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(Exact name of registrant as specified in its charter)
iDelaware
i26-1119726
(State
or other jurisdiction of incorporation or organization)
(I.R.S. Employer Identification No.)
i350 Mt. Kemble Avenue
i07960
iMorristown,
iNew
Jersey
(Address of Principal executive offices)
(Zip Code)
(i908) i953-6000
(Registrant's telephone number, including area code)
None
(Former name,
former address and former fiscal year, if changed since last report)
Securities registered pursuant to Section 12(b) of the Act
Title of Each Class
Trading Symbol(s)
Name
of each exchange on which registered
iCommon Stock
iAVYA
iNew York Stock Exchange
Indicate
by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ☐iNo☒
Indicate by check mark whether the
registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes ☐iNo☒
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated
filer, a smaller reporting company, or an emerging growth company. See the definitions of "large accelerated filer,""accelerated filer,""smaller reporting company," and "emerging growth company" in Rule 12b-2 of the Exchange Act.
iLarge accelerated filer
☒
Accelerated
filer
☐
Non-accelerated filer
☐
Smaller Reporting Company
i☐
Emerging growth company
i☐
If
an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes i☐ No ☒
Indicate
by check mark whether the registrant has filed all documents and reports required to be filed by Section 12, 13 or 15(d) of the Securities Exchange Act of 1934 subsequent to the distribution of securities under a plan confirmed by a court. Yes ☐ No ☒
When
we use the terms "we,""us,""our,""Avaya" or the "Company," we mean Avaya Holdings Corp., a Delaware corporation, and its consolidated subsidiaries taken as a whole, unless the context otherwise indicates.
This Quarterly Report on Form 10-Q (this "Quarterly Report") contains the registered and unregistered trademarks or service marks of Avaya and are the property of Avaya Holdings Corp. and/or its affiliates. This Quarterly Report on Form 10-Q also contains additional trade names, trademarks or service marks belonging to us and to other companies. We do not intend our use or display of other parties' trademarks, trade names or service marks to imply, and such use or display should not be construed to imply, a relationship with, or endorsement or sponsorship of us by, these other parties.
Explanatory
Note
As previously disclosed in the Company’s NT 10-Q (the "12b-25") filed with the U.S. Securities & Exchange Commission (the “SEC”) on February 10, 2023, the Company was not able to timely file its quarterly report on Form 10-Q because the audit committee (the “Audit Committee”) of the Company’s board of directors was conducting internal investigations to review, among other things, the circumstances surrounding the Company’s financial results for the quarter ended June
30, 2022 and items related to a whistleblower claim. The Audit Committee has completed its planned procedures with respect to its investigations and continues to cooperate with the SEC's ongoing investigation, which could require additional procedures to be performed. The results of the investigations are disclosed in Note 1, "Background and Basis of Presentation," to the Company's Condensed Consolidated Financial Statements. Additionally, the Company has completed its impairment assessment of its long lived assets, including its intangible assets. The Company has also determined that its internal control over financial reporting is not effective as of December
31, 2022 as a result of material weaknesses disclosed in Item 4.
Additionally, on February 14, 2023 (the “Petition Date”), Avaya Holdings Corp. (“Avaya Holdings”) and certain of its direct and indirect subsidiaries (the “Debtors”) commenced voluntary cases (the “Chapter 11 Cases”) under Chapter 11 of Title 11 of the United States Code (the “Bankruptcy Code”) in the United States Bankruptcy Court for the Southern District of Texas (the “Bankruptcy Court”). On the Petition Date, the Company entered into a Restructuring Support Agreement (the “RSA”) with certain of its creditors that contemplated a prepackaged joint plan
of reorganization (the “Plan”). The implementation of the Plan pursuant to the RSA did not provide for any recovery for holders of the Company’s existing common stock, par value $0.01 per share (the “Common Stock”) or Series A Convertible Preferred Stock, par value $0.01 per share (the "Series A Preferred Stock").
After the Petition Date, following the effectiveness of a Form 25-NSE and the filing of post-effective amendments to outstanding registration statements to remove unsold securities, the Company filed a Form 15 with the United States Securities and Exchange Commission (the "SEC") to deregister its Common Stock under the Securities Exchange Act of 1934 (the “Exchange Act”) and to suspend its reporting obligations
pursuant to Section 15(d)(1) of the Exchange Act, because the Company had less than 300 holders of record of each class of securities to which Securities Act registration statements related at the beginning of its 2023 fiscal year. The Company is filing this report to comply with its obligations to file all reports required to be filed with the SEC not filed prior to the filing of the Form 15.
2
The Bankruptcy Court confirmed the Plan on March 22, 2023, and the Debtors satisfied all conditions required for Plan effectiveness and emerged from the Chapter
11 Cases as a non-reporting private company on May 1, 2023 (the "Emergence Date").
Pension, post-retirement and post-employment benefit-related items, net of income taxes of $ii0/
for both the three months ended December 31, 2022 and 2021, respectively
(i6)
(i1)
Cumulative
translation adjustment
(i14)
i13
Change
in interest rate swaps, net of income taxes of $(i18) and $i0 for the three months ended December
31, 2022 and 2021, respectively
(i80)
i28
Other
comprehensive (loss) income
(ii100/)
ii40/
Total
comprehensive loss
$
(i264)
$
(i26)
The
accompanying Notes to Condensed Consolidated Financial Statements are an integral part of these statements.
Common stock, $ii0.01/
par value; ii550,000,000/ shares authorized; iiii86,846,958///
shares issued and outstanding at December 31, 2022 and September 30, 2022
i1
i1
Additional
paid-in capital
i1,428
i1,546
Accumulated
deficit
(i3,198)
(i3,081)
Accumulated
other comprehensive income
i132
i232
TOTAL
STOCKHOLDERS' DEFICIT
(i1,637)
(i1,302)
TOTAL
LIABILITIES, PREFERRED STOCK AND STOCKHOLDERS' DEFICIT
$
i3,847
$
i4,073
The
accompanying Notes to Condensed Consolidated Financial Statements are an integral part of these statements.
Notes to Condensed Consolidated Financial Statements (Unaudited)
1. iBackground
and Basis of Presentation
Background
Avaya Holdings Corp. (the "Parent" or "Avaya Holdings"), together with its consolidated subsidiaries (collectively, the "Company" or "Avaya"), is a global leader in digital communications products, solutions and services for businesses of all sizes delivering its technology predominantly through software and services. Avaya builds innovative open, converged software solutions to enhance and simplify communications and collaboration in the cloud, on-premise or a hybrid of both. The Company's global team of professionals delivers services from initial planning and design, to implementation and integration, to ongoing managed operations,
optimization, training and support. The Company manages its business operations in itwo segments: Products & Solutions and Services. The Company sells directly to customers through its worldwide sales force and indirectly through its global network of channel partners, including distributors, service providers, dealers, value-added resellers, system integrators and business partners that provide sales and services support.
Basis
of Presentation
Avaya Holdings has no material assets or standalone operations other than its ownership of its direct wholly-owned subsidiary Avaya Inc. and its subsidiaries. The accompanying unaudited interim Condensed Consolidated Financial Statements reflect the operating results of Avaya Holdings and its consolidated subsidiaries and have been prepared in accordance with accounting principles generally accepted in the United States of America ("GAAP") and the rules and regulations of the U.S. Securities and Exchange Commission ("SEC") for interim financial statements. The unaudited interim Condensed Consolidated Financial Statements should be read in conjunction with the audited Consolidated Financial Statements and other financial
information for the fiscal year ended September 30, 2022, included in the Company's Annual Report on Form 10-K filed with the SEC on September 8, 2023. In management's opinion, these unaudited interim Condensed Consolidated Financial Statements reflect all adjustments, consisting of normal and recurring adjustments, necessary to fairly state the results of operations, financial position and cash flows for the periods indicated. The unaudited condensed consolidated results of operations for the interim periods reported are not necessarily indicative of the results for the entire fiscal year.
Management is required 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 periods reported. The Company uses estimates to assess expected credit losses on its financial assets, sales returns and allowances, the use and recoverability of inventory, the realization of deferred tax assets, annual effective tax rate, the recoverability of long-lived assets, useful lives and impairment of tangible and intangible assets including goodwill, business restructuring reserves, pension and post-retirement benefit costs, the fair value of assets and liabilities in business combinations and the amount of exposure from potential loss contingencies, among others. Estimates and assumptions are reviewed periodically, and the effects of revisions are reflected in the Condensed Consolidated Financial Statements in the period they are determined to be necessary. Actual results could
differ from these estimates. The ongoing military conflict between Russia and Ukraine, including the sanctions and export controls that have been imposed by the U.S. and other countries in response to the conflict, severely limits commercial activities in Russia and impacts other markets where we do business. This global issue, among others, have resulted in elevated levels of inflation throughout the world, increased raw material costs and other supply chain issues all of which may affect management's estimates and assumptions, in particular those that require a projection of our financial results, our cash flows or broader economic conditions.
Board and Audit Committee Investigations
In February 2023, the Company announced a delay in the filing of its Quarterly Report on Form 10-Q (this "Quarterly
Report") for the quarter ended December 31, 2022, due to, among other things, the commencement of an investigation by the audit committee (the "Audit Committee", and such investigation, the "Financial Results Investigation") of the Company's board of directors (the "Board") related to the circumstances surrounding the Company's financial results for the third quarter of fiscal 2022, which were significantly lower than the Company's expectations and previously issued guidance. This investigation also addressed the information provided by the Company to
the lenders of the Tranche B-3 Term Loans and the i8.00% Exchangeable Senior Secured Notes due 2027 which was funded in July 2022 as discussed in Note 7, "Financing Arrangements."
The Company also announced the Audit Committee had commenced a separate internal investigation to review matters related to a whistleblower letter (the "Whistleblower Letter Investigation"). The Company engaged
outside counsel, which reported to the Audit Committee, to assist in these investigations and notified the SEC and the Company's external auditor, PricewaterhouseCoopers LLP, about the investigations at that time.
The Company also announced in August 2022 that it was reviewing matters related to the maintenance of its whistleblower log and the proper dissemination of related information and materials. The review related to an email received by a Board member
prior to the filing of the Company's Annual Report on Form 10-K for fiscal year ended September 30, 2021 (the "2021 Form 10-K"). Upon receipt of the email, the Board determined to undertake an investigation, assisted by outside counsel (the “Whistleblower Email Investigation” and together with the Financial Results Investigation and the Whistleblower Letter Investigation, the "Investigations"). Upon conclusion of the Whistleblower Email Investigation, it was determined that the claims included were unsubstantiated (see Note 18, "Commitments and Contingencies").
Avaya notified the SEC of the Investigations and the SEC initiated an investigation to review, among other things, the circumstances surrounding Avaya's financial results for the quarter ended June
30, 2022.
On February 10, 2023, the Company filed a Form 12b-25 announcing a delay in the filing of its Quarterly Report on Form 10-Q for the three months ended December 31, 2022. As a result of the activities noted above, the Company required additional time to complete its review of its financial statements and other disclosures as of December 31, 2022, and to complete its quarterly closing processes and controls, and was unable to file its Quarterly Report on Form 10-Q on or prior to the prescribed due date of February 9, 2023.
The
Audit Committee has completed its planned procedures with respect to its Investigations and continues to cooperate with the SEC's on-going investigation, which could require additional procedures to be performed. The Audit Committee identified several contributing factors for the significant differences between the Company's forecasts and actual financial results for the third quarter of fiscal 2022, including:
•Inappropriate tone at the top among certain members of senior management, which resulted in a corporate culture characterized by significant pressure to meet aggressive sales projections and a failure to foster an environment of appropriate and open communication of significant matters throughout the organization and with others outside of the organization;
•A
declining pipeline of existing legacy customers (with expiring maintenance contracts) eligible for migration to the Company's subscription model;
•A business model in which a significant portion of quarterly revenue is generated at the end of each quarter, making it difficult to accurately forecast revenue;
•Adverse market conditions, as well as concerns that arose during the third quarter about the Company's financial health, which negatively influenced customer sentiment; and
•The ineffective control environment
with respect to tone at the top noted above contributed to additional material weaknesses, that the Company did not design and maintain effective controls over the information and communication component of the Committee of Sponsoring Organizations of the Treadway Commission ("COSO") framework which led to an additional material weakness with respect to the ethics and compliance program. The Company did not maintain a complete and accurate whistleblower log and did not inform certain members of senior management and its external auditor about an investigation undertaken by a committee of the Board of Directors.
In addition, the investigation identified revenue of $i3
million that was recognized for product shipments during the three months ended March 31, 2022 that had rights of return and, accordingly, should not have been recognized as revenue. The Company corrected this error during the three months ended June 30, 2022. This out-of-period correction was not material to any interim period and had no impact on the financial results for the year ended September 30, 2022.
The SEC is investigating the matters underlying the Audit Committee's investigation and may be subject to additional regulatory or legal proceedings. These investigations and legal proceedings may result in adverse findings, damages, the imposition of fines or other penalties, increased
costs and expenses as well as the diversion of management's time and resources.
Chapter 11 Filing
On iFebruary 14, 2023 (the "Petition Date"), Avaya Holdings and certain of its direct and indirect subsidiaries (collectively, the "Debtors") commenced voluntary cases (the "Chapter 11 Cases") under Chapter 11 of Title 11 of the United States Code (the "Bankruptcy Code")
in the iUnited States Bankruptcy Court for the Southern District of Texas. The Chapter 11 Cases were jointly administered under the caption In re Avaya Inc., et al., case number 23-90088.
