the goodwill for these reporting units existed. The Company determined that no other events occurred or circumstances changed during the three months ended September 30, 2016 that would more likely than not reduce the fair value of its other reporting units below their respective carrying amounts. However, if market conditions deteriorate, it may be necessary to record impairment charges in the future.

Restructuring charges, net, for fiscal 2016 and 2015 were $105 million and $62 million, respectively, an increase of $43 million. As the Company continued its transformation to a software and service-led organization, it implemented programs designed to streamline its operations, generate cost savings and eliminate overlapping processes and resources. Restructuring charges recorded during fiscal 2016 include employee separation costs of $101 million primarily associated with employee severance actions in EMEA and Canada, and a voluntary plan initiated in the U.S. as the Company continues its transformation to a software and service-led organization, as well as lease obligations of $4 million. Restructuring charges recorded during fiscal 2015 include employee separation costs of $52 million primarily associated with employee severance actions in EMEA and the U.S. and lease obligations of $10 million primarily related to facilities in the U.S. The separation charges 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.

Acquisition-related costs for fiscal 2015 were $1 million and include third-party legal and other costs related to business acquisitions in fiscal 2015.

Operating (Loss) Income

Fiscal 2016 had an operating loss of $316 million compared to operating income of $371 million for fiscal 2015.

Operating (loss) income for fiscal 2016 and 2015 includes impairments of goodwill and indefinite-lived intangible assets of $542 million and $0 million, non-cash depreciation and amortization of $374 million and $371 million, and share-based compensation of $16 million and $19 million, respectively.

Interest Expense

Interest expense for fiscal 2016 and 2015 was $471 million and $452 million, respectively, and includes non-cash interest expense of $20 million and $20 million, respectively. Non-cash interest expense for fiscal 2016 and 2015 includes amortization of debt issuance costs and accretion of debt discounts. Cash interest expense for fiscal 2016 and 2015 was $451 million and $432 million, respectively, an increase of $19 million. The increase in cash interest expense is the result of certain debt refinancing transactions that occurred during fiscal 2015.

 

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Loss on Extinguishment of Debt

During fiscal 2015, we recognized a $6 million loss on extinguishment of debt associated with an amendment to our Senior Secured Credit Agreement completed on May 29, 2015, pursuant to which the Company refinanced a portion of its outstanding term B-3, term B-4 and term B-6 loans with the proceeds of the issuance of term B-7 loans maturing May 29, 2020. The loss represents the difference between the reacquisition price and the carrying value (including unamortized discount and debt issuance costs) for the portion of the refinanced debt accounted for as a debt extinguishment.

Other Income (Expense), Net

Other income (expense), net for fiscal 2016 was $68 million compared with $(11) million in fiscal 2015.

Other income, net for fiscal 2016 includes $73 million from changes in the fair value of the Preferred Series B embedded derivative, net foreign currency transaction gains of $10 million and a $11 million loss on an equity investment in fiscal 2016. Other (expense), net for fiscal 2015 includes $24 million from changes in the fair value of the Preferred Series B embedded derivative and $8 million of third-party fees incurred in connection with debt modification, partially offset by $14 million of net foreign currency transaction gains and $9 million of net charges associated with certain tax indemnifications.

Provision for Income Taxes of Continuing Operations

The provision for income taxes of continuing operations was $11 million and $70 million for fiscal 2016 and 2015, respectively. The Company’s effective income tax rates for fiscal 2016 and 2015 differ from the U.S. federal tax rate primarily due to (1) the effect of tax rate differentials on foreign income/loss, (2) changes in the valuation allowance established against the Company’s deferred tax assets, (3) tax positions taken during the current period offset by reductions for unrecognized tax benefits resulting from the lapse of statute of limitations, (4) the non-deductible portion of the goodwill impairment and (5) the effect of enacted changes in tax laws.

At September 30, 2016, the Company’s book basis exceeded the tax basis it had in its foreign subsidiaries, creating an outside basis difference. Included in this outside basis difference were amounts attributable to earnings and profits for which the Company provided a deferred tax liability. Deferred taxes were not provided on the remaining portion of the outside basis difference as these amounts related to items other than the earnings and profits of the foreign subsidiaries and were essentially permanent in duration. During fiscal 2016, the Company could no longer assert that it had the intent to indefinitely reinvest these amounts and the Company was required to adjust its deferred tax liability for the effects of this change in assertion and additional current year activity, which increased the provision for income taxes of continuing operations by $5 million.

