<Page>
Exhibit 99.1
To the Board of Directors and Stockholders of Avaya Inc.:
In our opinion, the accompanying consolidated balance sheets and the
related consolidated statements of operations, of changes in stockholders'
equity and of comprehensive income (loss), and of cash flows present fairly, in
all material respects, the financial position of Avaya Inc. and its subsidiaries
(the "Company") at September 30, 2001 and 2000, and the results of their
operations and their cash flows for each of the three years in the period ended
September 30, 2001, in conformity with accounting principles generally accepted
in the United States of America. These financial statements are the
responsibility of the Company's management; our responsibility is to express an
opinion on these financial statements based on our audits. We conducted our
audits of these statements in accordance with auditing standards generally
accepted in the United States of America, which require that we plan and perform
the audit to obtain reasonable assurance about whether the financial statements
are free of material misstatement. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the financial statements,
assessing the accounting principles used and significant estimates made by
management, and evaluating the overall financial statement presentation. We
believe that our audits provide a reasonable basis for our opinion.
Until September 30, 2000, the Company was a fully integrated business of
Lucent Technologies Inc. ("Lucent"); consequently, as indicated in Note 1, these
consolidated financial statements have been derived from the consolidated
financial statements and accounting records of Lucent, and reflect significant
assumptions and allocations. Moreover, as indicated in Note 1, prior to
September 30, 2000, the Company relied on Lucent and its other businesses for
administrative, management and other services. Accordingly, the consolidated
financial statements as of and for each of the two years ended September 30,
2000 do not necessarily reflect the financial position, results of operations,
changes in stockholders' equity and cash flows of the Company had it been a
separate stand-alone entity, independent of Lucent during such periods.
As discussed in Notes 2 and 12 to the consolidated financial statements,
the Company adopted Statement of Position 98-1 "Accounting for the Costs of
Computer Software Developed or Obtained for Internal Use" in 2000 and changed
its method for calculating annual pension and postretirement benefit costs in
1999, respectively.
/s/ PRICEWATERHOUSECOOPERS LLP
PricewaterhouseCoopers LLP
New York, New York
October 24, 2001, except for the first
four paragraphs of Note 15 and the
tables entitled "Reportable Segments"
and "Reconciling Items" in Note 15
as to which the date is June 5, 2002
<Page>
CONSOLIDATED STATEMENTS OF OPERATIONS
Avaya Inc. and Subsidiaries
<Table>
<Caption>
Year Ended September 30,
-----------------------------
2001 2000 1999
---- ---- ----
(dollars in millions, except per share amounts)
REVENUE
Products $ 4,470 $ 5,774 $ 6,368
Services 2,323 1,958 1,900
------- ------- -------
6,793 7,732 8,268
------- ------- -------
COSTS
Products 2,407 3,471 3,720
Services 1,490 1,012 1,040
------- ------- -------
3,897 4,483 4,760
------- ------- -------
GROSS MARGIN 2,896 3,249 3,508
------- ------- -------
OPERATING EXPENSES
Selling, general and administrative 2,058 2,540 2,632
Business restructuring and related charges (reversals) 837 684 (33)
Research and development 536 468 540
Purchased in-process research and development 32 -- --
------- ------- -------
TOTAL OPERATING EXPENSES 3,463 3,692 3,139
------- ------- -------
OPERATING INCOME (LOSS) (567) (443) 369
Other income, net 34 71 28
Interest expense (37) (76) (90)
------- ------- -------
INCOME (LOSS) BEFORE INCOME TAXES (570) (448) 307
Provision (benefit) for income taxes (218) (73) 121
------- ------- -------
INCOME (LOSS) BEFORE CUMULATIVE EFFECT OF ACCOUNTING CHANGE (352) (375) 186
Cumulative effect of accounting change (net of income taxes of $62) -- -- 96
------- ------- -------
NET INCOME (LOSS) $ (352) $ (375) $ 282
======= ======= =======
EARNINGS (LOSS) PER COMMON SHARE:
Basic $ (1.33) $ (1.39) $ 1.09
======= ======= =======
Diluted $ (1.33) $ (1.39) $ 1.03
======= ======= =======
</Table>
See Notes to Consolidated Financial Statements.
28.
<Page>
CONSOLIDATED BALANCE SHEETS
Avaya Inc. and Subsidiaries
<Table>
<Caption>
As of September 30,
-------------------
2001 2000
---- ----
(dollars in millions, except per share amounts)
ASSETS
Current assets:
Cash and cash equivalents $ 250 $ 271
Receivables, less allowances of $68 in 2001 and $62 in 2000 1,163 1,758
Inventory 649 639
Deferred income taxes, net 246 450
Other current assets 461 244
------- -------
TOTAL CURRENT ASSETS 2,769 3,362
------- -------
Property, plant and equipment, net 988 966
Prepaid benefit costs -- 387
Deferred income taxes, net 529 44
Goodwill and other intangible assets, net 255 204
Other assets 107 74
------- -------
TOTAL ASSETS $ 4,648 $ 5,037
======= =======
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 624 $ 763
Current portion of long-term debt 145 80
Business restructuring reserve 179 499
Payroll and benefit obligations 333 491
Advance billings and deposits 133 253
Other current liabilities 604 503
------- -------
TOTAL CURRENT LIABILITIES 2,018 2,589
------- -------
Long-term debt 500 713
Benefit obligations 637 421
Deferred revenue 84 83
Other liabilities 533 467
------- -------
TOTAL NON-CURRENT LIABILITIES 1,754 1,684
------- -------
Commitments and contingencies
Series B convertible participating preferred stock, par value $1.00 per share,
4 million shares authorized, issued and outstanding as of September 30, 2001 395 --
------- -------
STOCKHOLDERS' EQUITY
Series A junior participating preferred stock, par value $1.00 per share,
7.5 million shares authorized; none issued and outstanding -- --
Common stock, par value $0.01 per share, 1.5 billion shares authorized, 286,851,934 and
282,027,675 issued and outstanding as of September 30, 2001 and 2000, respectively 3 3
Additional paid-in capital 905 825
Accumulated deficit (379) --
Accumulated other comprehensive loss (46) (64)
Less treasury stock at cost (147,653 shares as of September 30, 2001) (2) --
------- -------
TOTAL STOCKHOLDERS' EQUITY 481 764
------- -------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 4,648 $ 5,037
======= =======
</Table>
See Notes to Consolidated Financial Statements.
29.
<Page>
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY AND OF COMPREHENSIVE
INCOME (LOSS)
Avaya Inc. and Subsidiaries
<Table>
<Caption>
Year Ended September 30,
-----------------------------
2001 2000 1999
---- ---- ----
(dollars in millions)
FORMER PARENT'S NET INVESTMENT:
Beginning balance $ -- $ 1,871 $ 1,854
Net income (loss) -- (375) 282
Transfers to Lucent -- (7,783) (8,488)
Transfers from Lucent -- 7,115 8,223
Recapitalization upon Distribution -- (828) --
------- ------- -------
Ending balance $ -- $ -- $ 1,871
------- ------- -------
COMMON STOCK:
Beginning balance $ 3 $ -- $ --
Issuance of stock pursuant to the Distribution -- 3 --
------- ------- -------
Ending balance $ 3 $ 3 $ --
------- ------- -------
ADDITIONAL PAID-IN CAPITAL:
Beginning balance $ 825 $ -- $ --
Additional paid-in capital resulting from the Distribution -- 825 --
Issuance of warrants 32 -- --
Issuance of common stock for options exercised 7 -- --
Issuance of common stock to employees under the stock purchase plan 33 -- --
Issuance of other stock unit awards 28 -- --
Other stock transactions (Note 4) 22 -- --
Adjustment to Lucent capital contribution (Notes 12 and 16) (42) -- --
------- ------- -------
Ending balance $ 905 $ 825 $ --
------- ------- -------
ACCUMULATED DEFICIT:
Beginning balance $ -- $ -- $ --
Preferred stock accretion (27) -- --
Net loss (352) -- --
------- ------- -------
Ending balance $ (379) $ -- $ --
------- ------- -------
ACCUMULATED OTHER COMPREHENSIVE LOSS:
Beginning balance $ (64) $ (54) $ (59)
Foreign currency translations 18 (10) 5
------- ------- -------
Ending balance $ (46) $ (64) $ (54)
------- ------- -------
TREASURY STOCK:
Beginning balance $ -- $ -- $ --
Purchase of treasury stock at cost (2) -- --
------- ------- -------
Ending balance $ (2) $ -- $ --
------- ------- -------
TOTAL STOCKHOLDERS' EQUITY $ 481 $ 764 $ 1,817
======= ======= =======
COMPREHENSIVE INCOME (LOSS):
Net income (loss) $ (352) $ (375) $ 282
Other comprehensive income (loss) - foreign currency translations 18 (10) 5
------- ------- -------
Comprehensive income (loss) $ (334) $ (385) $ 287
======= ======= =======
</Table>
See Notes to Consolidated Financial Statements.
30.
<Page>
CONSOLIDATED STATEMENTS OF CASH FLOWS
Avaya Inc. and Subsidiaries
<Table>
<Caption>
Year Ended September 30,
-----------------------
2001 2000 1999
---- ---- ----
(dollars in millions)
OPERATING ACTIVITIES:
Net income (loss) $(352) $(375) $ 282
Adjustments to reconcile net income (loss) to net cash provided by
(used for) operating activities:
Cumulative effect of accounting change -- -- (96)
Business restructuring and related charges (reversals) 659 595 (33)
Depreciation and amortization 273 220 212
Provision for uncollectible receivables 53 36 25
Deferred income taxes (264) (288) (2)
Purchased in-process research and development 32 -- --
Gain on businesses sold (6) (44) (24)
Adjustments for other non-cash items, net 32 19 26
Changes in operating assets and liabilities, net of effects of
acquired and divested businesses:
Receivables 198 (50) 5
Inventory (6) 131 81
Accounts payable (138) 298 (47)
Payroll and benefits, net (215) (372) (12)
Advance billings and deposits (120) 55 59
Other assets and liabilities (279) 260 (45)
----- ----- -----
NET CASH PROVIDED BY (USED FOR) OPERATING ACTIVITIES (133) 485 431
----- ----- -----
INVESTING ACTIVITIES:
Capital expenditures (341) (499) (202)
Proceeds from the sale of property, plant and equipment 108 14 17
Disposal of businesses -- 82 29
Acquisitions of businesses, net of cash acquired (120) -- --
Cash from merger -- -- 60
Purchases of equity investments (27) -- --
Other investing activities, net 15 (25) 10
----- ----- -----
NET CASH USED FOR INVESTING ACTIVITIES (365) (428) (86)
----- ----- -----
FINANCING ACTIVITIES:
Issuance of convertible participating preferred stock 368 -- --
Issuance of warrants 32 -- --
Issuance of common stock 40 -- --
Transfers to Lucent, net -- (741) (253)
Credit facility borrowing 200 -- --
Net decrease in commercial paper (348) -- --
Assumption of commercial paper from Lucent -- 780 --
Proceeds from securitization of accounts receivable 200 -- --
Other financing activities, net (9) 3 (4)
----- ----- -----
NET CASH PROVIDED BY (USED FOR) FINANCING ACTIVITIES 483 42 (257)
----- ----- -----
Effect of exchange rate changes on cash and cash equivalents (6) (22) (1)
----- ----- -----
Net increase (decrease) in cash and cash equivalents (21) 77 87
Cash and cash equivalents at beginning of year 271 194 107
----- ----- -----
Cash and cash equivalents at end of year $ 250 $ 271 $ 194
===== ===== =====
</Table>
See Notes to Consolidated Financial Statements.
31.
<Page>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Avaya Inc. and Subsidiaries
1. BACKGROUND AND BASIS OF PRESENTATION
BACKGROUND
On September 30, 2000, Avaya Inc. (the "Company" or "Avaya") was spun
off from Lucent Technologies Inc. ("Lucent" or "Former Parent") pursuant to a
contribution by Lucent of its enterprise networking businesses to the Company
and a distribution of the outstanding shares of the Company's common stock, to
Lucent stockholders (the "Distribution"). The Company provides communication
systems and software for enterprises, including businesses, government agencies
and other organizations. The Company offers a broad range of voice, converged
voice and data, customer relationship management, messaging, multi-service
networking and structured cabling products and services.
The Company was incorporated in Delaware under the name "Lucent EN Corp." in
February 2000 as a wholly owned subsidiary of Lucent. In June 2000, the
Company's name was changed to "Avaya Inc." At the Distribution, the Company's
authorized capital stock consisted of 200 million shares of preferred stock, par
value $1.00 per share, of which the Company has presently designated 7.5 million
shares as Series A junior participating preferred stock and 4 million shares as
Series B convertible participating preferred stock, and 1.5 billion shares of
common stock, par value $0.01 per share.
The Company adopted a rights agreement prior to the Distribution date. The
issuance of a share of the Company's common stock also constitutes the issuance
of a Series A junior participating preferred stock purchase right associated
with such share. These rights may have anti-takeover effects in that the
existence of the rights may deter a potential acquirer from making a takeover
proposal or a tender offer.
BASIS OF PRESENTATION
The accompanying consolidated financial statements as of and for the fiscal year
ended September 30, 2001 depict the first full year of Avaya's results as a
stand-alone company.