On the Petition Date, the Company entered into a Restructuring Support Agreement (the "RSA") with certain of its creditors (the "Consenting Stakeholders") and RingCentral, Inc. ("RingCentral"). The RSA contemplated a prepackaged joint plan
of reorganization (the "Plan"). The Plan provided for (i) the commencement of the Chapter 11 Cases, (ii) debtor-in-possession financing facilities in the aggregate amount of approximately $i628 million that were subsequently converted into exit financing facilities upon the Company's Emergence (as defined below), (iii) a fully backstopped $i150
million rights offering, (iv) payment in full of all trade liabilities, (v) the repayment of approximately $i225 million escrowed cash to certain senior lenders
and (vi) entry into amended and restated agreements with RingCentral (the "Amended and Restated RingCentral Agreements")
that collectively govern the Company's commercial relationship with RingCentral upon Emergence (which agreements were entered into immediately prior to, and in connection with, the execution of the RSA).
The RSA and the Plan did not contemplate any recovery for holders of the Company's existing common stock, par value $ii0.01/
per share (the "Common Stock") or Series A Convertible Preferred Stock, par value $ii0.01/ per share (the "Series
A Preferred Stock").
On February 15, 2023, trading in the Company's Common Stock on the New York Stock Exchange ("NYSE") was permanently suspended and the Common Stock was delisted from the NYSE effective February 25, 2023.
To ensure their ability to continue operating in the ordinary course of business, the Debtors filed a variety of motions seeking "first day" relief, including the authority to continue using their cash management system, pay employee wages and benefits and pay vendors in the ordinary course of business. As of March 22, 2023, all "first day" relief had been granted by the Bankruptcy Court on a final basis.
The
commencement of the Chapter 11 Cases constituted an event of default that accelerated and, as applicable, increased certain obligations under each of the Term Loan and ABL Credit Agreements and the indentures governing the Senior Notes, the Convertible Notes and the Exchangeable Notes (each as defined below) (collectively the "Pre-Petition Debt Instruments") and agreements described in Note 7, "Financing Arrangements," other than the DIP Term Loan (as defined below) and the DIP ABL Loan (as defined below). At December 31, 2022, all debt was classified as a current liability based on the Company's violation of certain covenants in December 2022.
The Pre-Petition Debt Instruments provided
that, as a result of the Chapter 11 Cases, the principal and interest and certain other amounts (to the extent applicable) due thereunder were immediately due and payable. Any efforts to enforce such payment obligations under the Pre-Petition Debt Instruments against the Debtors were automatically stayed as a result of the Chapter 11 Cases, and the creditors' rights of enforcement in respect of the Pre-Petition Debt Instruments were subject to the applicable provisions of the Bankruptcy Code.
Under the Plan, holders of pre-petition claims were not required to file proofs of claim and all filed proofs of claim were automatically considered objected and disputed, and all other claims (other than cure disputes/rejection claims) were deemed withdrawn and expunged as of May 1, 2023 (the "Emergence Date"). On the Emergence Date, the
Company reviewed claims that had been filed and updated the claims register to reflect whether claims had been withdrawn, expunged or satisfied, as applicable, as of the Emergence Date and did not identify any adjustments to its consolidated financial statements.
Subject to certain specific exceptions under the Bankruptcy Code, the Chapter 11 Cases automatically stayed most judicial or administrative actions against the Debtors and efforts by creditors to collect on or otherwise exercise rights or remedies with respect to pre-petition claims.
The Debtors operated as debtors-in-possession in accordance with the applicable provisions of the Bankruptcy Code and entered into (a) a $i500
million priming superpriority senior secured debtors-in-possession term loan facility (the "DIP Term Loan," and such facility, the "DIP Term Loan Facility") and (b) an approximately $i128 million priming superpriority senior secured debtors-in-possession asset-based loan facility (the "DIP ABL Loan," and such facility, the "DIP ABL Facility"). The DIP Term Loan and DIP ABL Loan converted into exit financing upon Avaya's Emergence. See Note 7, "Financing Arrangements".
Emergence from Voluntary Reorganization
under Chapter 11 of the Bankruptcy Code
The Bankruptcy Court confirmed the Plan on iMarch 22, 2023, and the Debtors satisfied all conditions required for Plan effectiveness and emerged from the Chapter 11 Cases ("Emergence") on May 1, 2023.
On or following the Emergence Date and pursuant to the terms of the Plan, the following occurred or became effective:
▪Debtors' Equity and
Indebtedness. All of the Debtors' pre-petition equity and debt facilities as well as the Debtors' securities were canceled.
▪Reorganized Company Equity. The Company's certificate of incorporation was amended and restated to authorize the issuance of i80 million shares of the
Company's common stock, par value $i0.01 per share (the "New Common Stock"), of which i36 million shares were issued on the Emergence Date. The Company's certificate
of incorporation was also amended and restated to authorize the issuance of i20 million shares of the Company's preferred stock, par value $i0.01 per share
(the "New Preferred Stock"), of which ino shares were issued on the Emergence Date.
▪Exit Financing. The DIP Term Loan converted into an Exit Term Loan (as defined herein) and the Company incurred an additional $i310
million under the Exit Term Loan Facility (including amounts incurred pursuant to a rights offering and amounts deemed incurred pursuant to the Plan by creditors under the Pre-Petition Debt Instruments) for an aggregate principal amount of $i810 million, and the DIP ABL Loan converted into an Exit ABL Loan (as defined
herein) in the amount of approximately $i128 million. As contemplated in the bankruptcy court proceedings and approved by the court, the imputed enterprise value of the Company upon Emergence was approximately $i1,426
million.
▪Contracts with Customers and Suppliers. Suppliers and customers were paid or will be paid in full in respect of pre-petition amounts owed by the Company, and the Company assumed the Amended and Restated RingCentral Agreements (as defined within Note 18, "Commitments and Contingencies") (which agreements were entered into immediately prior to, and in connection with, the execution of the RSA).
▪PBGC Settlement. The Company
entered into a settlement with the Pension Benefit Guaranty Corporation (the "PBGC") providing for the assumption of the hourly pension plan and the consensual termination of the settlement with the PBGC entered into as part of the Company's 2017 plan of reorganization, including the excess contribution obligations thereunder.
▪Settlements. The Company entered into a number of other settlements, including, inter alia, those with the Consenting Stakeholders and an ad hoc group of holders of the Convertible Notes, and all of these settlements became effective on
the Emergence Date.
Adoption of Accounting Standards Codification ("ASC") Topic 852
On the Emergence Date, the Company may qualify for and adopt fresh start accounting in accordance with Financial Accounting Standards Board Codification Topic 852, Reorganizations ("ASC 852"), which specifies the accounting and financial reporting requirements for entities reorganizing through Chapter 11 bankruptcy proceedings. The application of fresh start accounting would result in a new basis of accounting and the Company would become a new entity for financial reporting purposes. As a result of the implementation of the Plan and the potential application of fresh start accounting, the Consolidated Financial
Statements after the Emergence Date would not be comparable to the Consolidated Financial Statements before that date, and the historical financial statements on or before the Emergence Date would not be a reliable indicator of its financial condition and results of operations for any period after the Company's adoption of fresh start accounting.
Liquidity and Going Concern
The accompanying unaudited Condensed Consolidated Financial Statements of the Company have been prepared assuming the Company will continue as a going concern and in accordance with GAAP. The going concern basis of presentation assumes that the
Company will continue in operation one year after the date these Condensed Consolidated Financial Statements are issued and will be able to realize its assets and discharge its liabilities and commitments in the normal course of business.
During the fiscal year ended September 30, 2022, the Company experienced a significant slowdown in its operations and had operating cash outflows of $i312
million. Additionally, prior to the Chapter 11 Cases, the Company had been involved in discussions with its lenders relating to the financing transactions it completed in July 2022 (as described further in Note 7, "Financing Arrangements") and the scheduled June 2023 maturity of the Convertible Notes. In its Form 12b-25 in respect of the Quarterly Report on Form 10-Q for the period ended June 30, 2022 filed with the SEC on August 9, 2022, the Company indicated that in light of the Convertible Notes being characterized as a current liability and the related engagement with advisors to address the Convertible Notes, coupled with the decline in revenues during the third quarter, which represented
substantially lower revenues than previous Company expectations, and the negative impact of significant operating losses on the Company's cash balance, the Company determined that there was substantial doubt about the Company's ability to continue as a going concern.
The Company has completed certain restructuring actions and is working to complete its remaining restructuring plan as its operating cash flows are expected to remain negative through at least fiscal 2023. The Company may take additional
actions, as needed. The Company’s plans are designed to reduce its operating expenses and improve cash flows in line with its forecasted revenues. On the Emergence Date, the Company had approximately $i585 million of cash and cash equivalents, and its post-Emergence debt profile was significantly improved (an aggregate principal amount of $i810
million compared to $i3,420 million at December 31, 2022), reducing its annual interest expense and extending the earliest maturity of its non-revolving long-term debt to 2028. This post-Emergence capital structure, coupled with restructuring actions that the Company executed to reduce its on-going operating expenses, have provided the Company with sufficient working capital to meet its operating
cash flow requirements for at least one year from the issuance of these financial statements. Accordingly, as a result of the successful Emergence, the Company has alleviated the substantial doubt that had previously existed regarding the Company's ability to continue as a going concern. The Company's longer term liquidity profile will depend on successfully implementing its strategic plan which includes enhancing its product offerings, successfully partnering with alliance companies and executing on remaining cost reductions.
In August 2020, the Financial Accounting Standards Board ("FASB") issued Accounting Standards Update ("ASU") 2020-06, "Debt - Debt with Conversion and Other Options (Subtopic 470-20) and Derivatives and Hedging - Contracts
in Entity’s Own Equity (Subtopic 815-40): Accounting for Convertible Instruments and Contracts in an Entity’s Own Equity." This standard simplifies the accounting for convertible instruments and the application of the derivatives scope exception for contracts in an entity's own equity. The standard also amends the accounting for convertible instruments in the diluted earnings per share calculation and requires enhanced disclosures of convertible instruments and contracts in an entity's own equity. The Company adopted the standard on a modified retrospective basis effective October
1, 2022.
Upon adoption, the Company recorded a cumulative effect adjustment which decreased the opening balance of Accumulated deficit on the Condensed Consolidated Balance Sheet by $i47 million, decreased Additional paid-in-capital by $i118 million
and increased Debt maturing within one year and Long-term debt by $i10 million and $i61 million, respectively, to eliminate the historical separation of debt and equity components of the Company's
convertible or exchangeable debt instruments.
Recent Standards Not Yet Adopted
In March 2020, the FASB issued ASU 2020-04, Reference Rate Reform (Topic 848): "Facilitation of the Effects of Reference Rate Reform on Financial Reporting". This standard, along with other guidance subsequently issued by the FASB, contains practical expedients for reference rate reform related activities that impact debt, derivatives and other contracts. The guidance in this standard is optional and may be elected at any time as reference rate reform activities occur. The standard may be applied prospectively to contract modifications made and hedging relationships entered into or evaluated on or before December
31, 2024. The Company intends to use the expedients, if needed, for the reference rate transition. The Company continues to monitor activities related to reference rate reform and does not currently expect this standard to have a material impact on the Company's Condensed Consolidated Financial Statements.
In October 2021, the FASB issued ASU 2021-08, Business Combinations (Topic 805): "Accounting for Contract Assets and Contract Liabilities from Contracts
with Customers." This standard requires contract assets and contract liabilities acquired in a business combination to be recognized in accordance with Topic 606 as if the acquirer had originated the contracts. This standard is effective for the Company in the first quarter of fiscal 2024, with early adoption permitted. The impact of this standard will depend on the nature of future transactions within its scope.
In March 2022, the FASB issued ASU 2022-02, "Financial Instruments – Credit Losses (Topic 326): Troubled Debt Restructurings and Vintage Disclosures."
This standard requires an entity to disclose current-period gross write-offs by year of origination for financing receivables and net investment in leases measured at amortized cost. The standard also eliminates the existing troubled debt restructuring recognition and measurement guidance and, instead, requires an entity to evaluate whether the modification represents a new loan or a continuation of an existing loan in a manner consistent with other loan modifications. This standard is effective for the Company in the first quarter of fiscal 2024, with early adoption permitted. The Company is currently assessing the impact the new guidance will have on its Condensed Consolidated Financial Statements.
In September 2022, the FASB issued ASU 2022-04, "Liabilities—Supplier
Finance Programs (Subtopic 405-50): Disclosure of Supplier Finance Program Obligations." This standard requires that a buyer in a supplier finance program disclose sufficient information about the program to allow a user of financial statements to understand the program’s nature, activity during the period, changes from period to period, and potential magnitude. The amendments in this standard do not affect the recognition, measurement, or financial statement presentation of obligations covered by supplier finance programs. The standard is effective for the Company in the first quarter of fiscal 2024, with early adoption permitted. Certain disclosures required by the standard are effective in the first quarter of fiscal 2025. The Company is currently assessing the impact the new guidance will
have on its disclosures within its Condensed Consolidated Financial Statements.
Transaction
Price Allocated to the Remaining Performance Obligations
The transaction price allocated to remaining performance obligations that were wholly or partially unsatisfied as of December 31, 2022 was $i1,920 million, of which i52%
and i26% is expected to be recognized within i12 months and i13-i24
months, respectively, with the remaining balance expected to be recognized thereafter. This excludes amounts for remaining performance obligations that are (1) for contracts recognized over time using the "right to invoice" practical expedient, (2) related to sales or usage based royalties promised in exchange for a license of intellectual property and (3) related to variable consideration allocated entirely to a wholly unsatisfied performance obligation.
iThe following table provides information about accounts receivable, contract assets, contract costs and contract liabilities for the periods presented:
The
decrease in Contract assets was mainly driven by billings which outpaced bookings in the Company's subscription offerings during the quarter. The decrease in contract costs was driven by lower sales and continued shift to subscription offerings. The decrease in Contract liabilities was mainly driven by anticipated declines in hardware maintenance and software support services as customers continue to transition to the Company's subscription hybrid offering. The decrease was also driven by lower revenue earned from the consideration
advance received in connection with the strategic partnership with RingCentral, Inc..
During the three months ended December 31, 2022 and 2021, the
Company recognized a decrease in revenue of $i4 million and $i2 million, respectively,
for performance obligations that were satisfied, or partially satisfied, in prior periods.