During fiscal 2015, the Company recorded a correction to the prior period valuation allowance on deferred tax assets, which decreased the provision for income taxes by $6 million. The Company evaluated the correction in relation to the period of adjustment, as well as the period in which the adjustment originated, and concluded that the adjustment was not material to fiscal 2015.

Liquidity and Capital Resources

On the Petition Date, the Company and certain of its affiliates filed the Bankruptcy Filing. Until emergence from bankruptcy on December 15, 2017, the Debtors continued to operate their business as debtors-in-possession under the jurisdiction of the Bankruptcy Court and in accordance with the applicable provisions of the Bankruptcy Code and the orders of the Bankruptcy Court. The Bankruptcy Filing constituted an event of default that accelerated the Company’s payment obligations under the Credit Facilities and Senior Secured Notes. As a result of the Bankruptcy Filing, the principal and interest due under our debt agreements became due and payable, except as described in the Forbearance Agreement below. However, any efforts to enforce such payment

 

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obligations were automatically stayed as a result of the Bankruptcy Filing, and the creditors’ rights of enforcement were subject to the applicable provisions of the Bankruptcy Code and orders of the Bankruptcy Court. Consequently, all debt outstanding under the Credit Facilities and Senior Secured Notes was classified as debt subject to compromise and all unamortized debt issuance costs and unaccreted debt discounts were expensed.

Contemporaneously with the Bankruptcy Filing, the Foreign ABL Borrowers entered into the Forbearance Agreement pursuant to which, among other things, the Foreign ABL lenders agreed to forbear from exercising certain rights as a result of the Debtors filing voluntary petitions for relief under the Bankruptcy Code, which constituted events of default under the Foreign ABL. The Forbearance Agreement also provided for, among other things, entry into a payoff letter, which contemplated that all loans and other obligations that were accrued and payable under the Foreign ABL and the corresponding loan documents were required to be paid in full within eight business days after the Petition Date. The Foreign ABL and Domestic ABL were repaid in full on January 24, 2017 in the amount of $50 million and $55 million, respectively.

In connection with the Bankruptcy Filing, on January 19, 2017, the Company entered into the DIP Credit Agreement, which provided a $725 million term loan facility due January 2018, and also included a cash collateralized letter of credit facility in an aggregate amount equal to $150 million. All letters of credit were cash collateralized in an amount equal to 101.5% of the face amount of such letters of credit denominated in U.S. dollars and 103% of the face amount of letters of credit denominated in alternative currencies. The DIP Credit Agreement, in the case of the Base Rate Loans, bore interest at a rate per annum equal to 6.5% plus the highest of (i) Citibank, N.A.’s prime rate, (ii) the Federal Funds Rate plus 0.5% and (iii) the Eurocurrency Rate for an interest period of one month, subject to a 2% floor and in the case of the Eurocurrency Loans, bore interest at a rate per annum equal to 7.5% plus the applicable Eurocurrency Rate, subject to a 1% floor. As of September 30, 2017, the weighted average interest rate for the $725 million term loan facility was 8.7%.

The DIP Credit Agreement limited, among other things, the Company’s ability to (i) incur indebtedness, (ii) incur or create liens, (iii) dispose of assets, (iv) prepay subordinated indebtedness and make other restricted payments, (v) enter into sale and leaseback transactions, (vi) make dividends, redemptions and repurchases of capital stock, (vii) enter into transactions with affiliates and (viii) modify the terms of any organizational documents and certain material contracts of the Company. In addition to standard obligations, the DIP order provided for specific milestones that the Company had to achieve by specific target dates. In addition, the Company and its subsidiaries were required to maintain minimum cumulative consolidated EBITDA (as defined in the DIP Credit Agreement) of not less than specified levels ranging from $133 million to $386 million, depending on the applicable period referenced in the DIP Credit Agreement. The Debtors were also required to maintain minimum Consolidated Liquidity (as defined in the DIP Credit Agreement) ranging from $20 million to $100 million depending on the applicable period referenced in the DIP Credit Agreement.

The Company drew $425 million in term loans under the DIP Credit Agreement on January 24, 2017 upon the Bankruptcy Court’s issuance of the interim order. The proceeds were used to repay the outstanding balance of $55 million under the Domestic ABL, to repay the outstanding balance of $50 million under the Foreign ABL, to cash collateralize $69 million of existing letters of credit and for general working capital needs.