The consolidated financial statements as of and for each of the two fiscal
years ended September 30, 2000 include the Company and its subsidiaries as well
as certain assets, liabilities, and related operations transferred to the
Company from Lucent immediately prior to the Distribution. These consolidated
financial statements have been derived from the accounting records of Lucent
using the historical results of operations and historical basis of the assets
and liabilities of the enterprise networking businesses transferred to the
Company. Since no direct ownership existed among all of the various units
comprising the Company prior to the Distribution, Lucent's net investment in
Avaya is shown in place of stockholders' equity in the Consolidated Statements
of Changes in Stockholders' Equity in fiscal 2000 and 1999. Management believes
these consolidated financial statements are a reasonable representation of the
financial position, results of operations, cash flows and changes in
stockholders' equity of such businesses as if Avaya were a separate entity
during such periods.
The consolidated financial statements as of and for each of the two years
ended September 30, 2000 include allocations of certain Lucent corporate
headquarters' assets, liabilities, and expenses relating to these businesses
that were transferred to Avaya fromLucent. General corporate overhead has been
allocated either based on the ratio of the Company's costs and expenses to
Lucent's costs and expenses, or based on the Company's revenue as a percentage
of Lucent's total revenue.General corporate overhead primarily includes cash
management, legal, accounting, tax, insurance, public relations, advertising and
data services and amounted to $398 million and $449 million in fiscal 2000 and
1999, respectively. In addition, the consolidated financial statements for
fiscal 2000 and 1999 include an allocation from Lucent to fund a portion of the
costs of basic research conducted byLucent's Bell Laboratories.This allocation
was based on the Company's revenue as a percentage of Lucent's total revenue and
amounted to $75 million and $78 million in fiscal 2000 and 1999, respectively.
Management believes the costs of corporate services and research charged to the
Company are a reasonable representation of the costs that would have been
incurred if the Company had performed these functions as a stand-alone entity.
The Company currently performs these corporate functions and basic research
requirements using its own resources or purchased services.
During the periods covered by the consolidated financial statements as of and
for each of the two years ended September 30, 2000, Lucent used a centralized
approach to cash management and the financing of its operations.Prior to the
Distribution, cash deposits from the Company's businesses were transferred to
Lucent on a regular basis and were netted against Lucent's net investment
account. As a result, none of Lucent's cash or cash equivalents at the corporate
level had been allocated to the Company. Changes in stockholders' equity in
fiscal 2000 and 1999 represent funding required fromLucent for working capital,
acquisitions or capital expenditures after giving effect to the Company's
transfers to or fromLucent of its cash flows from operations and other non-cash
transactions between the Company and Lucent.
Although the Company's Consolidated Statements of Operations include interest
expense for each of the two fiscal years ended September 30, 2000, the
Consolidated Balance Sheets for periods prior to the Distribution do not include
an allocation of Lucent debt at the corporate level because of the centralized
approach that Lucent used to finance its operations. The Company has assumed for
purposes of calculating interest expense that it would have had average debt
balances of $962 million and $1,320 million and average interest rates of 7.9%
and 6.8% per annum for fiscal 2000 and 1999, respectively. The Company believes
the interest rates and average debt balances used in the calculation of interest
expense reasonably reflect the cost of financing its assets and operations
during the periods prior to the Distribution.
Income taxes were calculated in fiscal 2000 and 1999 as if the Company filed
separate tax returns. However, Lucent was managing its tax position for the
benefit of its entire portfolio of businesses, and its tax strategies were not
necessarily reflective of the tax strategies that the Company would have
followed or will follow as a stand-alone company. Commencing with fiscal 2001,
the Company will begin filing consolidated income tax returns for Avaya and its
subsidiaries.
32.
<Page>
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
PRINCIPLES OF CONSOLIDATION
The consolidated financial statements include all majority-owned subsidiaries in
which the Company exercises control. Investments in which the Company exercises
significant influence, but which it does not control (generally a 20%-50%
ownership interest), are accounted for under the equity method of accounting.
All intercompany transactions and balances between and among the Company's
businesses have been eliminated. Transactions between any of the Company's
businesses and Lucent are included in these financial statements.
USE OF ESTIMATES
The preparation of financial statements and related disclosures in conformity
with accounting principles generally accepted in the United States of America
requires management to make estimates and assumptions that affect the reported
amounts of assets and liabilities, the disclosure of contingent assets and
liabilities at the date of the financial statements and revenue and expenses
during the period reported. These estimates include an allocation of costs by
Lucent in fiscal 2000 and 1999, assessing the collectability of accounts
receivable, the use and recoverability of inventory, the realization of deferred
tax assets, restructuring reserves, and useful lives of tangible and intangible
assets, among others. The markets for the Company's products are characterized
by intense competition, rapid technological development and frequent new product
introductions, all of which could affect the future realizability of the
Company's assets. Estimates and assumptions are reviewed periodically and the
effects of revisions are reflected in the consolidated financial statements in
the period they are determined to be necessary. Actual results could differ from
these estimates.
FOREIGN CURRENCY TRANSLATION
Balance sheet accounts of the Company's foreign operations are translated from
foreign currencies into U.S. dollars at period-end exchange rates while income
and expenses are translated at average exchange rates during the period.
Translation gains or losses related to net assets located outside the U.S. are
shown as a component of accumulated other comprehensive loss in stockholders'
equity. Gains and losses resulting from foreign currency transactions, which are
denominated in a currency other than the entity's functional currency, are
included in the Consolidated Statements of Operations.
REVENUE RECOGNITION
Revenue from sales of communications systems and software is recognized when
contractual obligations have been satisfied, title and risk of loss have been
transferred to the customer, and collection of the resulting receivable is
reasonably assured. Revenue from the direct sales of products that include
installation services is recognized at the time the products are installed,
after satisfaction of all the terms and conditions of the underlying customer
contract. The Company's indirect sales to distribution partners are generally
recognized at the time of shipment if all contractual obligations have been
satisfied. The Company accrues a provision for estimated sales returns and other
allowances and deferrals as a reduction of revenue at the time of revenue
recognition, as required. Revenue from services performed under value-added
service arrangements, professional services and services performed under
maintenance contracts are recognized over the term of the underlying customer
contract or at the end of the contract, when obligations have been satisfied.
For services performed on a time and materials basis, revenue is recognized upon
performance.
RESEARCH AND DEVELOPMENT COSTS AND
SOFTWARE DEVELOPMENT COSTS
Research and development costs are charged to expense as incurred. The costs
incurred for the development of computer software that will be sold, leased or
otherwise marketed, however, are capitalized when technological feasibility has
been established. These capitalized costs are subject to an ongoing assessment
of recoverability based on anticipated future revenues and changes in hardware
and software technologies. Costs that are capitalized include direct labor and
related overhead.
Amortization of capitalized software development costs begins when the
product is available for general release to customers. Amortization is
recognized on a product-by-product basis on the greater of either the ratio of
current gross revenues to the total of current and anticipated future gross
revenues, or the straight-line method over three years. Unamortized capitalized
software development costs determined to be in excess of net realizable value of
the product are expensed immediately.
CASH AND CASH EQUIVALENTS
Cash and cash equivalents primarily represent amounts held by the Company's
foreign operations. All highly liquid investments with original maturities of
three months or less are considered to be cash equivalents.
ACCOUNTS RECEIVABLE SECURITIZATION
The amount attributable to the sale of a qualified trade accounts receivable is
removed from the Consolidated Balance Sheets and the proceeds received from the
sale are reflected as cash provided by financing activities in the Consolidated
Statements of Cash Flows. The Company is generally required to retain an
interest in the trade receivables sold and arranges for the transfer of the
applicable receivables at their carrying amount to a wholly owned
bankruptcy-remote subsidiary, a special purpose entity. The carrying amount of
the retained interest in the receivables is reclassified to other current assets
and typically approximates fair value because of the relatively short-term
nature of the receivable collections. Costs associated with the sale of
receivables are recorded in other income, net in the Consolidated Statements of
Operations.
The Company reviews the fair value assigned to retained interests at each
reporting date. Fair value is reviewed using similar valuation techniques as
those used to initially measure the retained interest and, if a change in events
or circumstances warrants, the fair value is adjusted.
33.
<Page>
INVENTORY
Inventory is stated at the lower of cost, determined on a first-in, first-out
basis, or market.
PROPERTY, PLANT AND EQUIPMENT
Property, plant and equipment are stated at cost less accumulated depreciation.
Depreciation is determined using a straight-line method over the estimated
useful lives of the various asset classes. Estimated lives range from three to
10 years for machinery and equipment, and 40 years for buildings.
Major renewals and improvements are capitalized and minor replacements,
maintenance and repairs are charged to expense as incurred. Upon retirement or
disposal of assets, the cost and related accumulated depreciation are removed
from the Consolidated Balance Sheets and any gain or loss is reflected in the
Consolidated Statements of Operations.
The Company adopted Statement of Position 98-1, "Accounting for the Costs of
Computer Software Developed or Obtained for Internal Use" in October 1999.
Certain costs of computer software developed or obtained for internal use, which
were previously expensed as incurred, are capitalized and amortized on a
straight-line basis over three years. Costs for general and administrative,
overhead, maintenance and training, as well as the cost of software that does
not add functionality to the existing system, are expensed as incurred. As of
September 30, 2001 and 2000, the Company had unamortized internal use software
costs of $68 million and $46 million, respectively.
GOODWILL AND LONG-LIVED ASSETS
Goodwill is the excess of the purchase price over the fair value of identifiable
net assets acquired in business combinations accounted for as purchases.
Goodwill is amortized on a straight-line basis over the periods benefited.
Long-lived assets and goodwill are reviewed for impairment whenever events such
as product discontinuance, plant closures, product dispositions or other changes
in circumstances indicate that the carrying amount may not be recoverable. In
reviewing for impairment, the Company compares the carrying value of such assets
to the estimated undiscounted future cash flows expected from the use of the
assets and their eventual disposition. An impairment loss, equal to the
difference between the assets' fair value and their carrying value, is
recognized when the estimated future cash flows are less than their carrying
amount (see Note 3 - SFAS 142).
Goodwill and other intangible assets as of September 30, 2001 and 2000 were
net of accumulated amortization of $230 million and $161 million, respectively.
FINANCIAL INSTRUMENTS
The Company uses various financial instruments, including foreign currency
forward contracts, to manage and reduce risk to the Company by generating cash
flows which offset the cash flows of certain transactions in foreign currencies
or underlying financial instruments in relation to their amount and timing. The
Company's derivative financial instruments are used as risk management tools and
not for speculative or trading purposes. Although not material, these
derivatives represent assets and liabilities and are classified as other current
assets or other current liabilities on the accompanying Consolidated Balance
Sheets. Gains and losses on the changes in the fair values of the Company's
derivative instruments are included in other income, net on the Consolidated
Statements of Operations.
The Company has elected to not use hedge accounting under Statement of
Financial Accounting Standards ("SFAS") No. 133, "Accounting for Derivative
Instruments and Hedging Activities," which could result in a gain or loss from
fluctuations in exchange rates related to a derivative contract which is
different from the loss or gain recognized from the underlying forecasted
transaction. However, the Company has procedures to manage risks associated with
its derivative instruments, which include limiting the duration of the
contracts, typically six months or less, and the amount of the underlying
exposures that can be economically hedged. Historically, the gains and losses on
these transactions have not been significant.
The Company also utilizes non-derivative financial instruments including
letters of credit and commitments to extend credit.
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, and operating loss 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. The effect on deferred tax assets and liabilities of a change in tax
rates is recognized in the Consolidated Statement of Operations in the period
that includes the enactment date. A valuation allowance is recorded to reduce
the carrying amounts of deferred tax assets if it is more likely than not that
such assets will not be realized.
OTHER COMPREHENSIVE INCOME (LOSS)
Other comprehensive income (loss) is recorded directly to a separate section of
stockholders' equity in accumulated other comprehensive loss and includes
unrealized gains and losses excluded from the Consolidated Statements of
Operations. These unrealized gains and losses consist of foreign currency
translation adjustments, which are not adjusted for income taxes since they
primarily relate to indefinite investments in non-U.S. subsidiaries.
RECLASSIFICATIONS
Certain prior year amounts have been reclassified to conform with the current
year presentation. The realignment of certain of the Company's operating
segments resulted in changes to the composition of the products and services
captions as classified in revenue and costs in the statements of operations.
The Company determined however, that it was not practicable to restate the
information for 1999 and 2000. As a result, the 1999 and 2000 classification
of products and services revenue and costs has not been presented consistent
with the realignment and therefore is not necessarily comparable with the
2001 presentations.
34.
<Page>
3. RECENT ACCOUNTING PRONOUNCEMENTS
SFAS 141 - In July 2001, the Financial Accounting Standards Board ("FASB")
issued Statement No. 141, "Business Combinations" ("SFAS 141"), which requires
all business combinations initiated after June 30, 2001 to be accounted for
using the purchase method of accounting. As a result, use of the
pooling-of-interests method is prohibited for business combinations initiated
thereafter. SFAS 141 also establishes criteria for the separate recognition of
intangible assets acquired in a business combination. In fiscal 2001, Avaya
adopted this Statement, which did not have a material impact on the Company's
consolidated results of operations, financial position or cash flows.