As disclosed in Note 19, "Subsequent Events,”the Company and RingCentral agreed to amend their agreement.
iThe
following table provides information regarding the location and amount for amortization of costs to obtain and costs to fulfill customer contracts recognized in the Company's Condensed Consolidated Statements of Operations for the periods presented:
Intangible
assets with finite lives are amortized using the straight-line method over the estimated economic lives of the assets. Intangible assets with finite lives are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of such assets may not be recoverable. Intangible assets determined to have indefinite useful lives are not amortized but are subject to impairment testing annually, on July 1st, or more frequently if events occur or circumstances change that indicate an asset may be impaired.
As announced in a Form 8-K dated December 13, 2022, the Company was unable to reach an out-of-court resolution with certain holders of the Convertible Notes, Senior Notes, Exchangeable Notes, and the Term Loans outstanding
under the Term Loan Credit Agreement, regarding one or more potential financings, refinancings, recapitalizations, reorganizations, restructurings, or investment transactions involving the Company. As a result, the Company revised its outlook to reflect the increased likelihood of a solvency event. The Company concluded that a triggering event had occurred and performed an interim quantitative impairment test for its indefinite-lived intangible asset, the Avaya Trade Name, as of December 31, 2022 to compare the fair value of the Avaya Trade Name to its carrying amount.
The fair value of the Avaya Trade Name was estimated
using the relief-from-royalty model, a form of the income approach. Under this methodology, the fair value of the trade name was estimated by applying a royalty rate to forecasted net revenues which was then discounted using a risk-adjusted rate of return on capital. The model relies on assumptions regarding revenue growth rates, royalty rate, discount rate and terminal growth rate. Revenue growth rates inherent in the forecast were based on input from internal and external market intelligence research sources that compare factors such as growth in global economies, regional industry trends and product evolutions. The royalty rate was determined using a set of observed market royalty rates. The discount rate the Company used represents the estimated weighted average cost of capital, which reflects the overall level of inherent risk and the rate of return an outside investor would expect
to earn. To estimate royalty cash flows beyond the final year of its model, the Company used a terminal value approach. Under this approach, the Company applied a perpetuity growth assumption to determine the terminal value. The Company incorporated the present value of the resulting terminal value into its estimate of fair value. The result of the interim impairment test of the Avaya Trade Name as of December 31, 2022 indicated that the carrying amount of the Avaya Trade Name exceeded its estimated fair value primarily due to the updated outlook. As a result, the Company recorded
an indefinite-lived intangible asset impairment charge of $i9 million within the Impairment charges line item in the Condensed Consolidated Statements of Operations, representing the amount by which the carrying
amount of the Avaya Trade Name exceeded its fair value. As of December 31,
2022, the remaining carrying amount of the Avaya Trade Name was $i178 million.
To the extent that business conditions deteriorate further or if changes in key assumptions and estimates differ significantly from management's expectations, it may be necessary to record additional impairment charges in the future.
5. iSupplementary
Financial Information
iThe following table presents a summary of other (expense) income, net for the periods indicated:
Three months ended December 31,
(In
millions)
2022
2021
OTHER (EXPENSE) INCOME, NET
Interest income
$
i4
$
i—
Foreign
currency losses, net
(i10)
i—
Other
pension and post-retirement benefit credits, net
i2
i6
Change
in fair value of 2017 Emergence Date Warrants
i—
i1
Total
other (expense) income, net
$
(i4)
$
i7
/
i
The
following table presents supplemental cash flow information for the periods presented:
Three months ended December 31,
(In millions)
2022
2021
OTHER PAYMENTS
Interest payments (excluding lease related interest)
$
i55
$
i33
Income
tax payments
i5
i7
NON-CASH
INVESTING ACTIVITIES
Increase (decrease) in Accounts payable for Capital expenditures
$
i1
$
(i2)
Acquisition
of equipment under operating leases
i1
i7
During
the three months ended December 31, 2022 and 2021, the Company made payments for operating lease liabilities of $i12 million and $i15
million, respectively, and made payments for finance lease liabilities of $i3 million and $i3 million, respectively.
The following table presents a reconciliation of cash, cash equivalents, and restricted cash that sum to the total of the same such amounts
shown in the Condensed Consolidated Statements of Cash Flows for the periods presented:
The Company's employee separation costs generally consist of severance charges which include, but are not limited to, termination payments, pension fund payments, health care and unemployment insurance costs to be paid to, or on behalf of, the affected employees and other associated costs. Facility exit costs primarily consist of lease obligation charges for exited facilities, including the impact of accelerated lease expense for right-of-use assets and accelerated depreciation expense for leasehold improvements with reductions in their estimated useful lives due to exited facilities. The restructuring charges include changes in estimates for increases and decreases in costs or changes in the timing of payments related to the restructuring programs of prior fiscal years. The
Company does not allocate restructuring reserves to its operating segments.
i
The following table summarizes the activity for employee separation costs recognized under the Company's restructuring programs for the three months ended December 31, 2022:
Long-term
debt, net of current portion and derivatives
$
i—
$
i—
$
i3,215
$
i3,032
/
Term
Loan and ABL Credit Agreements
As of December 31, 2022 and September 30, 2022, the Company maintained (i) its Term Loan Credit Agreement among Avaya Inc., as borrower, Avaya Holdings, the lending institutions from time to time party thereto, and Goldman Sachs Bank USA, as administrative agent and collateral agent (the "Term Loan Credit Agreement") and (ii) its ABL Credit Agreement, among Avaya Inc., as borrower, Avaya Holdings, the several other borrowers party thereto, the several lenders from time to time party thereto, and Citibank, N.A., as administrative agent and collateral agent, which provided a revolving credit facility consisting of a U.S. tranche and a foreign tranche allowing for borrowings of up to an aggregate principal
amount of $i200 million subject to borrowing base availability (the "ABL Credit Agreement"). The ABL Credit Agreement matures on September 25, 2025.
Prior to July 12, 2022, the Term Loan Credit Agreement matured in two tranches, with principal amounts of $i800
million (the "Tranche B-1 Term Loans") and $i743 million (the "Tranche B-2 Term Loans") maturing on December 15, 2027. On July 12, 2022, the Company amended the Term Loan Credit Agreement ("Amendment No. 4"), pursuant to which the Company incurred incremental term loans in an aggregate principal amount of $i350
million (the "Tranche B-3 Term Loans"). The Tranche B-3 Term Loans bear interest (a) in the case of alternative base rate ("ABR") Loans at rate per annum equal to i9.00% plus the highest of (i) the Federal Funds Rate plus i0.50%, (ii) the U.S.
prime rate as publicly announced in the Wall Street
Journal and (iii) the greater of (x) the adjusted Secured Overnight Financing Rate ("SOFR") Rate for an interest period of one month plus i1.00% and (y) i2.00%
and (b) in the case of SOFR Loans, bear interest at a rate per annum equal to i10.00% plus the applicable SOFR rate, subject to a i1.00% floor. Amendment No. 4 also made certain other changes to the Term Loan Credit Agreement solely for the benefit of the lenders providing the Tranche B-3
Term Loans, including reducing flexibility for the Company to incur additional debt and liens or make restricted payments or investments under certain of the negative covenants. The Company placed $i221 million of the net proceeds of the Tranche B-3 Term Loans in escrow.Filing of the Chapter 11 Cases triggered an event of default under the Term Loan Credit Agreement causing
the automatic acceleration of all obligations thereunder, including the Tranche B-3 Term Loans.
The Company evaluated Amendment No. 4 in accordance with ASC 815, Derivatives and Hedging, and determined that there are embedded features in the amendment that are not clearly and closely related to the underlying debt instrument and did not qualify for any scope exceptions set forth in the accounting standards. Accordingly, these embedded features are required to be bifurcated from their host instrument and accounted for separately as an embedded derivative liability. As a result, the Company recorded the fair value of the embedded derivatives as of the issuance date as a $i30
million reduction of the initial carrying amount of the Tranche B-3 Term Loans (as part of the debt discount). The discount is amortized to interest expense using the effective interest method over the life of the Tranche B-3 Term Loans. The embedded derivatives will be adjusted to fair value each reported period with changes in fair value subsequent to the issuance date recognized within Interest Expense in the Condensed Consolidated Statements of Operations. See Note 8, "Derivative Instruments and Hedging Activities," for further information regarding the valuation of the embedded derivatives. The aggregate fair value of the embedded derivatives is reflected within Long-term debt in the Condensed Consolidated Balance Sheets.
For the three months ended December 31, 2022 and 2021, the
Company recognized interest expense of $i30 million and $i18 million, respectively, related to the Term Loan Credit Agreement, including the amortization of the underwriting discount and issuance costs. The three months ended December 31,
2022 includes $(i17) million of interest expense related to the change in the fair value of the Tranche B-3 Term Loans embedded derivatives during the period.
As of December 31, 2022, the Company had an outstanding balance of $i56
million under the ABL Credit Agreement, which includes borrowings of $i90 million and repayments of $i34 million made during the first quarter of fiscal 2023. The borrowing matures monthly and is renewable at the
Company's election in accordance with the terms and conditions of the ABL Credit Agreement. As of December 31, 2022, the Company has the ability and intent to repay the ABL Credit Agreement balance within one year and has classified the balance as current. Under the terms of the ABL Credit Agreement, the Company can issue letters of credit up to $i150
million. At December 31, 2022, the Company had issued and outstanding letters of credit and guarantees of $i38 million under the ABL Credit Agreement. The aggregate additional principal amount that may be borrowed under the ABL Credit Agreement, based on the borrowing base less $i38 million
of outstanding borrowings, letters of credit and guarantees was $i21 million at December 31, 2022. For the three months ended December 31, 2022, recognized interest expense related to the ABL Credit Agreement was $i1
million. For the three months ended December 31, 2021, recognized interest expense related to the ABL Credit Agreement was not material.
Senior Notes
The Company’s Senior i6.125% First Lien Notes have an aggregate principal amount outstanding of $i1,000
million and mature on September 15, 2028 (the "Senior Notes").The Senior Notes were issued on September 25, 2020, pursuant to an indenture among the Company, the Company's subsidiaries that are guarantors of the Senior Notes and party thereto and Wilmington Trust, National Association, as trustee and notes collateral agent.
For each of the three months ended December 31, 2022
and 2021, the Company recognized interest expense of $ii16/ million
related to the Senior Notes, including the amortization of debt issuance costs.
Convertible Notes
The Company's i2.25% Convertible Notes have an aggregate principal amount outstanding of $i350
million (including notes issued in connection with the underwriters' exercise in full of an over-allotment option of $i50 million) and mature on June 15, 2023. The Convertible Notes were issued under an indenture, by and between the Company and the Bank of New York Mellon Trust Company N.A., as trustee.
On July
12, 2022, the Company repurchased approximately $i129 million principal amount of the Company's $i350
million Convertible Notes due June 15, 2023. The repurchase was accounted for as a loan extinguishment. Based on the application of the loan extinguishment guidance within ASC 470, the Company recorded a $i5 million gain on extinguishment within Interest expense in the Consolidated Statements of Operations during fiscal 2022. In connection with the repurchase, the Company terminated
a portion of the Bond Hedge and Call Spread Warrants, each representing i4.7 million of its common stock.
For the three months ended December 31, 2022 and 2021, the
Company recognized interest expense of $i2 million and $i7 million related to the Convertible Notes, which includes $i0
million and $i5 million of amortization of the debt discount and issuance costs, respectively.
i
The net carrying amount of the Convertible Notes for the periods indicated was as follows:
(1)Upon
adoption of ASU 2020-06 on October 1, 2022, the Company recorded an adjustment to reclassify the debt discount for the conversion option and issuance costs associated with the equity component of the Convertible Notes. See Note 2, "Recent Accounting Pronouncements," for further information regarding the cumulative effect adjustment made by the Company upon adoption. The remaining equity component of the Convertible Notes is related to the $i129
million of the Convertible Notes which were repurchased prior to the adoption of ASU 2020-06 as described above.
Exchangeable Notes
On July 12, 2022, the Company issued its i8.00% Exchangeable Senior Secured Notes due 2027 with an aggregate principal amount of $i250
million (the "Exchangeable Notes"). The Exchangeable Notes were issued pursuant to an indenture by and among Avaya Inc., the guarantors party thereto and Wilmington Trust, National Association, as trustee, exchange agent and notes collateral agent.
The Company evaluated the indenture governing the Exchangeable Notes in accordance with ASC 815, Derivatives and Hedging, and determined that there are embedded features in the indenture that are not clearly and closely related to the underlying debt instrument and did not qualify for any scope exceptions set forth in the
accounting standards. Accordingly, these embedded features are required to be bifurcated from their host instrument and accounted for separately as an embedded derivative liability. As a result, the Company recorded the fair value of the embedded derivatives as of the issuance date as a $i4 million reduction of the initial carrying amount of the Exchangeable Notes (as part of the debt discount). The discount is amortized to interest expense using the effective interest method over the life of the Exchangeable Notes. The
embedded derivatives will be adjusted to fair value each reported period with changes in fair value subsequent to the issuance date recognized within Interest Expense in the Condensed Consolidated Statements of Operations. See Note 8, "Derivative Instruments and Hedging Activities," for further information regarding the valuation of the embedded derivatives. The aggregate fair value of the embedded derivatives is reflected within Long-term debt in the Condensed Consolidated Balance Sheets.
For the three months ended December 31, 2022, the Company recognized interest expense of $i7
million related to the Exchangeable Notes, which includes $i1 million of amortization of the debt issuance costs, and $i1 million related to the change in the fair value of the Exchangeable Notes embedded derivatives
during the period.
(1)Upon
adoption of ASU 2020-06 on October 1, 2022, The Company recorded an adjustment to reclassify the debt discount for the conversion option and issuance costs associated with the equity component of the Exchangeable Notes. See Note 2, "Recent Accounting Pronouncements," for further information regarding the cumulative effect adjustment made by the Company upon adoption.