On March 10, 2017, the Bankruptcy Court approved the final order authorizing the Debtors to access the full amount under the DIP Credit Agreement. The Company drew the remaining $300 million upon approval of the final order. The proceeds were used for general working capital needs.

The Debtors filed a Plan of Reorganization with the Bankruptcy Court on October 24, 2017. On November 28, 2017, the Bankruptcy Court entered an order confirming the Debtors’ Plan of Reorganization. On December 15, 2017, the Debtors, including the Company, completed the Restructuring and emerged from chapter 11 proceedings. The DIP Credit Agreement was repaid in full on December 15, 2017.

 

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Sources and Uses of Cash

The following table provides the condensed statements of cash flows for the periods indicated:

 

     Fiscal years ended
September 30,
 
(In millions)    2017     2016     2015  

Net cash (used for) provided by:

      

Net loss

   $ (182   $ (730   $ (168

Adjustments to net loss for non-cash items

     518       829       468  

Changes in operating assets and liabilities

     (45     14       (85
  

 

 

   

 

 

   

 

 

 

Operating activities

     291       113       215  

Investing activities

     (70     (100     (129

Financing activities

     314       9       (53

Effect of exchange rate changes on cash and cash equivalents

     5       (9     (32
  

 

 

   

 

 

   

 

 

 

Net increase in cash and cash equivalents

     540       13       1  

Cash and cash equivalents at beginning of year

     336       323       322  
  

 

 

   

 

 

   

 

 

 

Cash and cash equivalents at end of year

   $ 876     $ 336     $ 323  
  

 

 

   

 

 

   

 

 

 

Operating Activities

Cash provided by operating activities was $291 million, $113 million and $215 million for fiscal 2017, 2016 and 2015, respectively.

Adjustments to reconcile net loss to net cash provided by operations primarily consisted of depreciation and amortization of $326 million, $374 million and $371 million; non-cash interest expense of $61 million, $20 million and $20 million; deferred income taxes of $(39) million, $(53) million and $29 million; share-based compensation of $11 million, $16 million and $19 million; and unrealized gain on foreign currency exchange of $4 million, $12 million and $4 million, during fiscal 2017, 2016 and 2015, respectively. Additionally, fiscal 2017 and 2016 included adjustments for the impairment of indefinite-lived intangible assets of $65 million and $100 million, and impairment of goodwill of $52 million and $442 million, respectively. Also included in the adjustments were $(73) million and $24 million of change in fair value of the Preferred Series B derivative during fiscal 2016 and 2015, respectively. Fiscal 2017 included $52 million for non-cash operating reorganization expenses.

Cash (used for) provided by changes in operating assets and liabilities for fiscal 2017, 2016 and 2015 were $(45) million, $14 million and $(85) million, respectively.

During fiscal 2017, changes in our operating assets and liabilities resulted in a net decrease in cash from operations, which was driven by decreases in payments of business restructuring reserves established in previous periods, deferred revenues, payments associated with our employee incentive programs and the timing of payments to our vendors. These decreases were partially offset by increases in collections of accounts receivable and inventory.

During fiscal 2016, changes in our operating assets and liabilities resulted in a net increase in cash from operations, which was driven by collections of accounts receivable, increases in accrued interest and lower inventory. These increases were partially offset by payments associated with our employee incentive programs, the timing of payments to our vendors and payments associated with our business restructuring reserves.

During fiscal 2015, changes in our operating assets and liabilities resulted in a net decrease in cash from operations, which was driven by payments associated with our employee incentive programs, the timing of business restructuring reserves established in previous periods, and payments to our vendors. These decreases were partially offset by increases in collections of accounts receivable and deferred revenues.

 

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Investing Activities

Net cash (used for) provided by investing activities included cash used for capital expenditures of $57 million, $94 million and $124 million and the acquisition of businesses of $4 million, $20 million and $24 million during fiscal 2017, 2016 and 2015, respectively. Also included were payments to develop capitalized software of $2 million and $2 million, during fiscal 2017 and 2016, respectively. During fiscal 2016 and 2015, we received proceeds of $14 million and $22 million, respectively, for the sale of equipment used in the performance of services under our agreement with HP. In addition, in 2017, we received $70 million for proceeds from the sale of our Networking business and increased our restricted cash by $80 million, primarily related to the cash collateralized letters of credit issued under the DIP Credit Agreement.