New accounting statements issued, but not yet adopted by the Company, include
the following:
SFAS 142 - In July 2001, the FASB issued Statement No. 142, "Goodwill and
Other Intangible Assets" ("SFAS 142"), which requires that goodwill and
certain other intangible assets having indefinite lives no longer be
amortized to earnings, but instead be subject to periodic testing for
impairment. Intangible assets determined to have definitive lives will
continue to be amortized over their useful lives. This Statement is effective
for the Company's 2003 fiscal year, and early adoption is permitted. However,
goodwill and intangible assets acquired after June 30, 2001 are subject
immediately to the non-amortization and amortization provisions of this
Statement. Effective October 1, 2001, the Company adopted SFAS142 and
implemented certain provisions, specifically the discontinuation of goodwill
amortization, and will be implementing the remaining provisions by the end of
fiscal 2002. In fiscal 2001, the Company recorded goodwill amortization
expense of $40 million. The Company is currently evaluating the remaining
provisions of SFAS 142 to determine the effect, if any, they may have on the
Company's consolidated results of operations, financial position or cash
flows.
SFAS 143 - In August 2001, the FASB issued Statement No. 143, "Accounting for
Asset Retirement Obligations" ("SFAS 143"), which provides the accounting
requirements for retirement obligations associated with tangible long-lived
assets. This Statement requires entities to record the fair value of a liability
for an asset retirement obligation in the period in which it is incurred. This
Statement is effective for the Company's 2003 fiscal year, and early adoption is
permitted. The adoption of SFAS 143 is not expected to have a material impact on
the Company's consolidated results of operations, financial position or cash
flows.
SFAS 144 - In October 2001, the FASB issued Statement No. 144, "Accounting for
the Impairment or Disposal of Long-Lived Assets" ("SFAS 144"), which excludes
from the definition of long-lived assets goodwill and other intangibles that are
not amortized in accordance with SFAS 142. SFAS 144 requires that long-lived
assets to be disposed of by sale be measured at the lower of carrying amount or
fair value less cost to sell, whether reported in continuing operations or in
discontinued operations. SFAS 144 also expands the reporting of discontinued
operations to include components of an entity that have been or will be disposed
of rather than limiting such discontinuance to a segment of a business. This
Statement is effective for the Company's 2003 fiscal year, and early adoption is
permitted. The Company is currently evaluating the impact of SFAS 144 to
determine the effect, if any, it may have on the Company's consolidated results
of operations, financial position or cash flows.
4. BUSINESS COMBINATIONS AND OTHER TRANSACTIONS
ACQUISITIONS
The following table presents information about certain acquisitions by the
Company during the fiscal year ended September 30, 2001. These acquisitions were
accounted for under the purchase method of accounting, and the acquired
technology valuation included existing technology, purchased in-process research
and development ("IPR&D") and other intangibles. The consolidated financial
statements include the results of operations and the estimated fair values of
the assets and liabilities assumed from the respective dates of acquisition. All
charges related to the write-off of purchased in-process research and
development were recorded in the quarter in which the transaction was completed.
There were no material acquisitions accounted for under the purchase method in
fiscal 2000 and 1999.
<Table>
<Caption>
Allocation of Purchase Price(1) Amortization Period (in years)
--------------------------------------------- ---------------------------------
Purchase Existing Other Purchased Existing Other
Acquisition Date Price Goodwill Technology Intangibles IPR&D Goodwill Technology Intangibles
---------------- ----- -------- ---------- ----------- ----- -------- ---------- -----------
(dollars in millions)
VPNet(2) February 6, 2001 $117 $48 $30 $16 $31 5 5 5
Quintus(3) April 11, 2001 $ 29 $ 3 $ 9 $ 3 $ 1 5 3 3
</Table>
(1) Excludes amounts allocated to specific tangible assets and liabilities.
(2) Acquisition of VPNet Technologies, Inc., a privately held distributor of
virtual private network solutions and devices. The total purchase price of $117
million was paid in cash and stock options.
(3) Acquisition of substantially all of the assets, including $10 million of
cash acquired, and the assumption of $20 million of certain liabilities of
Quintus Corporation, a provider of comprehensive electronic customer
relationship management solutions. The Company paid $29 million in cash for
these assets.
Included in the purchase price for each of the above acquisitions was purchased
in-process research and development. At the date of each acquisition, some of
the technology had not yet reached technological feasibility and had no future
alternative use. Accordingly, the purchased in-process research and development
was written off as a charge to earnings immediately upon consummation of the
respective acquisitions.
35.
<Page>
The charge related to VPNet purchased in-process research and development was
not tax deductible. The remaining purchase price was allocated to tangible and
intangible assets, including goodwill, existing technology and other intangible
assets, less liabilities assumed.
The value allocated to purchased in-process research and development for the
acquisitions was determined using an income approach. This involved estimating
the fair value of the in-process research and development using the present
value of the estimated after-tax cash flows expected to be generated by the
purchased in-process research and development, using risk-adjusted discount
rates and revenue forecasts as appropriate. Where appropriate, the Company
deducted an amount reflecting the contribution of the core technology from the
anticipated cash flows from an in-process research and development project. The
selection of the discount rate was based on consideration of the Company's
weighted average cost of capital, as well as other factors, including the useful
life of each technology, profitability levels of each technology, the
uncertainty of technology advances that were known at the time, and the stage of
completion of each technology. The Company believes that the estimated
in-process research and development amounts so determined represent fair value
and do not exceed the amount a third party would have paid for the projects.
Revenue forecasts were estimated based on relevant market size and growth
factors, expected industry trends, individual product sales cycles and the
estimated life of each product's underlying technology. Estimated operating
expenses, income taxes, and charges for the use of contributory assets were
deducted from estimated revenue to determine estimated after-tax cash flows for
each project. Estimated operating expenses include cost of goods sold, selling,
general and administrative expenses, and research and development expenses. The
research and development expenses include estimated costs to maintain the
products once they have been introduced into the market and generate revenue and
costs to complete the purchased in-process research and development.
Management is primarily responsible for estimating the fair value of the
assets and liabilities acquired, and has conducted due diligence in determining
the fair value. Management has made estimates and assumptions that affect the
reported amounts of assets, liabilities and expenses resulting from such
acquisitions. Actual results could differ from these amounts.
POOLING OF INTERESTS MERGER
In July 1999, the Company completed its merger with Mosaix, Inc., a provider of
software that manages an enterprise's various office functions and helps to
deliver more responsive and efficient customer service. Under the terms of the
agreement, the outstanding common stock of Mosaix was converted into
approximately 2.6 million shares of Lucent common stock with a value of $145
million. The financial position and results of operations of Mosaix were
immaterial to the Company and, as such, the consolidated financial statements
include the results of operations and the historical basis of the assets
acquired and liabilities assumed from the date of acquisition.
DIVESTITURES
In March 2000, the Company completed the sale of its U.S. sales division that
served small- and mid-sized businesses to Expanets, Inc. Under the agreement,
approximately 1,800 of the Company's sales and sales support employees were
transferred to Expanets, which became a distributor of the Company's products to
this market and a significant customer of the Company. A gain of $45 million was
recognized to the extent of cash proceeds received related to the sale of this
business and is included in other income, net.
OTHER TRANSACTIONS
AIRCRAFT SALE-LEASEBACK In June 2001, the Company sold a corporate aircraft for
approximately $34 million and subsequently entered into an agreement to lease it
back over a five-year period. At the end of the lease term, the Company has the
option to renew the lease subject to the consent of the lessors, or to purchase
the aircraft for a price as defined in the agreement. If the Company elects not
to either renew the lease or purchase the aircraft, the Company must arrange for
the sale of the aircraft to a third party. Under the sale option, the Company
has guaranteed approximately 60% of the unamortized original cost as the
residual value of the aircraft. The lease is accounted for as an operating lease
for financial statement purposes and as a loan for tax purposes.
OUTSOURCING OF CERTAIN MANUFACTURING FACILITIES In May 2001, the Company closed
the first phase of a five-year strategic manufacturing agreement to outsource
most of the manufacturing of its communications systems and software to
Celestica Inc. Under the agreement, Avaya will receive approximately $200
million in cash for the assets it is transferring to Celestica, of which the
Company has received $188 million as of September 30, 2001. The Company has
deferred $100 million of these proceeds, which will be recognized to income on a
straight-line basis over the term of the agreement. As of September 30, 2001,
the unamortized portion of these proceeds amounted to $20 million in other
current liabilities and $71 million in other liabilities. The Company expects
the remaining phases of the transaction, which include closing the Shreveport,
Louisiana facility, to be completed by the end of the first quarter of fiscal
2002.
In September 2000, in conjunction with the Company's restructuring plans to
exit certain manufacturing businesses, the Company sold its manufacturing
facility located in San Jose, California, to Sanmina Corporation. This facility
produced electronic equipment used in structured cabling systems. In connection
with the sale, the Company received proceeds of approximately $18 million and
recorded a loss of approximately $1 million.
SALE OF EQUIPMENT In fiscal 1999, the Company sold equipment, which was
previously leased to customers, for $97 million. The equipment had a net book
value of approximately $2 million and consisted predominantly of discontinued
product lines. Rental income generated by this equipment for fiscal 1999 was $79
million.
36.
<Page>
5. SUPPLEMENTARY FINANCIAL INFORMATION
STATEMENT OF OPERATIONS INFORMATION
<Table>
<Caption>
Year Ended September 30,
------------------------
2001 2000 1999
---- ---- ----
(dollars in millions)
DEPRECIATION AND AMORTIZATION
INCLUDED IN COSTS:
Amortization of software
development costs $ 24 $ 24 $ 14
INCLUDED IN SELLING, GENERAL
AND ADMINISTRATIVE EXPENSES:
Amortization of goodwill and
other intangible assets 72 55 59
INCLUDED IN COSTS AND
OPERATING EXPENSES:
Depreciation and amortization of
property, plant and equipment
and internal use software 177 141 139
----- ----- -----
Total depreciation and
amortization $ 273 $ 220 $ 212
===== ===== =====
OTHER INCOME, NET
Loss on foreign currency transactions $ (5) $ (10) $ --
Gain on businesses sold 6 44 24
Interest income 27 7 --
Miscellaneous, net 6 30 4
----- ----- -----
Total other income, net $ 34 $ 71 $ 28
===== ===== =====
<Caption>
BALANCE SHEET INFORMATION
As of September 30,
-------------------
2001 2000
---- ----
(dollars in millions)
INVENTORY
Completed goods $ 420 $ 472
Work in-process and raw materials 229 167
------- -------
Total inventory $ 649 $ 639
======= =======
PROPERTY, PLANT AND EQUIPMENT, NET
Land and improvements $ 46 $ 42
Buildings and improvements 485 383
Machinery and equipment 1,126 1,091
Assets under construction 47 179
Internal use software 89 50
------- -------
Total property, plant and equipment 1,793 1,745
Less: Accumulated depreciation and amortization (805) (779)
------- -------
Property, plant and equipment, net $ 988 $ 966
======= =======
<Caption>
SUPPLEMENTAL CASH FLOW INFORMATION
Year Ended September 30, 2001
-----------------------------
(dollars in millions)
ACQUISITION OF BUSINESSES:
Fair value of assets acquired, net of cash acquired $ 192
Less: Fair value of liabilities assumed (72)
-----
Acquisition of businesses, net of cash acquired $ 120
-----
In the second quarter of fiscal 2001, the Company
paid off $9 million of debt assumed from its
acquisition of VPNet
Interest payments, net of amounts capitalized $ 41
-----
Income tax payments $ 66
-----
Non-cash transactions:
Accretion of Series B Preferred Stock (Note 8) $ 27
Fair market value of stock options issued in connection
with acquisition (Note 4) 16
Adjustments to Contribution by Lucent
(Notes 12 and 16):
Accounts receivable 8
Property, plant and equipment, net 7
Net benefit assets 27
-----
Total non-cash transactions $ 85
=====
<Caption>
Year Ended September 30, 2000
-----------------------------
(dollars in millions)
DISPOSITION OF BUSINESSES:
Cash proceeds $ 82
Less: Basis in net assets sold (38)
Gain on businesses sold $ 44
</Table>
Payments for interest and income taxes prior to the Distribution were paid by
Lucent on behalf of the Company and do not necessarily reflect what the Company
would have paid had it been a stand-alone company.
Net transfers to Lucent prior to the Distribution are composed predominantly
of the following non-cash transactions: (1) for the fiscal year ended September
30, 2000, a $528 million increase in Former Parent's net investment due to
prepaid pension costs and other assets and a $439 million decrease from benefit
obligations and other accrued liabilities assumed by the Company from Lucent on
the Distribution date, and for the fiscal year ended September 30, 1999, (2) a
$96 million decrease in Former Parent's net investment for a change in
accounting related to pension and postretirement benefit costs, partially offset
by (3) an $82 million increase in Former Parent's net investment attributed to
the Mosaix pooling of interests merger.
37.
<Page>
6. SECURITIZATION OF ACCOUNTS RECEIVABLE
In June 2001, the Company entered into a receivables purchase agreement and
transferred a designated pool of qualified trade accounts receivable to a
special purpose entity ("SPE"), which in turn sold an undivided ownership
interest to an unaffiliated financial institution. The Company, through the SPE,
has a retained interest in a portion of the receivables, and the financial
institution has no recourse to the Company's other assets for failure of
customers to pay when due. The assets of the SPE are not available to pay
creditors of the Company. The Company is responsible for defined fees payable
monthly to the financial institution for costs associated with the outstanding
capital issued by the financial institution to fund the purchase of receivables
and a backstop liquidity commitment. The Company will continue to service,
administer and collect the receivables on behalf of the financial institution
and receive a fee for performance of these services. Collections of receivables
are used by the financial institution to purchase, from time to time, new
interests in receivables up to an aggregate of $200 million. The Company is
subject to certain receivable collection ratios, among other covenants contained
in the agreement. During fiscal 2001, the Company was in compliance with such
covenants. The receivables purchase agreement expires in June 2002, but may be
extended through June 2004 with the financial institution's consent.