/
The weighted average contractual interest rate of the Company's outstanding debt was i8.0%
as of December 31, 2022 and i7.4% as of September 30, 2022, including adjustments related to the Company's interest rate swap agreements (see Note 8, "Derivative Instruments and Hedging Activities"). The effective interest rate for the Term Loan Credit Agreement was i10.7%
as of December 31, 2022 and i9.0% as of September 30, 2022. The effective interest rate for the Senior Notes as of December 31, 2022 and September 30, 2022 was not materially different than its contractual interest rate. The effective interest rate for the Convertible Notes was i2.8%
as of December 31, 2022, reflecting adjustment to the conversion feature in equity upon adoption of ASU 2020-06. The effective interest rate for the Convertible Notes was i9.2% as of September 30, 2022, reflecting the separation of the conversion feature in equity. The effective interest rate for the Exchangeable Notes was i9.9%
as of December 31, 2022, reflecting adjustment to the conversion feature in equity upon adoption of ASU 2020-06. The effective interest rate for the Exchangeable Notes was i17.7% as of September 30, 2022, reflecting the separation of the conversion feature in equity. The effective interest rates include interest on the debt and amortization of discounts and issuance costs.
On December 29, 2022, the
Company provided Notices of Default to the administrative agents of the Term Loan Credit Agreement and ABL Credit Agreement; and the trustees of the Senior Notes, Convertible Notes and Exchangeable Notes due to the Company's failure to timely deliver financial statements for the nine months ended June 30, 2022 and the fiscal year ended September 30, 2022. It is not probable that the violation will be cured during the grace period and therefore, in accordance with the terms of the credit agreements, the debt is deemed callable and has been classified as a current liability on the Condensed Consolidated Balance Sheet as of December 31, 2022. As noted in Note 1, "Background and Basis of Presentation," all of the Debtors' pre-petition
equity and debt facilities as well as the Debtors' securities were extinguished upon Emergence.
Debtor in Possession Financing
On the Petition Date, the Debtors entered into the DIP Term Loan Facility. On February 24, 2023, the Debtors entered into the DIP ABL Facility. The Bankruptcy Court provided final approval for both facilities on iMarch 7, 2023.
The
filing of the Chapter 11 Cases constituted an event of default under the ABL Credit Agreement, the Term Loan Credit Agreement, the Senior Notes, the Convertible Notes and the Exchangeable Notes, that accelerated and, as applicable, increased certain obligations thereunder.
Reorganized Company Financing
On the Emergence Date, the DIP Term Loan converted on a dollar-for-dollar basis into a term loan under a senior secured exit term loan facility and the Company incurred an additional $i310
million under the facility (including amounts incurred pursuant to a rights offering) for an aggregate principal amount of $i810 million (the "Exit Term Loan", such facility, the "Exit Term Loan Facility", and the agreement providing for such facility, the "Exit Term Loan Credit Agreement") and the DIP ABL Facility converted on a dollar-for-dollar basis into a senior secured exit asset-based revolving loan facility (the "Exit ABL Loan", such facility, the "Exit ABL Loan Facility", and the agreement providing for such facility, the
"Exit ABL Credit Agreement"). The Exit Term Loan bears interest at a rate equal to (1) Term SOFR plus (i) i7.50% to the extent interest is paid
entirely in cash or (ii) i8.50%
to the extent interest is paid with a combination of cash and payment in kind (consisting of i1.50% payable in cash and i7.00% paid in kind) or (1) Base Rate plus (i) i6.50%
to the extent interest is paid entirely in cash or (ii) i7.50% to the extent interest is paid with a combination of cash and payment in kind (consisting of i1.00%
payable in cash and i6.50% paid in kind), subject to a i1.00% floor and matures on August 1, 2028. The Company
has the option to pay interest with a combination of cash and payment-in-kind for interest payment dates through, and including, June 30, 2024. For interest payments dates after June 30, 2024, interest is payable in cash. The Exit ABL Loan bears interest at a rate equal to Term SOFR plus i3.00% or Base Rate plus i2.00%
and matures on May 1, 2026.
The Exit Term Loan Credit Agreement and the Exit ABL Credit Agreement each include conditions precedent, representations and warranties, affirmative and negative covenants, and events of default customary for financings of this type and size. The Borrower's obligations under the Exit Term Loan Credit Agreement and the Exit ABL Credit Agreement are guaranteed by the Company and are collectively secured by a security interest in, and a lien on, substantially all property (subject to certain exceptions) of the Company. The Exit Term Loan Credit Agreement and the Exit ABL Credit Agreement also contain customary covenants that limit the ability of the
Company to, among other things, (1) incur additional indebtedness and permit liens to exist on their assets, (2) pay dividends or make certain other restricted payments, (3) sell assets or (4) make certain investments. These covenants are subject to exceptions and qualifications as set forth in each of the Exit Term Loan Credit Agreement and the Exit ABL Credit Agreement.
8. iDerivative Instruments and Hedging Activities
The
Company accounts for derivative financial instruments in accordance with FASB ASC Topic 815, "Derivatives and Hedging," ("ASC 815") and does not enter into derivatives for trading or speculative purposes.
The Company, from time to time, enters into interest rate swap contracts as a hedge against changes in interest rates on its outstanding variable rate loans.
On May 16, 2018, the Company entered
into interest rate swap agreements with isix counterparties, which fixed a portion of the variable interest due under its Term Loan Credit Agreement (the "Original Swap Agreements"). Under the terms of the Original Swap Agreements, which matured on December 15, 2022, the Company paid a fixed rate of i2.935%
and received a variable rate of interest based on one-month LIBOR. Through September 23, 2020, the total $i1,800 million notional amount of the Original Swap Agreements were designated as cash flow hedges and deemed highly effective as defined under ASC 815.
On September 23, 2020, the Company entered into an interest rate swap agreement for a notional amount of $i257
million (the “Offsetting Swap Agreement”). Under the terms of the Offsetting Swap Agreement, which matured on December 15, 2022, the Company paid a variable rate of interest based on one-month LIBOR and received a fixed rate of i0.1745%. The Company entered into the Offsetting Swap Agreement to maintain a net notional amount less than the amount of the
Company’s variable rate loans outstanding. The Offsetting Swap Agreement was not designated for hedge accounting treatment. On September 23, 2020, Original Swap Agreements with a notional amount of $i257 million were also de-designated from hedge accounting treatment. Through June 30, 2022, Original Swap Agreements with a notional amount of $i1,543
million were designated as cash flow hedges and deemed highly effective as defined under ASC 815. On June 30, 2022, the Company determined that the hedged transactions were no longer highly probable of occurring as forecasted, and as such, the Company de-designated the remaining Original Swap Agreements from hedge accounting treatment.
On July 1, 2020, the Company entered into interest rate swap agreements with ifour
counterparties, which fixed a portion of the variable interest due under its Term Loan Credit Agreement (the "Forward Swap Agreements") from December 15, 2022 (the maturity date of the Original Swap Agreements) through December 15, 2024. Under the terms of the Forward Swap Agreements, the Company would pay a fixed rate of i0.7047% and receive a variable rate of interest based on one-month LIBOR. The total notional amount of the Forward Swap Agreements was
$i1,400 million. Through March 23, 2022, the Forward Swap Agreements were designated as cash flow hedges and deemed highly effective as defined by ASC 815.
On March 23, 2022, the Company terminated the Forward Swap Agreements and simultaneously entered into new interest rate swap agreements with ifour
counterparties (the "New Forward Swap Agreements"), which resulted in the receipt of $i52 million cash proceeds. The New Forward Swap Agreements fixed a portion of the variable interest due under the Company's Term Loan Credit Agreement from December 15, 2022 through June 15, 2027. Under the terms of the New Forward Swap Agreements, the
Company paid a fixed rate of i2.5480% and received a variable rate of interest based on one-month SOFR. The total notional amount of the New Forward Swap Agreements is $i1,000 million. Through June 30, 2022, the New Forward Swap Agreements
were designated as cash flow hedges and deemed highly effective as defined by ASC 815. On June 30, 2022, the Company determined that the hedged transactions were no longer highly probable of occurring as forecasted, and as such, the Company de-designated the New Forward Swap Agreements from hedge accounting treatment.
The Company
records changes in the fair value of interest rate swap agreements designated as cash flow hedges initially within Accumulated other comprehensive income (loss) in the Condensed Consolidated Balance Sheets. As interest expense is recognized on the Term Loan Credit Agreement, the corresponding deferred gain or loss on the cash flow hedge is reclassified from Accumulated other comprehensive income (loss) to Interest expense in the Condensed Consolidated Statements of Operations. The Company records changes in the fair value of interest rate swap agreements not designated for hedge accounting within Interest expense. On September 23, 2020, the Company froze a $i15
million deferred loss within Accumulated other comprehensive income (loss) related to the de-designated Original Swap Agreements, which was reclassified to Interest expense over the term of the Original Swap Agreements. On March 23, 2022, the Company froze a $i52 million deferred gain within Accumulated other comprehensive income (loss) related to the termination of the Forward Swap Agreements, which was reclassified to
Interest expense over the term of the original Forward Swap Agreements. On June 30, 2022, the Company froze a $i9 million deferred gain within Accumulated other comprehensive income (loss) related to the de-designation of the Original Swap Agreements and New Forward Swap Agreements, which was reclassified to Interest expense over the term of the respective swap agreements.
In
December 2022, the Company concluded that the hedged forecasted transactions related to the interest rate swap agreements are probable of not occurring as a result of the Company's inability to reach an out of court solution regarding potential financings, refinancings, recapitalizations, reorganizations, restructurings or investment transactions involving the Company and certain debt holders. As a result, frozen deferred gains of $i63
million related to the Company's interest rate swap agreements were reclassified to Interest expense during the first quarter of fiscal 2023. The Company later terminated its New Forward Swap Agreements resulting in the receipt of $i40 million of net cash proceeds which is reflected within cash used for operating activities in the Condensed Consolidated
Statements of Cash Flows for the three months ended December 31, 2022.
It is management's intention that the net notional amount of interest rate swap agreements be less than or equal to the variable rate loans outstanding during the life of the derivatives.
Debt-Related Embedded Derivatives
The Company's Tranche B-3 Term Loans and Exchangeable Notes contain embedded features that, in certain scenarios, could modify the cash flows of their respective debt instruments. These embedded features (the "Debt-related embedded derivatives") are required to be bifurcated from their host contracts and accounted for
as an embedded derivative. The Debt-related embedded derivatives are recorded at fair value with changes in fair value subsequent to the issuance date recorded in Interest expense in the Condensed Consolidated Statements of Operations.
On July 12, 2022, the issuance date, the aggregate fair value of the Debt-related embedded derivatives was $i34 million, which was recorded as a debt discount (contra liability) and a derivative liability within Long-term debt on the Consolidated Balance Sheets. As of December 31,
2022 and September 30, 2022, the aggregate fair value of the Debt-related embedded derivatives was $i56 million and $72 million, respectively.
The fair value of the derivatives is determined using the with-and-without model which compares the estimated fair value of the underlying debt instrument with the embedded features to the estimated fair value of the underlying debt instrument without the embedded features, with the difference representing the estimated fair value of the embedded derivative features.
The with-and-without model includes significant unobservable estimates, including estimated market yield, an estimation of the Company’s probability of default and creditor recovery rates, and the probability of the occurrence of a change of control event or asset sale.
i
The fair value of the derivatives as of December 31, 2022 was determined using the market assumptions
summarized below:
The
Company, from time to time, utilizes foreign currency forward contracts primarily to hedge fluctuations associated with certain monetary assets and liabilities including receivables, payables and certain intercompany balances. These foreign currency forward contracts are not designated for hedge accounting treatment. As a result, changes in the fair value of these
contracts
are recorded as a component of Other income, net to offset the change in the value of the hedged assets and liabilities. As of December 31, 2022, the Company had no open foreign currency forward contracts. As of September 30, 2022, the Company maintained open foreign currency forward contracts with a total notional value of $i12
million, hedging the Czech Koruna.
2017 Emergence Date Warrants
In accordance with the bankruptcy plan of reorganization adopted in connection with the Company's emergence from bankruptcy on December 15, 2017 (the "2017 Plan of Reorganization"), the Company issued warrants to purchase i5,645,200
shares of the Company's common stock to the holders of the second lien obligations extinguished pursuant to the 2017 Plan of Reorganization (the "2017 Emergence Date Warrants"). Each 2017 Emergence Date Warrant had an exercise price of $i25.55 per share and expired on December 15, 2022. The 2017 Emergence Date Warrants contained certain derivative
features that required them to be classified as a liability and for changes in the fair value of the liability to be recognized in earnings each reporting period. On November 14, 2018, the Company's Board approved a warrant repurchase program, authorizing the Company to repurchase up to $i15
million worth of the 2017 Emergence Date Warrants. None of the 2017 Emergence Date Warrants were exercised or repurchased.
The fair value of the 2017 Emergence Date Warrants was determined using a probability weighted Black-Scholes option pricing model. This model requires certain input assumptions including risk-free interest rates, volatility, expected life and dividend rates. Selection of these inputs involves significant judgment. iThe fair value of the 2017 Emergence Date Warrants as of September 30,
2022 was determined using the input assumptions summarized below:
(1)The Company qualitatively determined the fair value of the 2017 Emergence Date Warrants as of September 30, 2022 to be negligible as a result of the decline in Company's stock price since the most recent quantitative analysis (June
30, 2022) and the remaining contractual term of 0.21 years as of September 30, 2022. The amounts presented represent the input assumptions as of June 30, 2022.
In determining the fair value of the 2017 Emergence Date Warrants, the dividend yield was assumed to be izero as the Company did not anticipate paying dividends on its common stock throughout
the term of the warrants.