Financing Activities

Net cash provided by (used for) financing activities primarily included proceeds from our financing agreements, offset by repayments and payments for debt issuance and modification costs.

Cash provided by financing activities for fiscal 2017 includes $712 million of net DIP borrowings, which was partially offset by $223 million of long-term debt payments, including $217 million of adequate protection payments, $150 million under our revolving credit facilities and $19 million in connection with financing the use of equipment for the performance of services under an agreement with HP Enterprise Services, LLC (“HP”).

Cash provided by financing activities for fiscal 2016 includes $57 million of borrowings in excess of repayments under our revolving credit facilities, partially offset by $25 million of long-term debt payments. We also made $19 million of payments in connection with financing the use of equipment for the performance of services under our agreement with HP.

Cash used for financing activities for fiscal 2015 includes cash proceeds of $2,100 million from the issuance of term B-7 loans maturing May 29, 2020. The proceeds from the issuance of the term B-7 loans were used to: (a) repay $2,054 million aggregate principal amounts of term B-3 loans, term B-4 loans, and term B-6 loans, (b) repay $32 million of revolving loans outstanding under our Senior Secured Credit Agreement, (c) pay $8 million of third-party fees and expenses for debt modification costs incurred in the refinancing transaction, and (d) pay $1 million for interest accrued on the refinanced term and revolving credit loans through the date of the refinancing transaction. The redemption price of the term B-3 loans and term B-6 loans includes $1 million of paid-in-kind interest expense recognized in prior periods and $3 million of unamortized discount, which is included in the loss on extinguishment of debt. In addition to the $32 million repaid with the proceeds of the term B-7 loans, we repaid another $90 million and borrowed $50 million of revolving loans under our Senior Secured Credit Agreement during fiscal 2015. We also made $12 million of payments in connection with financing the use of equipment for the performance of services under our agreement with HP.

Credit Facilities

On December 15, 2017, the Company entered into (i) the Term Loan Credit Agreement between Avaya Inc., as borrower, Avaya Holdings, the lending institutions from time to time party thereto, and Goldman Sachs Bank USA, as administrative agent and collateral agent, which provided a $2,925 million term loan facility due December 15, 2024 and (ii) the ABL Credit Agreement among Avaya Holdings, Avaya Inc., as borrower, the several borrowers party thereto, the several lenders from time to time party thereto, and Citibank, N.A., as administrative agent and collateral agent, which provided a revolving credit facility consisting of a U.S. tranche and a foreign tranche in an aggregate principal amount of $300 million, subject to borrowing base availability. The Term Loan Credit Agreement, in the case of ABR Loans, bears interest at a rate per annum equal to 3.75% plus the highest of (i) the Federal Funds Rate plus 0.50%, (ii) the U.S. prime rate as publicly announced in the Wall Street Journal and (iii) the LIBOR Rate for an interest period of one month, subject to a

 

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1% floor and in the case of LIBOR Loans, bears interest at a rate per annum equal to 4.75% plus the applicable LIBOR Rate, subject to a 1% floor. The ABL Credit Agreement bears interest:

 

  1. In the case of Base Rate Loans, at a rate per annum equal to 0.75% (subject to a step-up or step-down based on availability) plus the highest of (i) the Federal Funds Rate plus 0.50%, (ii) the U.S. prime rate as publicly announced by Citibank, N.A. and (iii) the LIBOR Rate for an interest period of one month, subject to a 1% floor;

 

  2. In the case of Canadian Prime Rate Loans, at a rate per annum equal to 0.75% (subject to a step-up or step-down based on availability) plus the highest of (i) the “Base Rate” as publicly announced by Citibank, N.A., Canadian branch and (ii) the CDOR Rate for an interest period of 30 days, subject to a 1% floor;

 

  3. In the case of LIBOR Rate Loans, at a rate per annum equal to 1.75% (subject to a step-up or step-down based on availability) plus the applicable LIBOR Rate, subject to a 0% floor;

 

  4. In the case of CDOR Rate Loans, at a rate per annum equal to 1.75% (subject to a step-up or step-down based on availability) plus the applicable CDOR Rate, subject to a 0% floor; and

 

  5. In the case of Overnight LIBOR Rate Loans, at a rate per annum equal to 1.75% (subject to a step-up or step-down based on availability) plus the applicable Overnight LIBOR Rate.