In connection with the transaction, the Company received cash proceeds of
$200 million from the sale and securitization of these receivables. The accounts
receivable balances were removed from the Consolidated Balance Sheet and the
proceeds received from the sale were reflected as cash provided by financing
activities in the Consolidated Statement of Cash Flows. As of September 30,
2001, the Company had a retained interest of $153 million in the SPE's
designated pool of qualified accounts receivable representing collateral for the
sale. The carrying amount of the Company's retained interest, which approximates
fair value because of the relatively short-term nature of the receivable
collections, was reclassified to other current assets.
The Company did not record an asset or liability related to any servicing
obligations because the initial measure for servicing was determined to be
adequate to compensate the Company for its servicing responsibilities. Although
not material, costs associated with the sale of the receivables were recorded in
other income, net in the Consolidated Statement of Operations. No significant
gain or loss resulted from this transaction.
7. BUSINESS RESTRUCTURING AND RELATED CHARGES
In fiscal 2001, the Company outsourced certain manufacturing facilities and
accelerated its restructuring plan that was originally adopted in September 2000
to improve profitability and business performance as a stand-alone company. As a
result, the Company recorded a pretax charge of $872 million in fiscal 2001 for
business restructuring and related charges, which is expected to result in a
$295 million usage of cash. This charge was partially offset by a $35 million
reversal to income primarily attributable to fewer employee separations than
originally anticipated and more favorable than expected real estate lease
termination costs.
The components of the fiscal 2001 charge include $650 million of employee
separation costs, $24 million of lease termination costs, and $198 million of
other related charges. The charge for employee separation costs is composed of
$577 million primarily related to enhanced pension and postretirement benefits,
which represent the cost of curtailment in accordance with SFAS No. 88,
"Employers' Accounting for Settlements and Curtailments of Defined Benefit
Pension Plans and for Termination Benefits," and $73 million for severance,
special benefit payments and other employee separation costs. The $198 million
of other related charges is composed of $178 million for incremental period
expenses primarily to facilitate the separation from Lucent, including computer
system transition costs, and $20 million for an asset impairment charge related
to land, buildings and equipment at the Shreveport manufacturing facility that
the Company expects to dispose of during fiscal 2002. Employee separation costs
of $55 million established in fiscal 2000 for union-represented employees at
Shreveport will be paid as enhanced severance benefits from existing pension and
benefit assets and, accordingly, such amount was reclassified in fiscal 2001 out
of the business restructuring reserve and recorded as a reduction to prepaid
benefit costs.
The employee separation costs in fiscal 2001 were incurred in connection with
the elimination of 6,810 employee positions of which 5,600 were through a
combination of involuntary and voluntary separations, including an early
retirement program targeted at U.S. management employees, and a workforce
reduction of 1,210 employees due to the outsourcing of certain of the Company's
manufacturing operations to Celestica. Employee separation payments that are
included in the business restructuring reserve will be made either through a
lump sum or a series of payments extending over a period of up to two years from
the date of departure at each employee's option. This workforce reduction was
substantially complete as of September 30, 2001. Real estate lease termination
costs are being incurred primarily in the U.S., Europe and Asia, and have been
reduced for sublease income that management believes is probable. Payments on
lease obligations, which consist of real estate and equipment leases, will
extend through 2003. In fiscal 2001, accrued costs for lease obligations
represent approximately 666,000 square feet of excess sales and services support
offices, materials, stocking and logistics warehouses, and Connectivity
Solutions facilities. As of September 30, 2001, the Company had not yet vacated
any of this space.
In fiscal 2000, the Company recorded a pretax business restructuring charge
of $684 million in connection with its separation from Lucent. The components of
the charge include $365 million of employee
38.
<Page>
separation costs, $127 million of lease termination costs, $28 million of other
exit costs, and $164 million of other related charges.
The charge for employee separation costs in fiscal 2000 includes severance,
medical and other benefits attributable to the worldwide reduction of 4,900
union-represented and management positions. This charge is the result of
redesigning the services organization by reducing the number of field
technicians to a level needed for non-peak workloads, consolidating and closing
certain U.S. and European manufacturing facilities and realigning the sales
effort to focus the direct sales force on strategic accounts and address smaller
accounts through indirect sales channels. This workforce reduction was
substantially complete as of September 30, 2001. The charge for lease
termination obligations included approximately two million square feet of excess
manufacturing, distribution and administrative space, of which the Company has
vacated 646,000 square feet as of September 30, 2001. Other exit costs consist
of decommissioning legacy computer systems in connection with the Company's
separation from Lucent and terminating other contractual obligations.
The $164 million of other related charges in fiscal 2000 is composed of $89
million for incremental period expenses related to the separation from Lucent,
including computer system transition costs, and a $75 million asset impairment
charge that was primarily related to an outsourcing contract with a major
customer. With respect to the asset impairment, the Company terminated its
obligation under a leasing arrangement and purchased the underlying equipment,
which had been used to support a contract with a customer to provide outsourcing
and related services. Based on the terms of this contract, the estimated
undiscounted cash flows from the equipment's use and eventual disposition was
determined to be less than the equipment's carrying value, and resulted in an
impairment charge of $50 million to write such equipment down to its fair value.
In fiscal 1999, the Company reversed $33 million of employee separation
costs, originally established in December 1995, due to higher than expected
voluntary employee attrition. As of September 30, 1999, all prior restructuring
related plans were complete and no such reserves remained.
The following table summarizes the status of the Company's business
restructuring and related charges as well as the related reserve during fiscal
2000 and 2001:
<Table>
<Caption>
Business Restructuring Charges Other Related Charges
-------------------------------------------------- -----------------------
Total
Total Business
Employee Lease Business Incremental Restructuring
Separation Termination Other Restructuring Asset Period and Related
Costs Obligations Exit Costs Charges Impairments Costs Charges
----- ----------- ---------- ------- ----------- ----- -------
(dollars in millions)
FISCAL 2000:
Charges $ 365 $127 $ 28 $ 520 $ 75 $ 89 $ 684
Cash payments (20) - (1) (21) - (89) (110)
Asset impairments - - - - (75) - (75)
----- ---- ----- ----- ----- ----- -----
Balance as of September 30, 2000 $ 345 $127 $ 27 $ 499 $ - $ - $ 499
----- ---- ----- ----- ----- ----- -----
FISCAL 2001:
Charges $ 650 $ 24 $ - $ 674 $ 20 $ 178 $ 872
Reversals (17) (7) (11) (35) - - (35)
Decrease in prepaid benefit costs/
increase in benefit obligations, net (577) - - (577) - - (577)
Cash payments (250) (66) (11) (327) - (178) (505)
Asset impairments - - - - (20) - (20)
Reclassification (55) - - (55) - - (55)
----- ---- ----- ----- ----- ----- -----
Balance as of September 30, 2001 $ 96 $ 78 $ 5 $ 179 $ - $ - $ 179
===== ==== ==== ===== ===== ===== =====
</Table>
In addition, in fiscal 2001 and 2000, the Company recorded $48 million and
$73 million, respectively, in selling, general and administrative expenses for
start-up activities related to establishing independent operations, including
fees for investment banking and other professional advisors, and marketing costs
associated with establishing the Avaya brand.
39.
<Page>
8. CONVERTIBLE PARTICIPATING PREFERRED STOCK
In October 2000, the Company sold to Warburg, Pincus Equity Partners, L.P. and
related investment funds (collectively, "the Warburg Funds") four million shares
of the Company's Series B convertible participating preferred stock and warrants
to purchase the Company's common stock for an aggregate purchase price of $400
million. Based on a conversion price of $26.71, the Series B preferred stock is
convertible into 15,973,068 shares of the Company's common stock as of September
30, 2001.
The warrants have an exercise price of $34.73 representing 130% of the
conversion price for the Series B preferred stock. Of these warrants, warrants
exercisable for 6,883,933 shares of common stock have a four-year term expiring
on October 2, 2004, and warrants exercisable for 5,507,146 shares of common
stock have a five-year term expiring on October 2, 2005. During the period from
May 24, 2001 until October 2, 2002, if the market price of the Company's common
stock exceeds 200%, in the case of the four-year warrants, and 225%, in the case
of the five-year warrants, of the exercise price of the warrants for 20
consecutive trading days, the Company can force the exercise of up to 50% of the
four-year and the five-year warrants, respectively.
The shares of Series B preferred stock had an aggregate initial liquidation
value of $400 million and will accrete for the first 10 years at an annual rate
of 6.5% and 12% thereafter, compounded quarterly. After the third anniversary of
the original issue date of the Series B preferred stock, 50% of the amount
accreted for the year may be paid in cash as a dividend on a quarterly basis at
the Company's option. After the fifth anniversary of the issue date through the
tenth anniversary, the Company may elect to pay 100% of the amount accreted for
the year as a cash dividend on a quarterly basis. The liquidation value
calculated on each quarterly dividend payment date, which includes the accretion
for the dividend period, will be reduced by the amount of any cash dividends
paid. Following the tenth anniversary of the issue date, the Company will pay
quarterly cash dividends at an annual rate of 12% of the then accreted
liquidation value of the Series B preferred stock, compounded quarterly. The
Series B preferred shares also participate, on an as-converted basis, in
dividends paid on the Company's common stock. For the fiscal year ended
September 30, 2001, accretion of the Series B preferred stock was $27 million
resulting in a liquidation value of $427 million as of September 30, 2001. The
total number of shares of common stock into which the Series B preferred stock
are convertible is determined by dividing the liquidation value in effect at the
time of conversion by the conversion price.
The $400 million proceeds from the Warburg Pincus investment were initially
allocated between the Series B preferred stock and warrants based upon the
relative fair market value of each security, with $368 million allocated to the
Series B preferred stock and $32 million to the warrants. The fair value
allocated to the Series B preferred stock including the amount accreted for the
fiscal year ended September 30, 2001 was recorded in the mezzanine section of
the Consolidated Balance Sheet because the investors may require the Company,
upon the occurrence of any change of control in the Company during the first
five years from the investment, to redeem the Series B preferred stock. As of
September 30, 2001, the Company recorded a $27 million reduction in accumulated
deficit representing the amount accreted for the dividend period. The fair value
allocated to the warrants was included in additional paid-in capital.
A beneficial conversion feature would exist if the conversion price for the
Series B preferred stock or warrants was less than the fair value of the
Company's common stock at the commitment date. The Company determined that no
beneficial conversion features existed at the commitment date and therefore
there was no impact on its results of operations associated with the Series B
preferred stock or with the warrants. The beneficial conversion features, if
any, associated with dividends paid in-kind, where it is the Company's option to
pay dividends on the Series B preferred stock in cash or in-kind, will be
measured when dividends are declared and recorded as a reduction to net income
available to common stockholders.
At any time after the fifth anniversary of their issuance, the Company may
force conversion of the shares of Series B preferred stock. If the Company gives
notice of a forced conversion, the investors will be able to require the Company
to redeem the Series B preferred shares at 100% of the then current liquidation
value, plus accrued and unpaid dividends. Following a change in control of the
Company during the first five years after the investment, other than a change of
control transaction involving solely the issuance of common stock, the accretion
of some or all of the liquidation value of the Series B preferred stock through
the fifth anniversary of the issue date will be accelerated, subject to the
Company's ability to pay a portion of the accelerated accretion in cash in some
instances. In addition, for 60 days following the occurrence of any change of
control of the Company during the first five years after the investment, the
investors will be able to require the Company to redeem the Series B preferred
stock at 101% of the liquidation value, including any accelerated accretion of
the liquidation value, plus accrued and unpaid dividends.
9. EARNINGS (LOSS) PER SHARE OF COMMON STOCK
Basic earnings (loss) per common share was calculated by dividing net income
(loss) available to common stockholders by the weighted average number of common
shares outstanding during the year. Since the Distribution was not effective
until September 30, 2000, the weighted average number of common shares
outstanding during fiscal 2000 and 1999 was calculated based on a twelve-to-one
ratio of Lucent's weighted average number of shares to Avaya's weighted average
number of shares. Diluted earnings (loss) per common share
40.
<Page>
was calculated by adjusting net income (loss) available to common stockholders
and weighted average outstanding shares, assuming conversion of all potentially
dilutive securities including stock options, warrants and convertible
participating preferred stock.