The
following table provides information regarding the location and amount of pre-tax gains (losses) for interest rate contracts designated as cash flow hedges:
Financial Statement Line Item in which Cash Flow Hedges are Recorded
$
(i5)
$
(ii100/)
$
(i54)
$
ii40/
Impact
of cash flow hedging relationships:
Gain recognized in AOCI on interest rate swaps
—
—
—
15
Interest expense
reclassified from AOCI
(i62)
i62
(i13)
i13
/
iThe
following table provides information regarding the pre-tax (losses) gains for derivatives not designated as hedging instruments on the Condensed Consolidated Statements of Operations:
The
Company records its derivatives on a gross basis in the Condensed Consolidated Balance Sheets. The Company has master netting agreements with several of its financial institution counterparties. iThe following table provides information on the Company's derivative positions as if those subject to master netting arrangements were presented on a net basis, allowing for the right to offset by counterparty per the master netting agreements:
Gross amounts recognized in the Condensed Consolidated Balance Sheets
$
i—
$
i56
$
i55
$
i74
Gross
amount subject to offset in master netting arrangements not offset in the Condensed Consolidated Balance Sheets
i—
i—
(i2)
(i2)
Net
amounts
$
i—
$
i56
$
i53
$
i72
9. iFair
Value Measurements
Pursuant to the accounting guidance for fair value measurements, fair value is defined as the price that would be received from selling an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. When determining the fair value measurements for assets and liabilities required or permitted to be recorded at fair value, the
Company considers the principal or most advantageous market in which it would transact and it considers assumptions that market participants would use when pricing the asset or liability.
Considerable judgment was required in developing certain of the estimates of fair value and accordingly, the estimates presented herein are not necessarily indicative of the amounts that the Company could realize in a current market exchange.
Fair Value Hierarchy
The accounting guidance for fair value measurements also requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. A financial instrument's categorization within the fair value hierarchy is based upon the lowest level of input that is significant to the fair value measurement. The inputs are prioritized into three levels that may be used to measure fair value:
Level 1: Inputs
that reflect quoted prices for identical assets or liabilities in active markets that are observable.
Level 2: Inputs that reflect quoted prices for similar assets or liabilities in active markets; quoted prices for identical or similar assets or liabilities in markets that are not active; or model-derived valuations in which significant inputs are observable or can be derived principally from, or corroborated by, observable market data.
Level 3: Inputs that are unobservable to the extent that observable inputs are not available for the asset or liability at the measurement date.
Assets and Liabilities Measured at Fair Value on a Recurring Basis
Interest
rate contracts classified as Level 2 assets and liabilities are not actively traded and are valued using pricing models that use observable inputs.
Debt-related Embedded Derivatives classified as Level 3 liabilities are valued using the with-and-without model which is further described in Note 8, "Derivative Instruments and Hedging Activities."
i
The following table provides changes to those fair value measurements using Level 3 inputs for the three months
ended December 31, 2022:
Fair Value Measurements Using Significant Unobservable Inputs (Level 3)
iThe estimated fair values of the Senior Notes, Term Loans, Exchangeable Notes and Convertible Notes as of December 31, 2022 and September 30,
2022 were as follows:
The
estimated fair value of the Company's Senior Notes and Term Loans was determined using Level 2 inputs based on a market approach utilizing market-clearing data on the valuation date in addition to bid/ask prices. The estimated fair value of the Exchangeable Notes and Convertible Notes was determined based on the quoted price of the Exchangeable Notes and Convertible Notes in an inactive market on the last trading day of the reporting period and has been classified as Level 2. The fair value of the outstanding balance under ABL credit agreement approximates its carrying amount due to its short term maturities and seniority over the Company's other outstanding debt instruments.
The fair values of cash and cash equivalents, accounts receivable, accounts payable
and accrued expenses, to the extent the underlying liability will be settled in cash, approximate their carrying values because of the short-term nature of these instruments.
10. iIncome Taxes
The Company's effective income tax rate for the three months ended December 31, 2022 differed from the U.S. federal tax rate by i7%
or $i14 million principally related to deferred taxes (including losses) for which no benefit was recorded because it is more likely than not that the tax benefits would not be realized and the release of deferred taxes from Accumulated Other Comprehensive Income upon termination of interest rate swaps.
The Company's effective income tax rate for the three months ended December 31, 2021 differed
from the U.S. federal tax rate by i59% or $i28 million principally related to deferred taxes (including losses) generated for which no benefit was recorded because it is more
likely than not that the tax benefits would not be realized; and certain nondeductible expenses.
11. iBenefit Obligations
The Company sponsors non-contributory defined benefit pension plans covering a portion of its U.S. employees and retirees, and post-retirement benefit plans covering a portion of its U.S. employees
and retirees that include healthcare benefits and life insurance coverage. Certain non-U.S. operations have various retirement benefit programs covering substantially all of their employees. Some of these programs are considered to be defined benefit pension plans for accounting purposes.
The components of the pension and post-retirement
net periodic benefit (credit) cost for the periods indicated are provided in the table below:
Three months ended December 31,
(In millions)
2022
2021
Pension Benefits - U.S.
Components
of net periodic benefit credit
Service cost
$
i1
$
i1
Interest
cost
i10
i5
Expected return on plan assets
(i12)
(i12)
Net
periodic benefit credit
$
(i1)
$
(i6)
Pension
Benefits - Non-U.S.
Components of net periodic benefit cost
Service cost
$
i1
$
i2
Interest
cost
i3
i1
Amortization of actuarial gain
(i3)
i—
Net
periodic benefit cost
$
i1
$
i3
Post-retirement
Benefits - U.S.
Components of net periodic benefit cost
Interest cost
$
i1
$
i1
Amortization
of prior service credit
(i1)
(i1)
Net
periodic benefit cost
$
i—
$
i—
/
The
service components of net periodic benefit (credit) cost were recorded similar to compensation expense, while all other components were recorded in Other (loss) income, net.
The Company's general funding policy with respect to its U.S. qualified pension plans is to contribute amounts at least sufficient to satisfy the minimum amount required by applicable law and regulations, or to directly pay benefits where appropriate. In March 2021, the American Rescue Plan Act was signed into law, providing limited interest-rate relief provisions and an extended shortfall amortization period for pension funding and retirement plan distributions. As a result, the Company did not make any contributions to the U.S. pension plans during the three months ended December
31, 2022 and does not expect to make any contributions to the U.S. pension plans during the remainder of fiscal 2023.
Contributions to the non-U.S. pension plans were $i5 million for the three months ended December 31, 2022. For the remainder of fiscal 2023, the Company estimates that it will make contributions totaling $i19
million for non-U.S. plans.
Most post-retirement medical benefits are not pre-funded. Consequently, the Company makes payments directly to the claims administrator as retiree medical benefit claims are disbursed. These payments are funded by the Company up to the maximum contribution amounts specified in the plan documents and contracts with the Communications Workers of America and the International Brotherhood of Electrical Workers, and contributions from the participants, if required. During the three months ended December 31, 2022, the
Company made payments for retiree medical and dental benefits of $i2 million and received reimbursements from the represented employees' post-retirement health trust of $i2
million related to payments in prior periods. The Company estimates it will make payments for retiree medical and dental benefits totaling $i8 million for the remainder of fiscal 2023.
12. iShare-based
Compensation
The Company maintains share-based compensation plans under which non-employee directors, employees of the Company or any of its affiliates, and certain consultants and advisors may be granted stock options, restricted stock, restricted stock units ("RSUs"), performance awards ("PRSUs") and other forms of awards granted or denominated in shares of the Company's common stock, as well as certain cash-based awards. Pre-tax share-based compensation expense for the three months ended December 31, 2022 and 2021 was $i1
million and $i14 million, respectively. The decrease in pre-tax share-based compensation is primarily due to forfeitures of RSUs and PRSUs which have occurred since the first quarter of fiscal 2022. The forfeitures were driven in part by restructuring activities initiated by the Company beginning in the fourth quarter of fiscal 2022.
During the fourth quarter of fiscal 2022, the
Company suspended distribution of shares under the 2019 Equity Incentive Plan (the "2019 Plan") and suspended purchases of shares under the Employee Stock Purchase Plan until the Company's registration statements are reinstated. Existing awards issued under the 2019 Plan will continue to vest in accordance with the terms of the
respective award agreements. As of December 31, 2022, there were i890,042
RSUs that vested but were unissued under the 2019 Plan. All awards and the shares reserved under the 2019 Plan were canceled upon Emergence.
Restricted Stock Units
During the three months ended December 31, 2022, there were i639,065 RSUs that vested with a weighted average grant date fair value
of $i18.79 per RSU. The Company did not grant any RSUs during the three months ended December 31, 2022.
Stock Bonus Program
In fiscal 2021, the
Company adopted the Avaya Holdings Corp. Stock Bonus Program ("Stock Bonus Program") under which certain employees can elect to receive a specified percentage of their annual incentive bonus in the form of fully vested shares of the Company’s common stock in lieu of cash. Annually, the Company's Board approved the maximum number of shares that could be issued under the Stock Bonus Program. For fiscal 2023, the Company's Board did not approve any shares for issuance under the Stock Bonus Program.
Upon implementation of the Plan, all share-based awards were canceled.
13. iPreferred
Stock
There were iiii125,000/// shares
of the Company's i3% Series A Convertible Preferred Stock, par value $ii0.01/
per share ("Series A Preferred Stock"), issued and outstanding as of December 31, 2022. Upon implementation of the Plan pursuant to the RSA, the Series A Preferred Stock was canceled upon Emergence and the attendant board designation rights described below were eliminated.
The Series A Preferred Stock was convertible into shares of the Company's common stock at an initial conversion price of $i16.00 per share, which represented an approximately i9%
interest in the Company's common stock on an as-converted basis as of December 31, 2022, assuming no holders of options, warrants, convertible notes or similar instruments exercised their exercise or conversion rights.
As of December 31, 2022, the carrying value of the Series A Preferred Stock was $ii134/
million, which included $i9 million of accreted dividends paid in kind. During the three months ended December 31, 2022, the carrying value of the Series A Preferred Stock increased $i1
million due to accreted dividends paid in kind.
In connection with the issuance of the Series A Preferred Stock, the Company granted RingCentral certain customary consent rights with respect to certain actions by the Company, including amending the Company's organizational documents in a manner that would have an adverse effect on the Series A Preferred Stock and issuing securities that are senior to, or equal in priority with, the Series A Preferred Stock. In addition, pursuant to an investor rights agreement, until such time when RingCentral and its affiliates hold or beneficially
own less than i4,759,339 shares of the Company's common stock (on an as-converted basis), RingCentral has the right to nominate one person for election to the Company's Board. The director designated by RingCentral has the option (i) to serve on the Company's Audit and Nominating and Corporate
Governance Committees or (ii) to attend (but not vote at) all of the Company's Board's committee meetings. On November 6, 2020, Robert Theis was elected to join the Company's Board as RingCentral's designee. On October 20, 2022, Robert Theis provided notice of his intent to resign from the Board effective October 31, 2022, in order to focus on his other commitments as General Partner of World Innovation Lab and Lead Independent Director of RingCentral. Mr. Theis's resignation was not due to any disagreement between Mr. Theis and the Company
on any matter relating to the Company’s operations, policies, or practices. Subsequent to Mr. Theis's departure, RingCentral nominated Jill K. Frizzley for election to the Company's Board. On December 13, 2022, Ms. Frizzley was elected to join the Board. On the Emergence Date, all members of the Board resigned and the New Board was appointed pursuant to the Plan.
iThe following table sets forth the calculation of net loss attributable to common stockholders and the computation of basic and diluted loss per share for the periods indicated:
Three
months ended December 31,
(In millions, except per share amounts)
2022
2021
Loss per share:
Numerator
Net loss
$
(ii164/)
$
(i66)
Dividends
to preferred stockholders
(i1)
(i1)
Undistributed
loss
(ii165/)
(ii67/)
Percentage
allocated to common stockholders(1)
i100.0
%
i100.0
%
Numerator
for basic and diluted loss per common share
$
(ii165/)
$
(ii67/)
Denominator
for basic and diluted loss per common share
ii87.5/
ii84.7/
Loss
per common share
Basic
$
(i1.89)
$
(i0.79)
Diluted
$
(i1.89)
$
(i0.79)
(1)
Basic weighted average common stock outstanding
i87.5
i84.7
Basic
weighted average common stock and common stock equivalents (preferred shares)
i87.5
i84.7
Percentage
allocated to common stockholders
i100.0
%
i100.0
%
/
For
the three months ended December 31, 2022, the Company excluded i3.2 million RSUs, i0.3
million stock options, i58.1 million shares underlying the Exchangeable Notes, i7.9
million shares underlying the Convertible Notes and Call Spread Warrants, i22.1 million shares underlying the outstanding consideration advance received in connection with the Company's strategic partnership with RingCentral and i0.1
million shares of Series A Preferred Stock from the diluted loss per share calculation as their effect would have been anti-dilutive. The Company also excluded i3.8 million PRSUs from the diluted loss per share calculation as either their performance metrics have not yet been attained or their effect would have been anti-dilutive.
For the three months ended December
31, 2021, the Company excluded i4.6 million RSUs, i0.3
million stock options, i0.2 million shares issuable under the ESPP, i5.6
million 2017 Emergence Date Warrants, i12.6 million shares underlying the Convertible Notes and Call Spread Warrants and i0.1
million shares of Series A Preferred Stock from the diluted loss per share calculation as their effect would have been anti-dilutive. The Company also excluded i2.1 million PRSUs and i0.3
million shares authorized under the Company's Stock Bonus Program from the diluted loss per share calculation as either their performance metrics had not yet been attained or their effect would have been anti-dilutive.
With the adoption of ASU 2020-06 on October 1, 2022, the Company is required to calculate the potential dilutive effect of its convertible instruments under the if-converted method. As disclosed in our fiscal 2022 Form 10-K filed on September 8, 2023, the Company has been using the if-converted method to calculate the dilutive impact of its convertible instruments
since the third quarter of fiscal 2022. The use of the if-converted method in the current period does not impact the comparability of diluted earnings per share for the three months ended December 31, 2022 and 2021 as the Company's convertible instruments would have been anti-dilutive under both the treasury stock and if-converted methodologies.