The Credit Agreements limit, among other things, Avaya Inc.’s ability to (i) incur indebtedness, (ii) incur or create liens, (iii) dispose of assets, (iv) prepay subordinated indebtedness and make other restricted payments, (v) enter into sale and leaseback transactions, (vi) make dividends, redemptions and repurchases of capital stock, (vii) enter into transactions with affiliates and (viii) modify the terms of any organizational documents and certain material contracts of Avaya Inc.

Contractual Obligations

The following table summarizes our contractual obligations and stated due dates as of September 30, 2017 as adjusted for Restructuring transactions on December 15, 2017:

 

    Payments due by period  
(In millions)   Total     Less than
1 year
    1-3
years
    3-5
years
    More than
5 years
 

Capital lease obligations(1)

  $ 25     $ 14     $ 11     $ —       $ —    

Operating lease obligations(2)

    264       71       97       51       45  

Purchase obligations with contract manufacturers and suppliers(3)

    68       68       —         —         —    

Other purchase obligations(4)

    549       391       139       14       5  

Term Loan Credit Agreement due December 15, 2024(5)

    2,925       22       59       59       2,785  

ABL Credit Agreement(6)

    —         —         —         —         —    

Interest payments due on debt(7)

    1,251       146       364       357       384  

Benefit obligations(8)

    89       89       —         —         —    
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total

  $ 5,171       801     $ 670     $ 481     $ 3,219  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

(1) The payments due for capital lease obligations do not include $1 million in future payments for interest.
(2) Contractual obligations for operating leases include $42 million of future minimum lease payments pertaining to restructuring and exit activities.
(3) We purchase components from a variety of suppliers and use several contract manufacturers to provide manufacturing services for our products. During the normal course of business, in order to manage manufacturing lead times and to help assure adequate component supply, we enter into agreements with contract manufacturers and suppliers that allow them to produce and procure inventory based upon forecasted requirements provided by us. If we do not meet these specified purchase commitments, we could be required to purchase the inventory.

 

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(4) Other purchase obligations represent an estimate of contractual obligations in the ordinary course of business, other than commitments with contract manufacturers and suppliers, for which we have not received the goods or services as of September 30, 2017. Although contractual obligations are considered enforceable and legally binding, the terms generally allow us the option to cancel, reschedule and adjust our requirements based on our business needs prior to the delivery of goods or performance of services. Other purchase obligations also includes estimated payments under the multi-year contract entered into with HP pursuant to which Avaya will outsource to HP certain delivery services associated with the APCS business including current specified customer contracts.
(5) The contractual obligations for our Term Loan Credit Agreement represents principal payment only.
(6) The ABL Credit Agreement is a $300 million revolving credit facility with a U.S. and foreign tranche. Upon emergence of bankruptcy, there was no draw down on this credit facility.
(7) The interest payments for the Term Loan Credit Agreement were calculated by applying an applicable margin to a projected LIBOR rate. An estimated unused facility fee was calculated for the ABL Credit Agreement using the contract rate.
(8) The Company sponsors non-contributory defined pension and postretirement plans covering certain employees and retirees. The Company’s general funding policy with respect to qualified pension plans is to contribute amounts at least sufficient to satisfy the minimum amount required by applicable law and regulations, or to directly pay benefits where appropriate. Most postretirement medical benefits are not pre-funded. Consequently, the Company makes payments as these retiree medical benefits are disbursed. Upon emergence, APPSE was transferred to the PBGC and the Avaya Supplemental Pension Plan was terminated.

As of September 30, 2017, the Company’s unrecognized tax benefits associated with uncertain tax positions were $268 million and interest and penalties related to these amounts were an additional $19 million.

Future Cash Requirements

A substantial portion of our future cash requirements are for the payment of principal and interest on our debt, which historically has been in excess of 70% of our operating cash flows as adjusted to add back interest payments on our debt. Our other future cash requirements relate to working capital, capital expenditures, restructuring payments and benefit obligations. In addition, we may use cash in the future to make strategic acquisitions.

In addition to our working capital requirements, we expect our primary cash requirements for fiscal 2018 to be as follows:

 

    Restructuring payments—We expect to make payments of approximately $55 million to $60 million during fiscal 2018 for employee separation costs and lease termination obligations associated with restructuring actions we have taken through September 30, 2017.

 

    Capital expenditures—We expect to spend approximately $65 million to $70 million for capital expenditures during fiscal 2018.