<Table>
<Caption>
Year Ended September 30,
------------------------
2001 2000 1999
---- ---- ----
(dollars and shares in millions,
except per share amounts)
Income (loss) before cumulative effect of accounting change $(352) $(375) $ 186
Accretion of Series B preferred stock (27) -- --
----- ----- -----
Income (loss) available to common stockholders (379) (375) 186
Cumulative effect of accounting change -- -- 96
----- ----- -----
Net income (loss) available to common stockholders $(379) $(375) $ 282
===== ===== =====
SHARES USED IN COMPUTING EARNINGS (LOSS) PER COMMON SHARE:
Basic 284 269 259
===== ===== =====
Diluted 284 269 273
===== ===== =====
EARNINGS (LOSS) PER COMMON SHARE - BASIC:
Income (loss) available to common stockholders $(1.33) $(1.39) $0.72
Cumulative effect of accounting change -- -- 0.37
----- ----- -----
Net income (loss) available to common stockholders $(1.33) $(1.39) $1.09
----- ----- -----
EARNINGS (LOSS) PER COMMON SHARE - DILUTED:
Income (loss) available to common stockholders $(1.33) $(1.39) $0.68
Cumulative effect of accounting change -- -- 0.35
----- ----- -----
Net income (loss) available to common stockholders $(1.33) $(1.39) $1.03
----- ----- -----
SECURITIES EXCLUDED FROM THE COMPUTATION OF DILUTED EARNINGS (LOSS) PER COMMON
SHARE:
Options(1) 52 9 2
Series B preferred stock(2) 16 -- --
Warrants(1) 12 -- --
----- ----- -----
Total 80 9 2
===== ===== =====
</Table>
(1) These securities have been excluded from the diluted earnings (loss) per
common share calculation since their inclusion would be antidilutive because the
option and warrant exercise prices are greater than the average market value of
the underlying stock.
(2) In applying the "if-converted" method, the Series B convertible
participating preferred stock was excluded from the diluted earnings (loss) per
common share calculation since the effect of its inclusion would have been
antidilutive.
10. LONG-TERM DEBT
Long-term debt outstanding consisted of the following:
<Table>
<Caption>
As of September 30,
-------------------
2001 2000
---- ----
(dollars in millions)
Commercial paper $432 $780
Revolving credit facilities:
364-day facility - -
Five-year facility 200 -
Other 13 13
---- ----
Total debt 645 793
Less: Current portion 145 80
---- ----
Total long-term debt $500 $713
==== ====
</Table>
COMMERCIAL PAPER PROGRAM
The Company has established a commercial paper program (the "CP Program")
pursuant to which the Company may issue up to $1.25 billion of commercial paper
at market interest rates with maturities not exceeding one year. Commercial
paper issued under the CP Program may bear interest at a fixed rate or at a
floating rate that may be reset periodically throughout the term. The floating
interest rate may be adjusted based on any one of a number of prevailing rates
for the relevant maturity period, as determined by the Company at the time of
issuance, including without limitation, certificate of deposit rates, commercial
paper rates for non-financial issuers, the federal funds rate, bank prime rates
and treasury bond rates.
41.
<Page>
Under the CP Program, the Company assumed, upon the Distribution, all of
Lucent's obligations in connection with its issuance of $780 million of
commercial paper. As of September 30, 2001 and 2000, $432 million and $700
million, respectively, in commercial paper was classified as long-term debt in
the Consolidated Balance Sheets since it is supported by the five-year credit
facility described below and it is management's intent to reissue the commercial
paper on a long-term basis. The weighted average yield and maturity period for
the commercial paper outstanding as of September 30, 2001 and 2000 was
approximately 3.9% and 6.9% and 62 days and 21 days, respectively.
CREDIT FACILITIES
The Company has two unsecured revolving credit facilities (the "Credit
Facilities") with third party financial institutions consisting of a $400
million 364-day credit facility that expires in August 2002 and an $850 million
five-year credit facility that expires in September 2005. Funds are available
under the Credit Facilities for general corporate purposes, to backstop
commercial paper, and for acquisitions. The Credit Facilities provide, at the
Company's option, for fixed interest rate and floating interest rate borrowings.
Fixed rate borrowings under the Credit Facilities bear interest at a rate equal
to (i) the greater of (A) Citibank, N.A.'s base rate and (B) the federal funds
rate plus 0.5% plus (ii) a margin based on the Company's long-term debt rating
(the "Applicable Margin"). Floating rate borrowings bear interest at a rate
equal to the LIBOR rate plus the Applicable Margin and a utilization fee based
on the Company's long-term debt rating (the "Applicable Utilization Fee"). Based
on the Company's current long-term debt rating, the Applicable Margins for the
364-day credit facility and the five-year credit facility are 0.5% and 0.4%,
respectively, and the Applicable Utilization Fee for both facilities is 0.125%.
As of September 30, 2001, $200 million was outstanding under the five-year
credit facility bearing interest at a floating rate of approximately 3.5%, which
was repaid in October 2001. There were no outstanding borrowings under the
364-day credit facility as of September 30, 2001. No amounts were drawn under
either credit facility as of September 30, 2000.
The Credit Facilities contain certain covenants, including limitations on the
Company's ability to incur liens in certain circumstances or enter into certain
change of control transactions. In addition, for each of the Company's first
three fiscal quarters of 2001, the Company had to maintain a ratio of annualized
consolidated earnings before interest and taxes to annualized consolidated
interest expense of at least three to one. Commencing in the fourth quarter of
fiscal 2001 and each fiscal quarter thereafter, the Company had to maintain such
ratio for the previous four consecutive fiscal quarters. The covenant permitted
the Company to exclude up to $950 million of business restructuring and related
charges and $300 million of start-up expenses from the calculation of
consolidated earnings before interest and taxes to be taken no later than
September 30, 2001. In August 2001, the five-year credit facility was amended to
permit the Company to exclude up to an additional $450 million of non-cash
business restructuring and related charges from the calculation of earnings
before interest and taxes during such period to be taken no later than the
fourth quarter of fiscal 2001. The Company was in compliance with this covenant
in fiscal 2001.
In addition, the Company, through its foreign operations, entered into
several uncommitted credit facilities totaling $118 million, of which letters of
credit of $10 million and $27 million, were issued and outstanding as of
September 30, 2001 and 2000, respectively. Letters of credit are purchased
guarantees that ensure the Company's performance or payment to third parties in
accordance with specified terms and conditions. Management does not believe it
is practicable to estimate the fair value of these financial instruments and
does not expect any material losses from their resolution since performance is
not likely to be required.
As of September 30, 2001 and 2000, the Company had debt outstanding
attributable to its foreign entities of $13 million.
FAIR VALUE
The carrying value of the Company's commercial paper and other borrowings
approximate fair value due to their short-term maturities and variable interest
rates.
11. INCOME TAXES
Commencing with fiscal 2001, the Company will begin filing its own consolidated
tax returns. Prior to the Distribution, the Company's income taxes were
reflected on a separate tax return basis and included as part of Lucent's
consolidated income tax returns. The following table presents the principal
reasons for the difference between the effective tax rate and the U.S. federal
statutory income tax rate:
<Table>
<Caption>
Year Ended September 30,
------------------------
2001 2000 1999
---- ---- ----
U.S. federal statutory income
tax rate (benefit) (35.0)% (35.0)% 35.0%
State and local income taxes, net
of federal income tax effect (4.3) (4.8) 4.2
Tax differentials on foreign earnings (2.2) 3.7 1.9
Research credits (2.1) (2.2) (3.7)
Purchased in-process research and
development and other acquisition
related costs 2.4 -- --
Amortization of intangibles 1.8 2.3 7.0
Non-deductible restructuring costs 2.3 18.2 --
Other differences - net (1.2) 1.5 (5.0)
----- ----- ----
Effective tax rate (benefit) (38.3)% (16.3)% 39.4%
===== ===== ====
</Table>
42.
<Page>
The following table presents the U.S. and foreign components of income (loss)
before income taxes and the provision (benefit) for income taxes:
<Table>
<Caption>
Year Ended September 30,
------------------------
2001 2000 1999
---- ---- ----
(dollars in millions)
INCOME (LOSS) BEFORE INCOME TAXES:
U.S. $(456) $(588) $ 173
Foreign (114) 140 134
----- ----- -----
Income (loss) before income taxes $(570) $(448) $ 307
===== ===== =====
PROVISION (BENEFIT) FOR INCOME TAXES:
CURRENT
Federal $ -- $ 130 $ 45
State and local -- 11 19
Foreign 46 74 59
----- ----- -----
Subtotal $ 46 $ 215 $ 123
===== ===== =====
DEFERRED
Federal $(219) $(244) $ (3)
State and local (38) (44) 1
Foreign (7) -- --
----- ----- -----
Subtotal $(264) $(288) $ (2)
----- ----- -----
Provision (benefit) for income taxes $(218) $ (73) $ 121
===== ===== =====
</Table>
As of September 30, 2001, the Company had tax credit carryforwards of $18
million and federal, state and local, and foreign net operating loss
carryforwards (after-tax) of $305 million. The tax credit carryforwards expire
primarily after the year 2003. Federal and state net operating loss
carryforwards expire through the year 2021. The majority of foreign net
operating loss carryforwards have no expiration.
The components of deferred tax assets and liabilities as of September 30,
2001 and 2000 are as follows:
<Table>
<Caption>
As of September 30,
-------------------
2001 2000
---- ----
(dollars in millions)
DEFERRED INCOME TAX ASSETS
Benefit obligations $ 249 $ 119
Accrued liabilities 353 459
Net operating loss/credit carryforwards 323 35
Valuation allowance (49) (49)
Other 7 5
----- -----
Total deferred tax assets $ 883 $ 569
===== =====
DEFERRED INCOME TAX LIABILITIES
Property, plant and equipment $ 37 $ 29
Other 71 46
----- -----
Total deferred tax liabilities $ 108 $ 75
===== =====
</Table>
The valuation allowance established for deferred tax assets primarily relates
to state tax credit carryforwards and foreign net operating loss carryforwards
for which management believes it is more likely than not such deferred tax
amounts will not be realized.
The Company has not provided for U.S. deferred income taxes or foreign
withholding taxes on $534 million of undistributed earnings of its non-U.S.
subsidiaries as of September 30, 2001, since the Company intends to reinvest
these earnings indefinitely.
12. BENEFIT OBLIGATIONS
PENSION AND POSTRETIREMENT BENEFITS
The Company maintains defined benefit pension plans covering the majority of its
employees and retirees, and postretirement benefit plans for retirees that
include healthcare benefits and life insurance coverage. At the Distribution,
the Company assumed responsibility for pension and postretirement benefit
obligations for its active employees. Obligations related to retired and
terminated vested employees as of September 30, 2000 remained the responsibility
of Lucent. Prior to the Distribution, the Company's employees participated in
the Lucent pension plans and postretirement benefit plans. The Company's share
of the Lucent plans' assets and liabilities was not included in the Company's
consolidated financial statements until the Distribution since Lucent had not
yet separated Avaya's portion of the employee benefit plans.
In connection with the Distribution, the Company recorded estimates in its
Consolidated Balance Sheet at September 30, 2000 in prepaid benefit costs and
benefit obligations of various existing Lucent benefit plans related to
employees for whom the Company assumed responsibility. Following an actuarial
review, the Company received a valuation, agreed upon by the Company and Lucent,
that reduced prepaid benefit costs by $44 million and pension and postretirement
benefit obligations by $17 million. The Company recorded the net effect of these
adjustments as a reduction to additional paid-in capital in fiscal 2001 because
the transfer of the net benefit assets relates to the original capital
contribution from Lucent.
The pension and postretirement costs incurred by Lucent for employees who
performed services for the Company were based on estimated plan assets being
equal to a proportional share of plan obligations incurred by Lucent for
employees who performed services for the Company. In relation to the Lucent
plans, the Company recorded pension expense of $115 million and $126 million,
and postretirement expense of $49 million and $53 million in fiscal 2000 and
1999, respectively, as adjusted through the Former Parent's net investment. In
fiscal 2001, the Company recorded pension and postretirement expense of $457
million and $138 million, respectively, including charges for curtailment and
special termination benefits of $474 million and $112 million, respectively, in
connection with the Company's business restructuring efforts.
During fiscal 2001, as a result of the restructuring initiatives, the
Company's pension plans experienced significant decreases in the number of
active employees. In fiscal 2001, as a result of the manufacturing outsourcing
transaction and an early retirement program,
43.
<Page>
interim measurements were performed and curtailment accounting was implemented.
The Company recognized a loss from curtailment and special termination benefits
related to its pension plan of $26 million and $448 million, respectively. The
special termination benefits provided employees with improved pension benefits
and earlier eligibility for postretirement benefits. In addition, effective
August 1, 2001, the Company amended its pension plan for salaried employees by
increasing the minimum retirement age which resulted in a $76 million decrease
to the projected benefit obligation.
The Company has several non-pension postretirement benefit plans. Consistent
with the curtailment accounting recorded for pensions during fiscal 2001, the
Company recorded curtailment and special termination benefit charges of $91
million and $21 million, respectively.
Effective August 1, 2001, the Company also amended its postretirement
benefits for salaried employees by decreasing the maximum employer contribution
to retiree healthcare coverage from 90% to 75%. In addition, the Company amended
the point in time when life insurance begins to be reduced. Under the amended
plan, retiree life insurance will be reduced by 10% a year beginning one year
after retirement, until 50% of the original coverage amount is reached.
Previously, this reduction started when the retiree reached age 66. The net
effect of these amendments resulted in a decrease in the accumulated
postretirement benefit obligation of $35 million.
Effective October 1, 1998, the Company changed its method for calculating the
market-related value of plan assets used in determining the expected
return-on-asset component of annual net pension and postretirement benefit
costs. The cumulative effect of this accounting change related to periods prior
to fiscal 1999 of $158 million ($96 million after-tax) is reflected as a
one-time, non-cash credit to fiscal 1999 earnings. This accounting change also
resulted in a reduction in benefit costs in fiscal 1999 that increased income by
$30 million ($18 million after-tax).