15. iOperating
Segments
The Products & Solutions segment primarily develops, markets, and sells unified communications and collaboration and contact center solutions, offered on-premise, in the cloud, or as a hybrid solution. These integrate multiple forms of communications, including telephony, email, instant messaging and video. The Services segment develops, markets and sells comprehensive end-to-end global service offerings that enable customers to evaluate, plan, design, implement, monitor, manage and optimize complex enterprise communications networks. Revenue from customers who upgrade and acquire new technology through the Company's subscription offerings is reported within the Services segment.
The Company's chief operating decision maker makes financial decisions and allocates resources based on segment profit information obtained from the Company's internal management systems. Management does not include in its segment measures of profitability selling, general and administrative expenses, research and development expenses, amortization of intangible assets, and certain discrete items, such as fair value adjustments recognized upon emergence from bankruptcy, charges relating to restructuring actions, and impairment charges as these costs are not core to the measurement of segment performance, but rather are controlled at the corporate level.
iSummarized
financial information relating to the Company's operating segments is shown in the following table for the periods indicated:
Three months ended December 31,
(In millions)
2022
2021
REVENUE
Products
& Solutions
$
i136
$
i231
Services
i282
i482
i418
i713
GROSS
PROFIT
Products & Solutions
i66
i120
Services
i117
i291
Unallocated
Amounts(1)
(i35)
(i42)
i148
i369
OPERATING
EXPENSES
Selling, general and administrative
i221
i262
Research
and development
i50
i61
Amortization of intangible assets
i39
i40
Impairment
charges
i9
i—
Restructuring charges, net
i10
i7
i329
i370
OPERATING
LOSS
(i181)
(i1)
INTEREST EXPENSE AND OTHER (EXPENSE) INCOME,
NET
(i9)
(i47)
LOSS
BEFORE INCOME TAXES
$
(i190)
$
(i48)
/
(1)Unallocated
amounts in Gross Profit reflect the effect of the amortization of technology intangible assets.
Reclassifications
from Accumulated other comprehensive income (loss) related to changes in unamortized pension, post-retirement and post-employment benefit-related items are recorded in Other (expense) income, net. Reclassifications from Accumulated other comprehensive income (loss) related to the unrealized gain (loss) on interest rate swap agreements are recorded in Interest expense.
17. iRelated Party Transactions
As of December 31,
2022, the Board was comprised of eight directors, including the Company's Chief Executive Officer and seven non-employee directors.
On October 20, 2022, Robert Theis, who was elected to join the Board as RingCentral's designee on November 6, 2020, provided notice of his intent to resign from the Board effective October 31, 2022. On December 13, 2022, Jill K. Frizzley was appointed to the Board in Mr. Theis' place pursuant to the Company's strategic partnership with RingCentral. See Note 13, "Preferred Stock," to our unaudited
interim Condensed Consolidated Financial Statements for additional information.
On February 1, 2023, the Board increased the size of the Board by one director, from eight to nine members, and appointed Carrie W. Teffner to fill the vacancy resulting from the increase.
Specific Arrangements Involving the Company's Directors and Executive Officers
Stephan Scholl, a Director of the Company who resigned in connection with Emergence, is the Chief Executive Officer of Alight Solutions LLC ("Alight"), a provider of integrated benefits, payroll and cloud solutions, and he also serves on Alight's board of directors. During
each of the three months ended December 31, 2022 and 2021, the Company purchased goods and services from subsidiaries of Alight of $ii1/
million. As of December 31, 2022 outstanding accounts payable due to Alight was immaterial. As of September 30, 2022, outstanding accounts payable due to Alight was $i1 million.
18. iCommitments
and Contingencies
Legal Proceedings
In the ordinary course of business, the Company is involved in litigation, claims, government inquiries, investigations and proceedings including, but not limited to, those relating to intellectual property, commercial, employment, environmental indemnity and regulatory matters. The Company records accruals for legal contingencies to the extent that it has concluded that it is probable that a liability has been incurred and the amount of the loss can be reasonably estimated. When a material loss contingency is reasonably possible but not probable, the Company does not record a liability,
but instead discloses the nature and the amount of the claim, and an estimate of the loss or range of loss, if such an estimate can be made.
Other than as described below, in the opinion of the Company's management, the likely results of these matters are not expected, either individually or in the aggregate, to have a material adverse effect on the Company's financial position, results
of operations or cash flows.
However, an unfavorable resolution could have a material adverse effect on the Company's financial position, results of operations or cash flows in the periods in which the matters are ultimately resolved, or in the periods in which more information is obtained that changes management's opinion of the ultimate disposition.
On January 14, 2020, Solaborate Inc. and Solaborate LLC (collectively, "Solaborate") filed suit against the Company in California Superior Court in San Bernardino County. The dispute concerned activities related to the Company's development of the CU360 collaboration unit. Solaborate alleged breach
of contract, trade secret misappropriation and unfair business practices, among other causes of action. During the third quarter of fiscal 2022, the Company accrued an expense representing its best estimate of the probable loss which was not material.
On February 3, 2023, the Company reached an agreement to settle the lawsuit with Solaborate and agreed to pay an amount consistent with the expense it accrued as of December 31, 2022.
The Company
enters into indemnification agreements with each of the Company's directors and officers. These agreements require the Company to indemnify these individuals to the fullest extent permitted under Delaware law against liabilities that may arise by reason of their service to the Company, and to advance expenses incurred as a result of any proceeding against them as to which they could be indemnified. Subject in all respects to applicable law, these agreements generally survive a director's or officer's resignation and/or termination and generally require the Company to indemnify such individuals unless the
conduct that is the subject of a claim constitutes a breach of their duty of loyalty to the Company or to the Company's stockholders, or is an act or omission not taken in good faith, or which involves intentional misconduct or a knowing violation of the law. In connection with the investigations, the Company has received requests under such indemnification agreements to provide funds for legal fees and other expenses and expects additional requests in connection with the Investigations and related litigation. The Company has not recorded a liability for expected
future expenses as of December 31, 2022 for these matters as it cannot estimate the ultimate outcome at this time but has expensed payments made through December 31, 2022. The Company maintains a directors and officers insurance policy under which a portion of the indemnification expenses may be recoverable to mitigate its exposure to potential indemnification obligations. As of December 31, 2022, the Company has not reached its insurance deductible and has not recorded a receivable related to the indemnification claims. We are unable to make a reliable estimate of the eventual cash flows by period related to the indemnification agreements and related
insurance recoveries.
Avaya notified the SEC of the Audit Committee Investigations and the SEC initiated an investigation to review, among other things, the circumstances surrounding Avaya's financial results for the quarter ended June 30, 2022. Avaya has been cooperating with the SEC's investigation, which is on-going. At this time, the Company is not able to predict the outcome or consequences of the SEC's investigation, however, an adverse outcome could have a material adverse effect on the Company's financial position, results of operations or cash flows.
On January 3, 2023, Jeffrey A. Fletcher, et al., filed
a putative securities class action complaint (Civil Action No. 1:23-cv-00003) in the United States District Court Middle District of North Carolina, naming Avaya Holdings Corp. and certain of our current and former officers as defendants. The complaint alleged violations of the Exchange Act, based on allegedly false or misleading statements related to the Company’s internal control over financial reporting, the effectiveness of our internal controls over our whistleblower policies and ethics and compliance program and our financial condition. The plaintiffs sought awards of compensatory damages, among other relief and their costs and attorneys’ and experts’ fees. On February 28, 2023, the plaintiff voluntarily filed for dismissal of the action without prejudice, as to all defendants. At this time, the
Company is not able to predict the ultimate outcome of this matter, however, an adverse outcome could have a material adverse effect on the Company's financial position, results of operations or cash flows.
On February 1, 2023, A6 Capital Management LP, et al., filed a summons with notice (Index No. 650626/2023) in the Supreme Court of the State of New York, New York County, naming certain of our former directors and officers as defendants. The plaintiffs were current or former investors in certain unsecured convertible notes issued by the Company in 2018 and due 2023 (the “Convertible Notes”) and certain plaintiffs invested in the
Company’s secured term loan issued in July 2022. The complaint alleged fraud as a result of allegedly false statements regarding the Company’s finances and management, which the plaintiffs relied upon in holding or purchasing the Company’s Convertible Notes. The plaintiffs sought awards of compensatory damages, among other relief. On May 3, 2023, the plaintiffs voluntarily filed an amended notice of discontinuance with prejudice, as to all parties.
On February 14, 2023, Oliver Jiang, et al., filed a putative class action complaint (Civil Action No. 1:23-cv-1258) in the United States District Court for the Southern District of New York against Avaya Holdings
Corp., and certain of our former officers as defendants (collectively, "Jiang Suit Defendants"). The complaint alleged the purported inclusion of false statements and material omissions in securities filings, and press releases filed with the SEC or issued, as applicable, between October 3, 2019 and November 29, 2022, regarding Avaya’s Q3 2022 earnings guidance and results and the Company’s relationship with RingCentral (the "Jiang Securities Lawsuit"). The lawsuit alleges that the Jiang Suit Defendants exploited Avaya’s insufficient reporting controls and procedures, which resulted in inaccurate budgeting and reporting, to inflate Avaya’s stock price, at which
point the Jiang Suit Defendants sold shares and secured financing on improper terms, all in violation of Section 10(b) of the Exchange Act and Rule 10b-5, as well as for derivative “control person” liability, which was pled against Mr. Chirico, our former CEO, and Mr. McGrath, our former Chief Financial Officer, for Avaya’s actions, and, vice versa, against the Company—pursuant to Section 20(a). This case was filed after the Company filed its petition for Chapter 11 proceedings and therefore the plaintiff voluntarily dismissed the case against the Company. The Plaintiff’s claims against Mr. Chirico and Mr. McGrath
remain and are subject to the indemnification agreements described above.
Product Warranties
The Company recognizes a liability for the estimated costs that may be incurred to remedy certain deficiencies of quality or performance of the Company's products. These product warranties extend over a specified period of time, generally ranging up to itwo years from the date of sale depending upon the product subject to the warranty. The
Company accrues a provision for estimated future warranty costs based upon the historical relationship of warranty claims to sales. The Company periodically reviews the adequacy of its product warranties and adjusts, if necessary, the warranty percentage and accrued warranty reserve, which is included in other current and non-current liabilities in the Condensed Consolidated Balance Sheets, for actual experience. As of both December 31, 2022 and September 30, 2022, the amount reserved for product warranties was $ii1/
million.
Guarantees of Indebtedness and Other Off-Balance Sheet Arrangements
Letters of Credit and Guarantees
The Company provides guarantees, letters of credit and surety bonds to various parties as required for certain transactions initiated during the ordinary course of business to guarantee the Company's performance in accordance with contractual or legal obligations. As of December 31, 2022, the maximum potential payment obligation with regards to letters of credit, guarantees and surety bonds was $i64
million. The outstanding letters of credit are deemed to have been issued under the DIP ABL Facility, other than with respect to letters of credit issued by Goldman Sachs, which are cash collateralized. The cash collateral of $i4 million is characterized as restricted cash and included in Other assets on the Condensed Consolidated Balance Sheets as of December 31, 2022.
Purchase Commitments and Termination Fees
The
Company purchases components from a variety of suppliers and uses several contract manufacturers to provide manufacturing services for its products. During the normal course of business, to manage manufacturing lead times and to help assure adequate component supply, the Company enters into agreements with contract manufacturers and suppliers that allow them to produce and procure inventory based upon forecasted requirements provided by the Company. If the Company does not meet these specified purchase commitments, it could be
required to purchase the inventory, or in the case of certain agreements, pay an early termination fee. Historically, the Company has not been required to pay a charge for not meeting its designated purchase commitments with these suppliers, but has been obligated to purchase certain excess inventory levels from its outsourced manufacturers due to actual sales of product varying from forecast and due to transition of manufacturing from one vendor to another.
The Company's outsourcing agreements with its most significant contract manufacturers automatically renew in July and September for successive periods of twelve months each, subject to specific termination rights
for the Company and the contract manufacturers. All manufacturing of the Company's products is performed in accordance with either detailed requirements or specifications and product designs furnished by the Company and is subject to quality control standards.
The Company maintains a reseller agreement with an equipment vendor to procure, build and store IT equipment on behalf of the Company based upon letters
of intent or other order forms provided by the Company. The Company either purchases the equipment or leases the equipment through a third party vendor for use in its data centers, predominantly to support its cloud customers. Under the agreement, the Company’s right to use the equipment commences upon delivery of the equipment. The Company's maximum obligation under these arrangements based on equipment held by the vendor as of December 31, 2022 was $i6
million. The Company is entitled to return the equipment subject to certain conditions.
From time to time, the Company also enters into cloud services agreements to support the delivery of the Company’s Avaya cloud solutions to its customers. These contracts range from three to isix
years and typically contain minimum consumption commitments over the life of the agreements. As of December 31, 2022, the Company’s remaining commitments under its cloud services agreements and hosting agreements were $i184 million, of which $i11
million, $i15 million and $i16 million is required to be utilized by fiscal 2024, 2025 and 2026, respectively, with the remaining balance required to be utilized by fiscal 2027.
During
fiscal 2022, the Company entered into an agreement to acquire third-party software licenses to enhance its product portfolio serving large and complex contact center environments. The consideration for the licenses is sales-based and includes a minimum commitment which is payable to the extent that the sales-based consideration does not meet specified thresholds
within the agreement. As of December 31, 2022, the
Company's remaining minimum commitment under the agreement is $iii8//
million for each of fiscal 2023, 2024 and 2025.