 

    Benefit obligations—We expect to make payments under our post-emergence pension and postretirement obligations of $89 million during fiscal 2018. These payments include $46 million to satisfy the minimum statutory funding requirements of our U.S. qualified pension plan, $1 million of payments under our U.S. benefit plans that are not pre-funded, $27 million under our non-U.S. benefit plans that are predominately not pre-funded and $15 million under our U.S. retiree medical benefit plan that is not pre-funded.

In addition to the matters identified above, 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.

 

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On October 23, 2014, in connection with an action in the U.S. District Court, District of New Jersey, against defendants Telecom Labs, Inc., TeamTLI.com Corp. and Continuant Technologies, Inc. (the “TLI/Continuant matter”), the Company filed a supersedeas bond with the Court in the amount of $63 million to stay execution of a judgment against it while the matter is on appeal. On February 22, 2016, the Company posted a bond in the amount of $8 million in connection with the TLI/Continuant’s attorneys’ fees, expenses and costs. The Company secured posting of the bonds through the issuance of a letter of credit under its Credit Facilities and Senior Secured Notes.

On September 30, 2016, the Third Circuit issued a favorable ruling for the Company which included: (1) reversing the mid-trial decision to dismiss four of the Company’s affirmative claims and reinstated them; (2) vacating the jury verdict on the two claims decided in TLI/Continuant’s favor; (3) entering judgment in the Company’s favor on a portion of TLI/Continuant’s claim relating to attempted monopolization; (4) dismissing TLI/Continuant’s PDS patches claim as a matter of law; (5) vacating the damages award to TLI/Continuant; (6) vacating the award of prejudgment interest to TLI/Continuant; and (7) vacating the injunction.

As a result of the Third Circuit’s opinion, on November 23, 2016, the Company filed a Notice of Motion to Release the Supersedeas Bonds, which the court granted on December 23, 2016. On January 13, 2017, the Court entered an Order staying the matter pending mediation. On January 20, 2017, the Company filed a Notice of Suggestion on Pendency of Bankruptcy for Avaya Inc., et. al. and Automatic Stay of Proceedings. On November 30, 2017, the Company filed a motion in the Bankruptcy Court seeking to estimate TLI/Continuant’s claim.

In July 2016, BlackBerry Limited (“BlackBerry”) filed a complaint for patent infringement against the Company in the Northern District of Texas, alleging infringement of multiple patents with respect to a variety of technologies including user interface design, encoding/decoding and call routing. In September 2016, the Company filed a motion to dismiss these claims and in October 2016, the Company also filed a motion to transfer this matter to the Northern District of California. In January 2017, the Company filed a notice of Suggestion of Pendency of Bankruptcy, which initially stayed the proceedings. The stay was partially lifted to allow the court in Texas to rule on the two pending motions. The Company’s motion to transfer the case from Texas to California has been denied. The Company’s motion to dismiss BlackBerry’s indirect infringement and willfulness claims was granted, although BlackBerry was provided an opportunity to file an Amended Complaint to cure the deficiencies, which it did on October 19, 2017.

In September 2011, Network-1 Security Solutions, Inc. (“Network-1”) filed a complaint for patent infringement against the Company and other corporations in the Eastern District of Texas (Tyler Division), alleging infringement of its patent with respect to power over Ethernet technology. Network-1 seeks to recover for alleged reasonable royalties, enhanced damages and attorneys’ fees. In January 2017, the Company filed a Notice of Suggestion of Pendency of Bankruptcy, which informed the Court of the Company’s voluntary bankruptcy petition filing and stay of proceedings. On October 16, 2017, the Bankruptcy Court entered an order approving a settlement agreement with Network-1.

In January 2010, SAE Power Incorporated and SAE Power Company (“SAE”) filed a complaint in the New Jersey Superior Court asserting various claims including breach of contract, unjust enrichment, promissory estoppel, and breach of the covenant of good faith and fair dealing arising out of Avaya’s relationship with SAE as a supplier of various power supply products. SAE has since asserted additional claims against Avaya for fraud, negligent misrepresentation, misappropriation of trade secrets, and civil conspiracy. SAE seeks to recover for alleged losses stemming from Avaya’s termination of its power supply purchases from SAE, including for Avaya’s alleged disclosure of SAE’s alleged trade secret and/or confidential information to another power supply vendor. On July 19, 2016, the Court entered an order granting Avaya’s motion for partial summary judgment, dismissing certain of SAE’s claims regarding the alleged disclosure of trade secrets. In January 2017, the Company filed a Notice of Suggestion of Pendency of Bankruptcy, which stayed the proceedings. On September 28, 2017, the Company filed a motion in the Bankruptcy Court seeking to estimate SAE’s claim.