The following table shows the activity in Avaya's defined benefit and
postretirement plans:
<Table>
<Caption>
Pension Benefits Postretirement Benefits
---------------- -----------------------
As of September 30, As of September 30,
------------------- -------------------
2001 2000 2001 2000
---- ---- ---- ----
(dollars in millions)
CHANGE IN BENEFIT OBLIGATION
Benefit obligation as of October 1 $ 1,758 $ 2,688 $ 412 $ 604
Adjustment for final obligation assumed from Lucent (174) -- (48) --
Service cost 79 115 11 16
Interest cost 128 195 30 44
Amendments (76) -- (35) --
Actuarial loss (gain) 399 (1,240) 124 (252)
Special termination benefits 448 -- 21 --
Reclassification (Note 7) 55 -- -- --
Benefits paid (99) -- (2) --
------- ------- ------- -------
Benefit obligation as of September 30 $ 2,518 $ 1,758 $ 513 $ 412
------- ------- ------- -------
CHANGE IN PLAN ASSETS
Fair value of plan assets as of October 1 $ 2,985 $ 2,450 $ 255 $ 222
Actual return on plan assets (255) 584 (44) 33
Adjustment for final assets assumed from Lucent (260) -- (36) --
Employer contributions -- -- 1 --
Benefits paid (99) -- (2) --
Transfer to former affiliates -- (49) -- --
------- ------- ------- -------
Fair value of plan assets as of September 30 $ 2,371 $ 2,985 $ 174 $ 255
------- ------- ------- -------
FUNDED (UNFUNDED) STATUS OF THE
PLAN $ (147) $ 1,227 $ (339) $ (157)
Unrecognized prior service cost (5) 133 (16) 35
Unrecognized transition asset (7) (22) -- --
Unrecognized net (gain)/loss (11) (951) 34 (76)
------- ------- ------- -------
Prepaid (accrued) benefit cost $ (170) $ 387 $ (321) $ (198)
======= ======= ======= =======
</Table>
44.
<Page>
<Table>
<Caption>
As of September 30,
-------------------
2001 2000
---- ----
PENSION AND POSTRETIREMENT BENEFITS WEIGHTED AVERAGE ASSUMPTIONS
Discount rate 7.0% 7.5%
Expected return on plan assets 9.0% 9.0%
Rate of compensation increase 4.5% 4.5%
</Table>
For postretirement healthcare, a 5.7% annual rate of increase in the per
capita cost of covered healthcare benefits was assumed for fiscal year 2002. The
rate was assumed to decline gradually to 3.9% by the year 2007, and remain at
that level thereafter.
<Table>
<Caption>
Pension Benefits Postretirement Benefits
------------------------------- ------------------------------
Year ended September 30, Year ended September 30,
------------------------------- ------------------------------
2001 2000 1999 2001 2000 1999
---- ---- ---- ---- ---- ----
(dollars in millions)
COMPONENTS OF NET PERIODIC BENEFIT COST
Service cost $ 79 $ 115 $ 125 $ 11 $ 16 $ 19
Interest cost 128 195 167 30 44 42
Expected return on plan assets (208) (200) (171) (18) (17) (15)
Amortization of unrecognized prior service cost 16 23 22 5 7 7
Recognized net actuarial gain (19) (1) - (2) (1) -
Amortization of transition asset (13) (17) (17) - - -
Curtailment expense 26 - - 91 - -
Special termination benefits 448 - - 21 - -
----- ----- ----- ---- ---- ----
Net periodic benefit cost $ 457 $ 115 $ 126 $138 $ 49 $ 53
===== ===== ====== ==== ==== ====
</Table>
As of September 30, 2001, the Company's pension and postretirement plan
assets did not hold any direct investment in Avaya common stock. As of September
30, 2000, the Lucent pension plan assets included $102 million and the
postretirement plan assets included $3 million of Avaya and Lucent common stock.
A one-percentage-point change in the Company's healthcare cost trend rate
would have the following effects:
<Table>
<Caption>
One-Percentage-Point
--------------------
Increase Decrease
-------- --------
(dollars in millions)
Effect on total of service and interest
cost components $0.1 $(0.1)
Effect on postretirement benefit obligation $0.6 $(0.8)
</Table>
SAVINGS PLANS
The majority of the Company's employees are eligible to participate in savings
plans sponsored by the Company. The plans allow employees to contribute a
portion of their compensation on a pre-tax and/or after-tax basis in accordance
with specified guidelines. Avaya matches a percentage of employee contributions
up to certain limits. The Company's expense related to these savings plans was
$58 million in fiscal 2001. Lucent had similar plans prior to the Distribution
of which the Company's expense was $54 million and $68 million in 2000 and 1999,
respectively.
13. STOCK COMPENSATION PLANS
Prior to fiscal 2001, certain employees of the Company were granted stock
options and other equity-based awards under Lucent's stock-based compensation
plans. At the time of the Distribution, unvested awards outstanding under
Lucent's stock plans that were held by Lucent employees who transferred to the
Company were converted to awards to acquire stock of Avaya. Vested Lucent stock
options have remained options to acquire Lucent common stock, subject to
adjustments as described below. The Avaya stock options and other awards as
converted have the same vesting provisions, option periods, and other terms and
conditions as the Lucent options and awards they replaced. The number of shares
and exercise price of each stock option has been adjusted so that each option,
whether a Lucent option or an Avaya option, has the same ratio of the exercise
price per share to the market value per share, and the same aggregate difference
between market value and exercise price (intrinsic value), as the Lucent stock
options prior to the Distribution. Upon conversion, the stock options retained
the measurement date from the original issuance.
STOCK OPTIONS
Stock options generally are granted with an exercise price equal to the market
value of a share of common stock on the date of grant, have a term of 10 years
or less and vest within four years from the date of grant. As of September 30,
2001, there were approximately
45.
<Page>
23 million stock options authorized for grant to purchase Avaya common stock
under the Company's stock compensation plans, excluding those stock options
assumed by the Company from Lucent and converted to Avaya stock options at the
Distribution date.
In connection with certain of the Company's acquisitions, outstanding stock
options held by employees of acquired companies became exercisable, according to
their terms, for Avaya's common stock effective at the acquisition date. For
acquisitions accounted for as purchases, the fair value of these options was
included as part of the purchase price.
The Company has adopted the disclosure requirements of SFAS No. 123,
"Accounting for Stock-Based Compensation" and, as permitted under SFAS No. 123,
applies Accounting Principles Board Opinion ("APB") No. 25 and related
interpretations in accounting for its stock compensation plans. Compensation
expense recorded under APB No. 25, which uses the intrinsic-value method, was
$10 million, $7 million and $14 million for the years ended September 30, 2001,
2000 and 1999, respectively. If the Company had elected to adopt the optional
recognition provisions of SFAS No. 123, which uses the fair value-based method,
for its stock option plans and employee stock purchase plan, net income (loss)
would have been changed to the pro forma amounts indicated below:
<Table>
<Caption>
Year Ended September 30,
-------------------------------
2001 2000 1999
---- ---- ----
(dollars in millions)
NET INCOME (LOSS)
As reported $(352) $(375) $282
Pro forma $(429) $(469) $231
</Table>
The fair value of stock options used to compute pro forma net income
disclosures is the estimated fair value at grant date using the Black-Scholes
option-pricing model with the following assumptions:
<Table>
<Caption>
Year Ended September 30,
-------------------------------
2001 2000 1999
---- ---- ----
WEIGHTED AVERAGE ASSUMPTIONS
Dividend yield 0% 0.20% 0.13%
Expected volatility 50.4% 38.4% 34.1%
Risk-free interest rate 5.7% 6.3% 5.3%
Expected holding period (in years) 3.3 2.8 3.8
</Table>
The following table summarizes information concerning options outstanding
including the related transactions for the fiscal year ended September 30, 2001
and a summary for the fiscal years ended September 30, 2000 and 1999 of the
Lucent stock options held by employees for whom the Company has assumed
responsibility. Stock option activity for fiscal 2000 and 1999 may not
necessarily be indicative of what the activity would have been had the Company
been a stand-alone entity during these periods.
<Table>
<Caption>
Weighted
Shares Average
(000's) Exercise Price
------- --------------
OPTIONS OUTSTANDING AS OF SEPTEMBER 30, 1998 27,066 $ 20.99
Granted/Assumed 6,814 49.81
Exercised (2,246) 11.44
Forfeited/Expired (33) 36.86
------
OPTIONS OUTSTANDING AS OF SEPTEMBER 30, 1999 31,601 27.87
Granted/Assumed 18,431 52.66
Exercised (5,124) 12.26
Forfeited/Expired/Transferred(1) (7,176) 28.37
------
OPTIONS OUTSTANDING AS OF SEPTEMBER 30, 2000
(IMMEDIATELY PRIOR TO DISTRIBUTION) 37,732 41.90
Less: Lucent vested options (7,147) 17.50
------
Lucent unvested options to be converted 30,585 47.61
======
AVAYA OPTIONS CONVERTED AT DISTRIBUTION DATE,
SEPTEMBER 30, 2000 44,971 31.63
Granted/Assumed 31,626 15.00
Exercised (1,384) 4.81
Forfeited/Expired/Exchanged(2) (26,890) 30.35
------
OPTIONS OUTSTANDING AS OF SEPTEMBER 30, 2001 48,323 $ 19.83
======
</Table>
(1) Includes 7,133 options attributable to the movement of employees between
Avaya and Lucent during the year.
(2) Includes the exchange of 19,506 employee stock options for restricted stock
units, as noted below.
The weighted average fair value of Avaya's stock options granted during the
fiscal year ended September 30, 2001 and Lucent's stock options granted during
the fiscal years ended September 30, 2000 and 1999, calculated using the
Black-Scholes option-pricing model, was $5.86, $15.75 and $19.21 per share,
respectively.
The following table summarizes the status of the Company's stock options as
of September 30, 2001:
<Table>
<Caption>
Stock Options Stock Options
Outstanding Exercisable
------------------------------ -------------------
Average Weighted Weighted
Remaining Average Average
Range of Shares Contractual Exercise Shares Exercise
Exercise Prices (000's) Life (Years) Price (000's) Price
------- ------------ ----- ------- -----
$ 0.01 to $10.00 951 7.64 $ 6.18 608 $ 5.35
$10.01 to $16.89 25,968 8.97 14.35 792 13.77
$16.90 to $34.98 19,846 4.74 25.98 11,530 27.37
$34.99 to $44.11 1,316 8.02 40.13 331 40.14
$44.12 to $61.98 242 8.17 47.33 99 47.81
------ ------
Total 48,323 $19.83 13,360 $26.03
====== ======
</Table>
There were no stock options exercisable as of September 30, 2000 and 1999.
46.
<Page>
RESTRICTED STOCK UNITS
In June 2001, the Company commenced an offer to eligible employees to exchange
(the "Exchange") certain employee stock options for restricted stock units
representing common shares. The Exchange was based on a predetermined exchange
value divided by $12.85 per common share, which was the average of the high and
low trading prices of Avaya common stock on the New York Stock Exchange ("NYSE")
on July 26, 2001. As a result of the Exchange, approximately 19.5 million
options were cancelled and approximately 3.4 million restricted stock units were
granted on July 31, 2001. The restricted stock units resulting from the Exchange
will vest in three succeeding annual anniversary dates beginning on August 1,
2002, subject to acceleration of vesting upon certain events.
The Company recorded approximately $43 million as non-cash deferred
compensation for the intrinsic value of the restricted stock units on the
effective date of the Exchange. This amount was calculated by multiplying the
number of restricted stock units by $12.62, which was the average of the high
and low trading price of the Company's common stock on the NYSE on July 31,
2001, the date of grant of the restricted stock units. The non-cash deferred
compensation associated with the restricted stock units will be recognized as
expense on a straight-line basis over the three-year vesting period.
Restricted stock units are granted under certain award plans. The following
table presents the total number of shares of common stock represented by
restricted stock units granted to Company employees, including those granted in
connection with the Exchange:
<Table>
<Caption>
Year Ended September 30,
------------------------
2001 2000 1999
---- ---- ----
Restricted stock units
granted (000's) 4,394 496 10
Weighted average market value of
shares granted during the period $ 13.06 $ 57.83 $ 47.73
</Table>
As of September 30, 2001, the Company recognized $17 million of non-cash
compensation expense related to restricted stock units, of which approximately
$7 million was recorded as a business restructuring charge attributable to the
vesting of 326,000 restricted stock units related to employees who departed the
business.
EMPLOYEE STOCK PURCHASE PLAN ("ESPP")
Under the terms of the Avaya ESPP, eligible employees may have up to 10% of
eligible compensation deducted from their pay to purchase common stock through
March 31, 2003, the expiration date of the existing plan. The per share purchase
price is 85% of the average high and low per share trading price of Avaya's
common stock on the NYSE on the last trading day of each month. During fiscal
2001, 3 million shares were purchased under the Avaya ESPP at a weighted average
price of $10.95. In fiscal 2000 and 1999, 1.3 million and 1.2 million Lucent
shares, respectively, were purchased under the Lucent ESPP by employees who were
transferred to the Company upon the Distribution, at a weighted average price of
$45.50 and $47.02, respectively.
14. DERIVATIVE FINANCIAL INSTRUMENTS
The Company conducts its business on a multi-national basis in a wide variety of
foreign currencies and, as such, uses derivative financial instruments to reduce
earnings and cash flow volatility associated with foreign exchange rate changes.
The Company uses foreign currency forward contracts, and to a lesser extent,
foreign currency options, to mitigate the effects of fluctuations of exchange
rates on intercompany loans which are denominated in currencies other than the
subsidiary's functional currency, and to reduce exposure to the risk that the
eventual net cash flows resulting from the purchase or sale of products to or
from non-U.S. customers will be adversely affected by changes in exchange rates.