On February 14, 2023, the Company and RingCentral amended the terms of the First Amended and Restated Framework Agreement, dated February 10, 2020, and the related partnership documents executed in connection therewith, by entering into the Second Amended and Restated Framework Agreement and the related partnership documents executed in connection therewith (the "Amended and Restated RingCentral Agreements"). Among other things, the Amended and Restated RingCentral Agreements, contemplate (i) the Company continuing to serve as the exclusive sales agent for Avaya Cloud Office by RingCentral ("Avaya
Cloud Office" or "ACO"); (ii) expanded go-to-market constructs that will enable the Company to directly sell ACO seats into its installed base; (iii) cash compensation to the Company as ACO seats are sold along with the elimination or modification of certain other financial obligations of the Company under the original agreements, including the waiver of the remaining balance of the consideration advance paid by RingCentral to the Company; and (iv) the Company's agreement to purchase seats of ACO in the event certain volumes of ACO
sales, which increase over the time period, are not met. The Company's volume commitments are based on cumulative ACO sales that are measured quarterly during the term of the Amended and Restated RingCentral Agreements, subject to the terms and conditions of such agreements. In the event that the cumulative number of ACO seats sold as of the end of each calendar quarter is lower than the agreed upon threshold established for such quarter, the Company will be required to purchase a number of ACO seats equal to such shortfall from RingCentral. Any such ACO seats are subject to certain limitations and must be purchased for a two-year paid term with payments made monthly and pricing that is variable based on sales volumes by jurisdiction, contract
size and product tier. The Company may resell such ACO seats to end customers or maintain them for internal use.
Transactions with Nokia
Pursuant to the Contribution and Distribution Agreement effective October 1, 2000 (the "Contribution and Distribution Agreement"), Nokia Corporation ("Nokia", formerly known as Lucent Technologies, Inc. ("Lucent")) contributed to the Company substantially all of the assets, liabilities and operations associated with its enterprise networking businesses (the "Contributed Businesses") and distributed the Company's
stock pro-rata to the shareholders of Lucent ("distribution"). The Contribution and Distribution Agreement, among other things, provides that, in general, the Company will indemnify Nokia for all liabilities including certain pre-distribution tax obligations of Nokia relating to the Contributed Businesses and all contingent liabilities primarily relating to the Contributed 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 Nokia 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 $i50 million. The Company is unable to determine the maximum potential amount of other future payments, if any, that it could be required to make under this agreement.
In addition, in connection with the distribution, the Company
and Lucent entered into a Tax Sharing Agreement effective October 1, 2000 (the "Tax Sharing Agreement") that governs Nokia's and the Company's respective rights, responsibilities and obligations after the distribution with respect to taxes for the periods ending on or before the distribution. Generally, pre-distribution taxes or benefits that are clearly attributable to the business of one party will be borne solely by that party and other pre-distribution taxes or benefits will be shared by the parties based on a formula set forth in the Tax Sharing Agreement. The Company may be subject to additional taxes or benefits pursuant to the Tax Sharing Agreement related to future settlements of audits by state and local and foreign taxing authorities
for the periods prior to the Company's separation from Nokia.
19. iSubsequent Events
Chapter 11
See Note 1, "Background and Basis of Presentation," Note 7, "Financing Arrangements," and Note 18, "Commitments and Contingencies," to our Condensed Consolidated Financial Statements for information related to the following,
all of which occurred subsequent to December 31, 2022.
▪the Board and Audit Committee Investigations;
▪the Chapter 11 Filing;
▪the Plan;
▪the Debtor in Possession Financing and Exit Financing;
▪the NYSE Delisting; and
▪the Emergence from Voluntary Reorganization under Chapter 11 of the Bankruptcy Code.
During the second quarter of fiscal 2023, the Company repaid the remainder of the ABL Credit Agreement.
Director Appointment
On February 1, 2023, the Board increased the size of the Board by one director, from eight to nine members and appointed Carrie W. Teffner to fill the vacancy resulting from the increase in the size of the Board.
Fiscal 2023 Restructuring Program
During the second quarter of fiscal 2023, the Company
authorized a reduction in force with respect to its global employees in connection with the Company’s cost-reduction actions. The reduction in force is aimed at aligning the size of Avaya’s workforce with its operational strategy and cost structure. The Company estimates that it will incur approximately $i57 million to $i65
million in pre-tax restructuring charges in connection with this reduction in force, all of which are expected to be in the form of cash-based expenditures and substantially all of which are expected to be related to employee severance and other termination benefits. The Company expects to complete the most recently authorized reduction in force and recognize substantially all of these pre-tax restructuring charges during fiscal 2023. As the Company continues to evaluate opportunities to streamline its operations, it may identify additional cost reduction actions that will include workforce reductions and other incremental cost reduction actions.
On February 14, 2023, the Company and RingCentral entered into the Amended and Restated RingCentral Agreements. Among other things, the Amended and Restated RingCentral Agreements contemplate (i) the Company continuing to serve as the exclusive sales agent for ACO; (ii) expanded go-to-market constructs that will enable the Company to directly sell ACO seats into its installed base; (iii) cash compensation to the Company as ACO seats are sold along with the elimination or modification of certain other financial obligations of the
Company under the original agreements, including the waiver of the remaining balance of the consideration advance paid by RingCentral to Avaya Inc; and (iv) the Company's agreement to purchase seats of ACO in the event certain volumes of cumulative ACO sales are not met (see Note 18, "Commitments and Contingencies").
Post-Emergence Board of Directors
Upon Emergence, all members of our Board resigned. Alan B. Masarek, our Chief Executive Officer, was appointed to the new Board, together with the following individuals: Patrick J. Bartels Jr., Patrick J. Dennis, Robert Kalsow-Ramos, Marylou Maco, Aaron Miller, Donald E. Morgan III, Thomas T. Nielsen and Jacqueline D. Woods.
Conversion of Avaya Inc. into a Delaware Limited Liability Company
On
May 1, 2023, Avaya Inc., a wholly-owned subsidiary of Avaya and its primary operating subsidiary, was converted from a Delaware corporation into a Delaware limited liability company and its name was changed to Avaya LLC.
Management's
Discussion and Analysis of Financial Condition and Results of Operations
Unless the context otherwise indicates, as used in this "Management's Discussion and Analysis of Financial Condition and Results of Operations," the terms "we,""us,""our,""the Company,""Avaya" and similar terms refer to Avaya Holdings Corp. and its consolidated subsidiaries. The following Management’s Discussion and Analysis of Financial Condition and Results of Operations is intended to help the reader understand the results of operations and financial condition of the Company.Management's
Discussion and Analysis of Financial Condition and Results of Operations should be read in conjunction with the unaudited interim Condensed Consolidated Financial Statements and the related notes included elsewhere in this Quarterly Report on Form 10-Q and our Consolidated Financial Statements and other financial information for the fiscal year ended September 30, 2022, included in our Annual Report on Form 10-K for the fiscal year ended September 30, 2022 filed with the United States Securities and Exchange Commission ("SEC") on September 8, 2023.
Our accompanying unaudited interim Condensed Consolidated Financial Statements have been prepared in accordance with accounting principles generally accepted in the United States of America ("GAAP") and the rules and
regulations of the SEC for interim financial statements. In our opinion, the unaudited interim Condensed Consolidated Financial Statements reflect all adjustments, consisting of normal and recurring adjustments, necessary to state fairly the financial position, results of operations and cash flows for the periods indicated. Capitalized terms used in this Management’s Discussion and Analysis of Financial Condition and Results of Operations not otherwise defined have the meaning given to them in the notes to the Company’s unaudited Condensed Consolidated Financial Statements included elsewhere in this Quarterly Report on Form 10-Q.
The matters discussed in this "Management's Discussion and Analysis of Financial Condition and Results of Operations" contain certain forward-looking statements within the meaning of the Private Securities
Litigation Reform Act of 1995. See "Cautionary Note Regarding Forward-Looking Statements" at the end of this discussion.
Overview
Avaya is a global leader in communications products, solutions and services for businesses of all sizes, delivering technology predominantly through software and services. We enable organizations worldwide to succeed by creating intelligent communications experiences for our clients, their employees and their customers. Avaya is building innovative open, converged contact center ("CC") and unified communications and collaboration ("UCC") software solutions to enhance and simplify communications and collaboration in the cloud, on-premises or as a hybrid of both. We offer hardware and gateway solutions, including devices
that enhance collaboration and productivity, and position organizations to incorporate future technological advancements.
Our global, experienced team of professionals delivers award-winning services from initial planning and design, to seamless implementation and integration, to ongoing managed operations, optimization and support. We also help clients customize and personalize our software solutions to address their specific needs.
Businesses are built by the experiences they provide, and Avaya solutions deliver millions of those experiences globally every day. With a global install base including many of the largest enterprise customers with the most complex needs, Avaya is shaping the future of businesses and workplaces, with innovation and partnerships that power tangible business results. Our communications solutions power tailored, effortless customer and employee experiences
that enable our clients to effectively engage and interact with each other and with their customers.
In serving both our existing and new customers across verticals, Avaya is uniquely positioned to meet customers where they are in their digital transformation and journeys to cloud communications, so they can innovate without disruption to gain the benefit of high-value cloud capabilities. We offer a full range of software sales and licensing models that can be deployed on-premises or via a public/multi-tenant cloud, private/dedicated instance cloud or as a hybrid cloud solution. With our open, extensible development platform, customers and third parties can create custom applications and automated workflows for their unique needs and integrate Avaya’s capabilities into the customer's existing infrastructure and business applications. Our solutions enable a seamless communications experience that adapts to how employees work,
instead of changing how they work.
Operating Segments
The Company has two operating segments: Products & Solutions and Services.
Products & Solutions
Products & Solutions encompasses our CC and UCC software platforms, applications and devices, including cloud-based solutions embedded with Artificial Intelligence ("AI") to create enhanced user experiences and improve performance.
•Contact Center: Avaya’s industry-leading contact center solutions enable clients to build a customized portfolio
of applications to drive stronger customer engagement and higher customer lifetime value. Our reliable, secure and
scalable communications solutions include voice, email, chat, social media, video, workforce engagement and third-party integration that can improve customer service and help companies compete more effectively. Avaya delivers Contact Center as a Service ("CCaaS") solutions for cloud deployment, and we continue to support enterprises with world-class premises-based solutions and add new value by complementing this highly dependable infrastructure with new capabilities from the cloud. We continue to integrate
AI and automation capabilities into our portfolio, providing our clients a deeper understanding of their customers’ needs with a robust and secure platform.
•Unified Communications: Avaya communications and collaboration solutions support hybrid working environments, empowering teams with fast, always-on continuous collaboration from anywhere. Employees can communicate in context with better access to communication tools and better quality of communications to help deliver greater business impacts.
Avaya multi-tenant cloud-based UCaaS solutions integrate chat, file sharing and task management with real-time collaboration including calling, meetings and content sharing for distributed team productivity. Avaya offers Avaya Cloud Office in partnership with RingCentral, giving customers looking to replace outdated or disparate legacy telephony
systems with a simple, comprehensive communications solution. Our on-premises Unified Communications ("UC") solutions, IP Office for midmarket clients and Avaya Aura for enterprise clients continue to deliver high reliability and functionality that is preferred in a variety of situations, including specific verticals, or where connectivity may be an issue.
Services
Complementing our product and solutions portfolio is an award-winning global services portfolio, delivered by Avaya and our extensive partner ecosystem. Within our services portfolio, we utilize a variety of formal survey and customer feedback mechanisms to drive continuous improvement and streamlined process automation, with a focus on constantly increasing our value to customers. Our innovative offerings provide solutions for new clients who want to directly utilize our cloud solutions, support for clients who
have the need for hybrid cloud solutions that maximize the value their on-premises systems can deliver, and flexible migration paths for our premises-based customers. This is delivered and supported by:
•Professional Services enable our customers to take full advantage of their IT and communications solution investments to drive measurable business results. Avaya has repositioned its professional services organization to focus on go-forward customer needs. The new Avaya Customer Experience Service ("ACES") brings our depth of experience as our experts partner with customers and guide them along each step of the solution lifecycle to deliver services that add value and drive business transformation — including journey to cloud consulting services. The role of professional services organizations changes in a cloud world, moving from implementations to cloud migration. ACES
takes a client-led approach to bring the expertise and practice areas that help clients define the choices and pace for their journey, based on their priorities for experiences and outcomes. Importantly, organizations can bring forward the customizations they have built over the years and add new value with AI and cloud capabilities. Most of our professional services revenue is non-recurring in nature.
•Enterprise Cloud and Managed Services enable customers to take advantage of our technology via the cloud, on-premises solutions or a hybrid of both, depending on the system and the needs of the customer. Avaya focuses on customer performance and growth, encompassing software releases, operating customer cloud, premise or hybrid-based communication systems and helping customers migrate to next-generation business communications environments. Most of our enterprise cloud and managed
services revenue is recurring in nature and based on multi-year services contracts.
•Global Support Services help businesses protect their technology investments and address the risk of business-impacting outages. Understanding that agility and high availability are critical to maintain or gain competitive advantage, we facilitate those capabilities through proactive problem prevention, rapid resolution, continual solution optimization, and we increasingly leverage automation to onboard and manage a customer’s communications infrastructure, for faster, more effective deployments from proof of concept to production, and ever-increasing automation. Our subscription offering sets a foundation for continually evolving the customer experience by providing access to future capabilities and solution
enhancements. Most of our global support services revenue is recurring in nature.
Through our comprehensive services, we support our customers' ability to fully leverage our technology and maximize their business results. Our solutions drive employee productivity improvements and a differentiated customer experience.
Our services teams help our customers maximize their ability to benefit from Avaya's next-generation communications solutions. Customers can choose the level of support best suited for their needs, aligned with deployment, monitoring, solution management, optimization and more. Our enhanced performance monitoring, coupled with a continuous focus on automation allows us to quickly identify and remediate issues to avoid business impact.