 

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These and other legal matters could have a material adverse effect on the manner in which the Company does business and the Company’s financial position, results of operations, cash flows and liquidity.

During fiscal 2017 and 2016, the Company recognized $64 million and $106 million, respectively, of costs incurred in connection with the resolution of certain legal matters.

Future Sources of Liquidity

Upon emergence, we had more than $300 million in cash. We expect our cash balances, cash generated by operations and borrowings available under our ABL Credit Agreement to be our primary sources of short-term liquidity.

On December 15, 2017, the Company entered into (i) the Term Loan Credit Agreement between Avaya Inc., as borrower, Avaya Holdings, the lending institutions from time to time party thereto, and Goldman Sachs Bank USA, as administrative agent and collateral agent, which provided a $2,925 million term loan facility due December 15, 2024 and (ii) the ABL Credit Agreement among Avaya Holdings, Avaya Inc., as borrower, the several borrowers party thereto, the several lenders from time to time party thereto, and Citibank, N.A., as administrative agent and collateral agent, which provided a revolving credit facility consisting of a U.S. tranche and a foreign tranche in an aggregate principal amount of $300 million, subject to borrowing base availability. The Term Loan Credit Agreement, in the case of ABR Loans, bears interest at a rate per annum equal to 3.75% plus the highest of (i) the Federal Funds Rate plus 0.50%, (ii) the U.S. prime rate as publicly announced in the Wall Street Journal and (iii) the LIBOR Rate for an interest period of one month, subject to a 1% floor and in the case of LIBOR Loans, bears interest at a rate per annum equal to 4.75% plus the applicable LIBOR Rate, subject to a 1% floor. The ABL Credit Agreement bears interest:

 

  1. In the case of Base Rate Loans, at a rate per annum equal to 0.75% (subject to a step-up or step-down based on availability) plus the highest of (i) the Federal Funds Rate plus 0.50%, (ii) the prime rate as publicly announced by Citibank, N.A. and (iii) the LIBOR Rate for an interest period of one month, subject to a 1% floor;

 

  2. In the case of Canadian Prime Rate Loans, at a rate per annum equal to 0.75% (subject to a step-up or step-down based on availability) plus the highest of (i) the “Base Rate” as publicly announced by Citibank, N.A., Canadian branch and (ii) the CDOR Rate for an interest period of 30 days, subject to a 1% floor;

 

  3. In the case of LIBOR Rate Loans, at a rate per annum equal to 1.75% (subject to a step-up or step-down based on availability) plus the applicable LIBOR Rate, subject to a 0% floor;

 

  4. In the case of CDOR Rate Loans, at a rate per annum equal to 1.75% (subject to a step-up or step-down based on availability) plus the applicable CDOR Rate, subject to a 0% floor; and

 

  5. In the case of Overnight LIBOR Rate Loans, at a rate per annum equal to 1.75% (subject to a step-up or step-down based on availability) plus the applicable Overnight LIBOR Rate.

The Credit Agreements limit, among other things, Avaya Inc.’s ability to (i) incur indebtedness, (ii) incur or create liens, (iii) dispose of assets, (iv) prepay subordinated indebtedness and make other restricted payments, (v) enter into sale and leaseback transactions, (vi) make dividends, redemptions and repurchases of capital stock, (vii) enter into transactions with affiliates and (viii) modify the terms of any organizational documents and certain material contracts of Avaya Inc.

As of September 30, 2017 and 2016, our cash and cash equivalent balances held outside the U.S. were $246 million and $97 million, respectively. As of September 30, 2017, balances of cash and cash equivalents held outside the U.S. in excess of in-country needs and, which could not be distributed to the U.S. without restriction were not material.

 

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Debt Ratings

On December 15, 2017, the Company obtained ratings from Moody’s Investors Service (“Moody’s”) and Fitch Ratings Inc. (“Fitch”). Moody’s issued a corporate family rating of “B2” with a stable outlook and a rating of the 7-year $2.925 billion Term Loan Credit Agreement of “B2”. Fitch issued a Long-Term Issuer Default Rating of “B” with a stable o