RECORDED TRANSACTIONS
Foreign currency forward contracts are used primarily to manage exchange rate
exposures on intercompany loans residing on foreign subsidiaries' books, which
are denominated in currencies other than the subsidiary's functional currency.
When these loans are translated into the subsidiary's functional currency at the
month-end exchange rates, the fluctuations in the exchange rates are recognized
in earnings as other income or expense. Gains and losses resulting from the
impact of currency exchange rate movements on foreign currency forward contracts
designated to offset these non-functional currency denominated loans are also
recognized in earnings as other income or expense in the period in which the
exchange rates change and are generally offset by the foreign currency losses
and gains on the loans. For the fiscal years ended September 30, 2001 and 2000,
the net effect of the gains and losses from the change in the fair value of the
foreign currency forward contracts and the translation of the non-functional
currency denominated loans were not material to the Company's results of
operations.
FORECASTED TRANSACTIONS
Foreign currency forward and option contracts are used to offset certain
forecasted foreign currency transactions primarily related to the purchase or
sale of product expected to occur during the ensuing twelve months. The gains
and losses resulting from the impact of currency exchange rate movements on
these foreign currency forward and option contracts are recognized as other
income or expense in the period in which the exchange rates change. For the
fiscal years ended September 30, 2001 and 2000, these gains and losses were not
material to the Company's results of operations.
The Company engages in foreign currency hedging activities to reduce the risk
that changes in exchange rates will adversely affect the eventual net cash flows
resulting from the sale of products to foreign customers and purchases from
foreign suppliers. The Company believes that it has achieved risk reduction and
hedge effectiveness because the gains and losses on its derivative instruments
substantially offset the losses and gains on the assets, liabilities and
transactions being hedged. Hedge effectiveness is periodically measured
47.
<Page>
by comparing the change in fair value of each hedged foreign currency exposure
at the applicable market rate with the change in market value of the
corresponding derivative instrument.
The notional amounts as of September 30, 2001 and 2000 of the Company's
foreign exchange forward contracts were $175 million and $339 million,
respectively, and foreign exchange option contracts were $17 million and $24
million, respectively. In fiscal 2001, these notional amounts principally
represent contracts in British pounds, Canadian dollars and Australian dollars.
Notional amounts represent the face amount of the contractual arrangements and
the basis on which U.S. dollars are to be exchanged and are not a measure of
market or credit exposure.
FAIR VALUE
The Company's foreign currency forward exchange contracts and options were
assets and had a net carrying amount and an estimated fair value each of $1
million as of September 30, 2001. Market quotes were used to estimate the fair
value of foreign currency forward contracts and options.
NON-DERIVATIVE AND OFF-BALANCE-SHEET INSTRUMENTS
Requests for providing commitments to extend credit and financial guarantees are
reviewed and approved by senior management. Management regularly reviews all
outstanding commitments, letters of credit and financial guarantees, and the
results of these reviews are considered in assessing the adequacy of the
Company's reserve for possible credit and guarantee losses.
As of September 30, 2001 and 2000, in management's opinion, there was no
significant risk of loss in the event of non-performance of the counterparties
to these financial instruments.
15. OPERATING SEGMENTS
Prior to January 1, 2002, the Company reported its operations in three segments:
Communications Solutions, Services and Connectivity Solutions. The
Communications Solutions segment represented the Company's core business,
composed of enterprise voice communications systems and software,
communications applications, professional services for customer relationship
management, converged voice and data networks and unified communication,
multi-service networking products and product installation services. The
Services segment represented maintenance, value-added and data services. The
Connectivity Solutions segment represented structured cabling systems and
electronic cabinets. The costs of shared services and other corporate center
operations managed on a common basis represented business activities that do
not qualify for separate operating segment reporting and were aggregated in
the Corporate and other category.
Effective January 1, 2002, the Company implemented an internal
reorganization and as a result, the Company currently assesses its performance
and allocates its resources among four rather than three operating segments. The
Company divided its Communications Solutions segment into two reportable
segments: Systems and Applications. The objective is to enable the Company to
understand and manage its product groups with greater precision. The Systems
segment consists of the Company's traditional voice communications systems,
converged voice and data network products, and multi-service networking
products. The Applications segment consists of software associated with the
traditional voice communications systems and the customer relationship
management, voice and unified messaging, and unified communication products and
related professional services. In addition, the Company shifted installation and
the network consulting portion of professional services previously reported in
Communications Solutions to the Services segment. The Services segment continues
to include maintenance, value-added and data services. The Connectivity
Solutions segment represents structured cabling systems and electronic cabinets.
As part of the changes made in the second quarter of fiscal 2002, the
Company also redirected a larger portion of corporate operating expenses,
consisting mostly of marketing and selling expenses, to each of the operating
segments. The costs of shared services and other corporate center operations
that (i) are managed on a common basis, (ii) are not identified with the
operating segments, and (iii) represent business activities that do not qualify
for separate operating segment reporting are aggregated in the Corporate and
other category. Such costs include primarily business restructuring charges and
related expenses, research and development, information technology, corporate
finance and real estate costs.
As a result of the changes discussed above, fiscal 2001 amounts have been
restated to conform to the Company's new operating segment presentation. The
Company is unable to restate amounts prior to fiscal 2001 into the new segment
presentation and current year data into the previous segment presentation
to provide comparability, as this would be impracticable, and would involve
excessive cost and require extensive estimations.
REPORTABLE SEGMENTS
<Table>
<Caption>
Year Ended September 30,
-------------------------------
2001 2000 1999
---- ---- ----
(dollars in millions)
COMMUNICATIONS SOLUTIONS:
External revenue - $4,354 $5,088
Intersegment revenue - 9 24
------ ------ ------
Total revenue - 4,363 5,112
Operating income - 1,375 1,704
Assets - 1,795 2,204
Capital expenditures - 137 64
Depreciation and amortization - 131 138
SYSTEMS:
External revenue $2,248 $ - $ -
Intersegment revenue - - -
------ ------ ------
Total revenue 2,248 - -
Operating income 206 - -
Assets 1,128 - -
Capital expenditures 21 - -
Depreciation and amortization 81 - -
APPLICATIONS:
External revenue $ 899 $ - $ -
Intersegment revenue - - -
------ ------ ------
Total revenue 899 - -
Operating income 9 - -
Assets 359 - -
Capital expenditures 4 - -
Depreciation and amortization 48 - -
SERVICES:
External revenue $2,323 $1,958 $1,900
Intersegment revenue - - -
------ ------ ------
Total revenue 2,323 1,958 1,900
Operating income 475 798 704
Assets 849 680 599
Capital expenditures 15 63 20
Depreciation and amortization 33 27 23
CONNECTIVITY SOLUTIONS:
External revenue $1,323 $1,418 $1,274
Intersegment revenue - 1 8
------ ------ ------
Total revenue 1,323 1,419 1,282
Operating income 364 265 225
Assets 619 804 707
Capital expenditures 26 22 51
Depreciation and amortization 30 42 37
</Table>
RECONCILING ITEMS
A reconciliation of the totals reported for the operating segments to the
corresponding line items in the consolidated financial statements is as follows:
<Table>
<Caption>
Year Ended September 30,
-------------------------------
2001 2000 1999
---- ---- ----
(dollars in millions)
EXTERNAL REVENUE
Total reportable segments $ 6,793 $ 7,730 $ 8,262
Corporate and other - 2 6
------- ------- -------
Total external revenue $ 6,793 $ 7,732 $ 8,268
======= ======= =======
OPERATING INCOME (LOSS)
Total reportable segments $ 1,054 $ 2,438 $ 2,633
Corporate and other:
Business restructuring and
related (charges) reversals
and start-up expenses (885) (757) 33
Purchased in-process research
and development (32) - -
Corporate and unallocated
shared expenses (704) (2,124) (2,297)
------- ------- -------
Total operating income (loss) $ (567) $ (443) $ 369
======= ======= =======
</Table>
48.
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GEOGRAPHIC INFORMATION
<Table>
<Caption>
External Revenue(1) Long-Lived Assets(2)
------------------------------- ------------------------------
Year Ended September 30, As of September 30,
------------------------------- ------------------------------
2001 2000 1999 2001 2000 1999
---- ---- ---- ---- ---- ----
(dollars in millions)
External Revenue(1)
U.S. $5,158 $6,110 $6,683 $868 $850 $583
Foreign countries 1,635 1,622 1,585 120 116 93
------ ------ ------ ---- ---- ----
Total $6,793 $7,732 $8,268 $988 $966 $676
====== ====== ====== ==== ==== ====
</Table>
(1) Revenue is attributed to geographic areas based on the location of
customers.
(2) Represents property, plant and equipment, net.
CONCENTRATIONS
The Company sells its products and services to a broad set of enterprises
ranging from large, multi-national enterprises, to small- and mid-sized
enterprises, governments agencies and schools. Management believes that the
Company is exposed to minimal risk since the majority of its business is
conducted with companies within numerous industries. The Company performs
periodic credit evaluations of its customers' financial condition and may
require collateral for its accounts receivables. In some cases, the Company will
require payment in advance or security in the form of a letter of credit or
third party guarantees.
For the fiscal year ended September 30, 2001, sales to Avaya's largest
distributor, which are included in the Communications Solutions segment, were
approximately 10% of the Company's revenue, and accounts receivable from such
distributor, including amounts outstanding under the line of credit described
below, represented 15% of the Company's total accounts receivable. No single
customer accounted for more than 10% of the Company's revenue and accounts
receivable as of and for the fiscal years ended September 30, 2000 and 1999,
respectively.
During fiscal 2001, the Company granted a short-term line of credit for the
purchase of Avaya products and services to its largest distributor. The credit
line applies to certain unpaid and outstanding receivables and the maximum
amount available under the credit agreement is $125 million. Outstanding amounts
under the credit agreement, which expires in March 2002, are secured by the
distributor's accounts receivable and inventory and accrue interest at an annual
rate of 12%. Interest payments are due to the Company monthly. Upon termination
of this agreement, the distributor is required to obtain a collateralized
commercial credit facility to replace the existing credit line and repay in full
all amounts due under the credit line. As of September 30, 2001, the amount
outstanding under the line of credit was $121 million, of which $71 million is
included in receivables and $50 million is included in other current assets.
There can be no assurance that the distributor will be able to obtain financing
sufficient to satisfy all of its obligations under the line of credit upon
termination of the credit agreement.
As a result of the contract manufacturing transaction, Celestica exclusively
manufactures substantially all of the Company's Communications Solutions
products at various facilities in the U.S. and Mexico. The Company is not
obligated to purchase products from Celestica in any specific quantity, except
as the Company outlines in forecasts or orders for products required to be
manufactured by Celestica. In addition, Avaya may be obligated to purchase
certain excess inventory levels from Celestica that could result from the
Company's actual sales of product varying from forecast. The Company's
outsourcing agreement with Celestica results in a concentration that, if
suddenly eliminated, could have an adverse effect on the Company's operations.
While the Company believes that alternative sources of supply would be
available, disruption of its primary source of supply could create a temporary,
adverse effect on product shipments. The Company is not aware of any other
significant concentration of business transacted with a particular supplier that
could, if suddenly eliminated, have a material adverse affect on the Company's
financial position, results of operations or cash flows.
16. TRANSACTIONS WITH LUCENT AND OTHER RELATED PARTY TRANSACTIONS
Subsequent to the Distribution, Lucent was no longer a related party. For the
fiscal years 2000 and 1999, the Company had $98 million and $108 million,
respectively, of revenue for products sold to Lucent. For the fiscal years 2000
and 1999, the Company had $261 million and $189 million, respectively, of
products purchased from Lucent.
CONTRIBUTION AND DISTRIBUTION AGREEMENT
In connection with the Distribution, the Company and Lucent executed and
delivered the Contribution and Distribution Agreement and certain related
agreements.
Pursuant to the Contribution and Distribution Agreement, Lucent contributed
to the Company substantially all of the assets, liabilities and operations
associated with its enterprise networking businesses (the "Company's
Businesses"). The Contribution and Distribution Agreement, among other things,
provides that, in general, the
49.
<Page>
Company will indemnify Lucent for all liabilities including certain
pre-Distribution tax obligations of Lucent relating to the Company's Businesses
and all contingent liabilities primarily relating to the Company's Businesses or
otherwise assigned to the Company. In addition, the Contribution and
Distribution Agreement provides that certain contingent liabilities not
allocated to one of the parties will be shared by Lucent and the Company in
prescribed percentages. The Contribution and Distribution Agreement also
provides that each party will share specified portions of contingent liabilities
based upon agreed percentages related to the business of the other party that
exceed $50 million.
In addition, if the Distribution fails to qualify as a tax-free distribution
under Section 355 of the Internal Revenue Code because of an acquisition of the
Company's stock or assets, or some other actions of the Company, then the
Company will be solely liable for any resulting corporate taxes.
The Company has resolved all of the Contribution and Distribution issues with
Lucent related to the settlement of certain employee obligations and the
transfer of certain assets. Following the Distribution, the Company had
identified approximately $15 million recorded in its Consolidated Balance Sheets
that was primarily related to certain accounts receivable balances due from
Lucent and certain fixed assets, which the Company has agreed will remain with
Lucent. Since these assets, among other resolved issues, relate to the original
capital contribution by Lucent, the Company reduced additional paid-in capital
in fiscal 2001 for the net effect of these adjustments.
OTHER RELATED PARTY TRANSACTIONS
Jeffrey A. Harris has been a Director of Avaya since October 2, 2000. Mr.
Harris is a Member and Senior Managing Director of Warburg Pincus LLC and a
general partner of Warburg, Pincus & Co. Each of Warburg Pincus LLC and
Warburg, Pincus & Co. is an affiliate of Warburg Pincus Equity Partners L.P.
Mr. Harris was designated for election to the Company's Board of Directors by
Warburg Pincus Equity Partners, L.P. and its affiliates pursuant to the terms
of the equity investment described in Note 8. Henry B. Schacht has been a
Director of Avaya since September 30, 2000. Mr. Schacht is currently on a
leave of absence as a managing director and senior advisor of Warburg Pincus
LLC but has not been designated for election to the Company's Board of
Directors by Warburg Pincus LLC or its affiliates.
During fiscal 2000, a privately held business, of which Mr. Schacht holds an
80% equity interest and of which his son is the controlling stockholder,
purchased and paid for call center equipment and consulting services from the
Company for a total of approximately $1 million. This business has continued
to purchase routine services from the Company on a time and materials basis.
17. COMMITMENTS AND CONTINGENCIES
From time to time the Company is involved in legal proceedings arising in the
ordinary course of business. Other than as described below, the Company believes
there is no litigation pending that could have, individually or in the
aggregate, a material adverse effect on its financial position, results of
operations or cash flows.
YEAR 2000 ACTIONS
Three separate purported class action lawsuits are pending against Lucent, one
in state court in West Virginia, one in federal court in the Southern District
of New York and another in federal court in the Southern District of California.
The case in New York was filed in January 1999 and, after being dismissed, was
refiled in September 2000. The case in West Virginia was filed in April 1999 and
the case in California was filed in June 1999, and amended in 2000, to include
Avaya as a defendant. The Company may also be named a party to the other actions
and, in any event, has assumed the obligations of Lucent for all of these cases
under the Contribution and Distribution Agreement. All three actions are based
upon claims that Lucent sold products that were not Year 2000 compliant, meaning
that the products were designed and developed without considering the possible
impact of the change in the calendar from December 31, 1999 to January 1, 2000.
The complaints allege that the sale of these products violated statutory
consumer protection laws and constituted breaches of implied warranties. A class
has not been certified in any of the three cases and, to the extent a class is
certified in any of the cases, the Company expects that class to constitute
those enterprises that purchased the products in question. The complaints seek,
among other remedies, compensatory damages, punitive damages and counsel fees in
amounts that have not yet been specified. Although the Company believes that the
outcome of these actions will not adversely affect its financial position,
results of operations or cash flows, if these cases are not resolved in a timely
manner, they will require expenditure of significant legal costs related to
their defense.
COUPON PROGRAM CLASS ACTION
In April 1998, a class action was filed against Lucent in state court in New
Jersey, alleging that Lucent improperly administered a coupon program resulting
from the settlement of a prior class action. The plaintiffs allege that Lucent
improperly limited the redemption of the coupons from dealers by not allowing
them to be combined with other volume discount offers, thus limiting the market
for the coupons. The Company has assumed the obligations of Lucent for these
cases under the Contribution and Distribution Agreement. The complaint alleges
breach of contract, fraud and other claims and the plaintiffs seek compensatory
and consequential damages, interest and attorneys' fees. The parties have
entered into a proposed settlement agreement pending final approval by the
court.
LUCENT SECURITIES LITIGATION
In November 2000, three purported class actions were filed against Lucent in the
Federal District Court for the District of New Jersey alleging violations of the
federal securities laws as a result of the facts disclosed in Lucent's
announcement on November 21, 2000 that it had identified a revenue recognition
issue affecting its financial results for the fourth quarter of fiscal 2000. The
actions purport to be filed on behalf of purchasers of Lucent common stock
during the period from October 10, 2000 (the date Lucent originally reported
these financial results) through November 21, 2000.
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The above actions have been consolidated with other purported class actions
filed against Lucent on behalf of its stockholders in January 2000 and are
pending in the Federal District Court for the District of New Jersey. The
Company understands that Lucent has filed its Answer to the Fifth Consolidated
Amended and Supplemental Class Action Complaint in the consolidated action. The
plaintiffs allege that they were injured by reason of certain alleged false and
misleading statements made by Lucent in violation of the federal securities
laws. The consolidated cases were initially filed on behalf of stockholders of
Lucent who bought Lucent common stock between October 26, 1999 and January 6,
2000, but the consolidated complaint was amended to include purported class
members who purchased Lucent common stock up to November 21, 2000. A class has
not yet been certified in the consolidated actions. The plaintiffs in all these
stockholder class actions seek compensatory damages plus interest and attorneys'
fees.
Any liability incurred by Lucent in connection with these stockholder class
action lawsuits may be deemed a shared contingent liability under the
Contribution and Distribution Agreement and, as a result, the Company would be
responsible for 10% of any such liability in excess of $50 million. All of these
actions are in the early stages of litigation and an outcome cannot be predicted
and, as a result, there can be no assurance that these cases will not have a
material adverse effect on the Company's financial position, results of
operations or cash flows.
LICENSING MEDIATION
In March 2001, a third party licensor made formal demand for alleged royalty
payments which it claims the Company owes as a result of a contract between the
licensor and the Company's predecessors, initially entered into in 1995, and
renewed in 1997. The contract provides for mediation of disputes followed by
binding arbitration if the mediation does not resolve the dispute. The licensor
claims that the Company owes royalty payments for software integrated into
certain of the Company's products. The licensor also alleges that the Company
has breached the governing contract by not honoring a right of first refusal
related to development of fax software for next generation products. The Company
engaged in mediation with the licensor, but did not resolve this matter. At this
point, an outcome in any future proceeding cannot be predicted and, as a result,
there can be no assurance that this case will not have a material adverse effect
on the Company's financial position, results of operations or cash flows.
ENVIRONMENTAL MATTERS
The Company is subject to a wide range of governmental requirements relating to
employee safety and health and to the handling and emission into the environment
of various substances used in its operations. The Company is subject to certain
provisions of environmental laws, particularly in the U.S., governing the
cleanup of soil and groundwater contamination. Such provisions impose liability
for the costs of investigating and remediating releases of hazardous materials
at currently or formerly owned or operated sites of the Company. In certain
circumstances, this liability may also include the cost of cleaning up
historical contamination, whether or not caused by the Company. The Company is
currently conducting investigation and/or cleanup of known contamination at
approximately five of the Company's facilities either voluntarily or pursuant to
government directives.
It is often difficult to estimate the future impact of environmental matters,
including potential liabilities. The Company has established financial reserves
to cover environmental liabilities where they are probable and reasonably
estimable. Reserves for estimated losses from environmental matters are,
depending on the site, based primarily upon internal or third party
environmental studies and the extent of contamination and the type of required
cleanup. Although the Company believes that its reserves are adequate to cover
known environmental liabilities, there can be no assurance that the actual
amount of environmental liabilities will not exceed the amount of reserves for
such matters or will not have a material adverse effect on the Company's
financial position, results of operations or cash flows.
CONDITIONAL REPURCHASE OBLIGATIONS
Avaya sells product to various distributors that may obtain financing from
unaffiliated third party lending institutions. In the event the lending
institution repossesses the distributor's inventory of Avaya products, Avaya is
obligated to repurchase such inventory from the lending institution. The
repurchase amount is equal to the price originally paid to Avaya by the lending
institution for the inventory. The Company's obligation to repurchase from the
lending institution terminates 180 days from the date of invoicing by Avaya to
the distributor. During the fiscal year ended September 30, 2001, there were no
repurchases made by the Company under such agreements. There can be no assurance
that the Company will not be obligated to repurchase inventory under these
arrangements in the future.
Leases
The Company leases land, buildings and equipment under agreements that expire in
various years through 2019. Rental expense under operating leases was $194
million, $176 million and $146 million for the years ended September 30, 2001,
2000 and 1999, respectively. The table below shows the future minimum lease
payments due under non-cancelable operating leases as of September 30, 2001.
<Table>
<Caption>
Year Ended September 30,
-----------------------------------------------------------------
Later
2002 2003 2004 2005 2006 Years Total
---- ---- ---- ---- ---- ----- -----
(dollars in millions)
$197 $153 $83 $56 $41 $236 $766
</Table>
The Company also has sales-type and direct financing leases for certain
products. Lease payment receivables under such agreements were $12 million and
$35 million as of September 30, 2001 and 2000, respectively. The future minimum
lease payments to be received under sales-type and direct financing leases as of
September 30, 2001 expire in fiscal 2005 and are not material to the Company's
financial position, results of operations or cash flows.
51.
<Page>
18. QUARTERLY INFORMATION (UNAUDITED)
<Table>
<Caption>
Fiscal Year Quarters
-----------------------------------------------
First Second Third Fourth Total
----- ------ ----- ------ -----
(dollars and shares in millions, except per share amounts)
YEAR ENDED SEPTEMBER 30, 2001
Revenue $ 1,785 $ 1,852 $ 1,714 $ 1,442 $ 6,793
Gross margin 757 819 731 589 2,896
Business restructuring and related charges(1) 23 182 66 566 837
Net income (loss) 16 (64) 24 (328) (352)
Earnings (loss) per share - Basic $ 0.03 $ (0.25) $ 0.06 $ (1.17) $ (1.33)
Earnings (loss) per share - Diluted $ 0.03 $ (0.25) $ 0.06 $ (1.17) $ (1.33)
Stock price (2):
High $ 22.94 $ 19.24 $ 17.06 $ 14.40 $ 22.94
Low $ 10.00 $ 9.88 $ 10.30 $ 9.39 $ 9.39
YEAR ENDED SEPTEMBER 30, 2000
Revenue $ 1,850 $ 1,945 $ 1,899 $ 2,038 $ 7,732
Gross margin 833 798 802 816 3,249
Business restructuring and related charges(1) -- -- -- 684 684
Net income (loss) 69 66 33 (543) (375)
Earnings (loss) per share - Basic $ 0.26 $ 0.25 $ 0.12 $ (1.95) $ (1.39)
Earnings (loss) per share - Diluted $ 0.25 $ 0.24 $ 0.12 $ (1.95) $ (1.39)
</Table>
(1) These charges represent costs associated with the Company's restructuring
plan to improve profitability and business performance as a stand-alone company.
(2) There were approximately 1,082,055 registered holders of the Company's
common stock as of December 5, 2001. The Company's common stock began "when
issued trading" on September 18, 2000 and began "regular way trading" on
September 30, 2000. The high and low stock price during this period was
$26.00 and $18.81, respectively.
19. SUBSEQUENT EVENTS
SECURITIZATION OF ACCOUNTS RECEIVABLE
On October 3, 2001, the financial institution participating in the receivables
purchase agreement granted the Company a waiver from a covenant that measures
the ratio of certain unpaid receivables as a percentage of the aggregate
outstanding balance of all designated receivables. The waiver effectively
increases the ratio required by the covenant for each of the individual months
of September through December 2001. Non-compliance with the required ratio would
entitle the financial institution to exercise its rights under the agreement,
including an early liquidation of the outstanding cash proceeds.
LYONS DEBT OFFERING (UNAUDITED)
On October 31, 2001, the Company sold through an underwritten public offering
under a shelf registration statement an aggregate principal amount at maturity
of approximately $821 million of Liquid Yield Option(TM) Notes (LYONs) due in
2021. On November 16, 2001, the Company sold an additional $123 million
aggregate principal amount at maturity of LYONs pursuant to the exercise of the
underwriter's overallotment option. The net proceeds of approximately $447
million were used to refinance a portion of the Company's outstanding commercial
paper. Underwriting fees for these transactions amounted to $13 million, which
will be recorded as deferred financing costs and amortized to interest expense
over a three-year period representing the first date on which the holders may
require us to purchase all or a portion of their LYONs. The LYONs were issued at
a $484 million discount that will accrue daily at a rate of 3.625% per year
calculated on a semiannual bond equivalent basis. The Company will not make
periodic cash payments of interest on the LYONs. Instead, the original issue
discount will be recorded as interest expense and represents the accretion of
the LYONs issue price to its maturity value. The original issue discount will
cease to accrue on the LYONs upon maturity, conversion, or purchase by the
Company at the option of the holder or redemption. The LYONs are unsecured
obligations that rank equally in right of payment with all existing and future
unsecured and unsubordinated indebtedness of Avaya.
The LYONs are convertible into 35,333,073 shares of Avaya common stock at any
time on or before the maturity date. The conversion rate may be adjusted for
certain reasons, but will not be adjusted for accrued original issue discount.
Upon conversion, the holder will not receive any cash payment representing
accrued original issue discount. Accrued original issue discount will be
considered paid by the shares of common stock received by the holder of the
LYONs on conversion.
Avaya may redeem all or a portion of the LYONs for cash at any time on or
after October 31, 2004 at a price equal to the sum of the issue price and
accrued original issue discount on the LYONs as of the applicable redemption
date. Conversely, holders may require the Company to purchase all or a portion
of their LYONs on the third, fifth and tenth anniversary from the original issue
date at a price equal to the sum of the issue price and accrued original issue
discount on the LYONs as of the applicable purchase date. The Company may, at
its option, elect to pay the purchase price in cash or shares of common stock,
or any combination thereof.>
52.