As previously disclosed, on February 14, 2023 (the “Petition Date”), Avaya Holdings and certain of its direct and indirect subsidiaries (the “Debtors”) entered into a Restructuring Support Agreement (the “RSA”) with certain of its creditors and RingCentral which contemplated the Plan.
On the Petition Date, the Debtors commenced the Chapter 11 Cases in the United States Bankruptcy Court for the Southern District of Texas (the “Bankruptcy Court”). The Chapter 11 Cases were jointly administered under the caption In re Avaya Inc., et al., case number 23-90088.
The Bankruptcy Court confirmed the Plan on March 22, 2023 and the Debtors satisfied all conditions required for Plan effectiveness and emerged from the Chapter 11 Cases on May 1, 2023.
Upon Emergence, the Debtors reduced their total debt by more than 75%, and increased their liquidity position to over $650 million.
See Note 1, “Background and Basis of Presentation,” Note 7, "Financing Arrangements," and Note 19, "Subsequent Events," to our unaudited Condensed Consolidated Financial Statements for additional information on the Chapter 11 Cases as well as:
▪the Board and Audit Committee Investigations;
▪the
Chapter 11 Filing;
▪the Restructuring Support Agreement;
▪the Automatic Stay;
▪the Plan;
▪the Debtor in Possession Financing and Exit Financing;
▪the NYSE Delisting; and
▪the Emergence from Voluntary Reorganization under Chapter 11 of the Bankruptcy Code.
Cost-Cutting Initiative
Since July 2022, the Company has initiated a number of cost-cutting measures that
are expected to primarily impact the Company’s overall selling, general and administrative expenses, as well as discretionary spending, including but not limited to reductions in force with respect to employees globally aimed at aligning the size of the Company’s workforce with the Company’s operational strategy and cost structure. As a result of these cost-cutting actions, the Company expects to generate more than $500 million in annual cost reductions. The Company has commenced these actions which began to yield quantifiable savings in the
first quarter of fiscal 2023 and are expected to be completed in fiscal 2024.
OneCloud Business Updates
During the first quarter of fiscal 2022, the Company executed a OneCloud arrangement for a large global financial institution with an estimated total contract value at that time in excess of $400 million over a term of up to 7 years. The contract was subsequently canceled during the fourth quarter of fiscal 2022. As a result, in the fourth quarter of fiscal 2022 the Company recognized revenue of $14 million and expenses of $22
million, which includes impairment of fixed assets, acceleration of previously deferred costs and other third party costs, associated with this arrangement.
Factors and Trends Affecting Our Results of Operations
There are several trends and uncertainties affecting our business. Most importantly, we are dependent on general economic conditions, the willingness of our customers to invest in technology and the manner in which our customers procure such technology and services.
Industry Trends
Cloud Growth and Migration:
•Growth in cloud-based technologies continues as businesses focus on digital transformation projects. This expansion of cloud delivery of software applications and management of varied devices in turn leads to
an increasing demand for reliability and security.
•Even with the growing contact center market conversion to cloud, on-premises solutions remain a meaningful share of the market, estimated at ~48% in 2026.
•While companies seek innovation, they also want to avoid disruption. The ability to add modular innovation over the top of existing systems can drive significant value, enabling them to transform in a phased approach. This preference
for a hybrid approach that mitigates risk favors vendors
that have a large install base of customers with dependable technology in place.
•With the increasing overlap between CC and UCC, driven by customer workflows and the need to bring the back office into the frontline of the company, platforms that deliver integrated CCaaS and UCaaS are the foundation of next-generation business communications solutions. A converged, integrated offering for next-generation communications capabilities delivered across a host of mobile devices, and multiple communication and customer service channels bridges what has typically been siloed CC and UCC applications into one powerful tool.
Hybrid/Distributed Workforce:
•A clear priority is the business need to support individuals'
expectations for flexible, multi-channel communications and remote and hybrid work styles that have arisen out of the COVID-19 pandemic. The global pandemic altered the way employees and end customers interact and engage, resulting in broad impacts to the ways businesses approach their internal and customer-facing communications planning and platforms.
•Evolving hybrid work environments highlight the need for organizations to ensure consistent collaboration experiences in unpredictable situations, regardless of workers' locations or time zones. Avaya solutions are well positioned to enable this work from anywhere approach while maintaining security, reliability and scalability requirements.
•Businesses plan to modify their use of office space to accommodate hybrid and remote work. Modifications will include space reduction, implementing
hot-desking and hoteling solutions and equipping shared spaces and meeting rooms for video conferencing with remote participants. Video conferencing and collaboration solutions are an integral part of the changing office environment.
The Rise of Artificial Intelligence:
•Automation through AI solutions is driving improved customer and employee experiences. Conversational AI infused in contact center solutions will improve operational efficiencies and customer experiences leading to accelerated contact center platform replacements. AI enhancements also improve the meeting and collaboration experience between in-person and remote meeting participants. Video applications are increasingly being infused with virtual assistants, smart transcription and translation, and facial recognition.
•Extreme
automation is fueling simplicity. Although the enabling technologies in our sector are becoming more complex, their use in contact center applications is driving increased simplicity for organizations and their employees. Simplicity in operations, engagement, customer intelligence and customer experience form the root of the innovation happening in our space.
Growth of the Experience Economy:
•The experience economy continues to grow. The experience economy is based on the concept that experience is a key source of value — it is a differentiator that creates a competitive advantage for products and services. As consumers embrace new technologies and devices in creative ways and at an accelerating pace, Avaya is continuing to invest in AI-powered solutions delivered through cloud and subscription models to create "experiences that matter" for customers,
employees and agents. This increased adoption and deployment of AI is providing significant new opportunities for enhanced CC and UCC solutions that improve the customer experience and transform the digital workplace communications and workflows.
Russia/Ukraine Conflict
The military operation launched by Russia against Ukraine created economic and security concerns that have had and will likely continue to have an impact on regional and global economies and, in turn, our business. Sanctions and other retaliatory measures against Russia have been taken, and could be taken in the future, by the U.S., EU (as defined herein) and other jurisdictions which severely limit our ability to conduct commercial activities with Russian companies, organizations and individuals on the U.S.'s List of Specially Designated Nationals, some of which are Avaya customers. Under current restrictions we
cannot provide certain services to customers in Russia, and as a result, as we comply with all applicable sanctions, we are unable to fulfill certain of our existing contractual obligations to customers in Russia, nor can we commence new maintenance and support arrangements in Russia. The conflict and related retaliatory measures have had, and will continue to have, a negative effect on revenue in Russia for the foreseeable future. Revenue from Russia during the three months ended December 31, 2022 was $2 million, compared to revenue of $17 million during the three months ended December 31, 2021. Prolonged hostilities could exacerbate the overall effects of the conflict on our Company, both in Russia and in other markets where we do business.
The Company’s operations expose it to the effects of inflation. Inflation has become a significant factor in the world economy post-pandemicand has led to an increased interest rate environment as well as inflationary pressures on the Company’s operations, including but not limited to increased labor and finance costs.
Financial Results Summary
The following table displays our consolidated
net loss for the three months ended December 31, 2022 and 2021:
Revenue for the three months ended December 31, 2022 was $418 million compared to $713 million for the three months ended December
31, 2021. The decrease was primarily driven by the cumulative effect of the continuing shift away from on-premise product solutions, and the associated maintenance, software support services and professional services, to subscription and cloud-based solutions; lower revenue from hardware products; the negative impact from various sanctions and other retaliatory measures against Russia resulting from the Russia/Ukraine conflict; and the unfavorable impact of foreign currency exchange rates. In addition, the Company's subscription revenue declined due to lower rates of migrations and shorter contract durations. The decrease was partially offset by higher revenue from the Company's public and private cloud
offerings.
The following table displays revenue and the percentage of revenue to total sales by operating segment for the periods indicated:
Percentage
of Total Revenue
Yr. to Yr. Percentage Change
Yr. to Yr. Percentage Change, net of Foreign Currency Impact
Three months ended December 31,
Three months ended December 31,
(In millions)
2022
2021
2022
2021
Products
& Solutions
$
136
$
231
33
%
32
%
(41)
%
(40)
%
Services
282
482
67
%
68
%
(41)
%
(39)
%
Total
revenue
$
418
$
713
100
%
100
%
(41)
%
(39)
%
Products & Solutions revenue for the three months ended December
31, 2022 was $136 million compared to $231 million for the three months ended December 31, 2021. The decrease was primarily driven by the continuing shift away from on-premise product solutions to the Company's subscription and cloud portfolio; lower revenue from hardware products; and the unfavorable impact of foreign currency exchange rates.
Services revenue for the three months ended December 31, 2022 was $282 million compared to $482 million for the three months ended December 31, 2021. The decrease was primarily driven by declines in hardware maintenance, software support services and professional services which continue to face headwinds driven by the cumulative effect of the continuing
shift away from on-premise product solutions to the Company's subscription and cloud portfolio; and the unfavorable impact of foreign currency exchange rates. In addition, the Company's subscription revenue declined due to lower rates of migrations and shorter contract durations. The decrease was partially offset by higher revenue from the Company's public and private cloud offerings.
The following table displays revenue and the percentage of revenue to total sales by location for the periods indicated:
Percentage
of Total Revenue
Yr. to Yr. Percentage Change
Yr. to Yr. Percentage Change, net of Foreign Currency Impact
Three months ended December 31,
Three months ended December 31,
(In millions)
2022
2021
2022
2021
U.S.
$
208
$
375
50
%
53
%
(45)
%
(45)
%
International:
Europe,
Middle East and Africa
109
192
26
%
27
%
(43)
%
(38)
%
Asia Pacific
56
81
13
%
11
%
(31)
%
(27)
%
Americas
International - Canada and Latin America
45
65
11
%
9
%
(31)
%
(28)
%
Total International
210
338
50
%
47
%
(38)
%
(34)
%
Total
Revenue
$
418
$
713
100
%
100
%
(41)
%
(39)
%
Revenue in the U.S. for the three months ended December
31, 2022 was $208 million compared to $375 million for the three months ended December 31, 2021. The decrease in the U.S. was mainly driven by the continuing shift away from on-premise product solutions, and the associated maintenance, software support services and professional services, to subscription and cloud-based solutions; and lower revenue from hardware products. In addition, the Company's subscription revenue declined due to lower rates of migrations and shorter contract durations. The decrease was partially offset by higher revenue from the Company's public and private cloud offerings.
Revenue in Europe,
Middle East and Africa ("EMEA") for the three months ended December 31, 2022 was $109 million compared to $192 million for the three months ended December 31, 2021. The decrease in EMEA was mainly driven by the continuing shift away from on-premise product solutions, and the associated hardware maintenance, software support services and professional services, to subscription and cloud-based solutions; lower revenue from hardware products; the negative impact from various sanctions and other retaliatory measures against Russia resulting from the Russia/Ukraine conflict; and the unfavorable impact of foreign currency exchange rates. In addition, the Company's subscription revenue declined due to lower rates of migrations and shorter contract
durations.
Revenue in Asia Pacific ("APAC") for the three months ended December 31, 2022 was $56 million compared to $81 million for the three months ended December 31, 2021. The decrease in APAC revenue was mainly driven by the continuing shift away from on-premise product solutions, and the associated hardware maintenance, software support services and professional services, to subscription and cloud-based solutions; lower revenue from hardware products; and to the unfavorable impact of foreign currency exchange rates. In addition, the Company's subscription revenue declined due to lower rates of migrations and shorter contract durations.
Revenue in Americas International for the three months ended December 31, 2022 was $45 million compared to $65 million for the three months ended December 31, 2021. The decrease in Americas International revenue was mainly driven by the continuing shift away from on-premise product solutions, and the associated hardware maintenance, software support services and professional services, to subscription and cloud-based solutions; lower revenue from hardware products; and to the unfavorable impact of foreign currency exchange rates. In addition, the Company's subscription revenue declined due to lower rates of migrations and shorter contract
durations.
Gross Profit
The following table sets forth gross profit and gross margin by operating segment for the periods indicated:
Gross
Margin
Change
Three months ended December 31,
Three months ended December 31,
(In millions)
2022
2021
2022
2021
Amount
Percent
Products
& Solutions
$
66
$
120
48.5
%
51.9
%
$
(54)
(45)
%
Services
117
291
41.5
%
60.4
%
(174)
(60)
%
Unallocated
amounts
(35)
(42)
(1)
(1)
7
(1)
Total
$
148
$
369
35.4
%
51.8
%
$
(221)
(60)
%
(1)Not
meaningful.
Products & Solutions gross profit for the three months ended December 31, 2022 was $66 million compared to $120 million for the three months ended December 31, 2021. The decrease was mainly attributable to the decline in revenue described above. Products & Solutions gross margin decrease from 51.9% for the three months ended December 31, 2021 to 48.5% for the three months ended December 31, 2022. The decrease in margin was attributable to a less favorable product mix including a higher proportion of revenue from hardware as the consumption of higher margin software continues to shift to a subscription model.
Services gross profit for the three months ended December
31, 2022 was $117 million compared to $291 million for the three months ended December 31, 2021. The decrease was mainly driven by the decline in revenue described above. Services gross margin decreased from 60.4% for the three months ended December 31, 2021 to 41.5% for the three months ended December 31, 2022. The decrease in margin was mainly driven by lower subscription revenues, the cumulative effect of the decline in higher margin software support services and a higher mix of lower margin cloud and partner offerings.
Unallocated amounts for the three months ended December 31, 2022 and 2021 include the amortization of technology intangible assets and fair value adjustments
recognized upon emergence from bankruptcy which are excluded from segment gross profit.
Operating Expenses
The following table sets forth operating expenses and the percentage of operating expenses to total revenue for the periods indicated:
Percentage
of Total Revenue
Change
Three months ended December 31,
Three months ended December 31,
(In millions)
2022
2021
2022
2021
Amount
Percent
Selling,
general and administrative
$
221
$
262
52.9
%
36.7
%
$
(41)
(16)
%
Research and development
50
61
12.0
%
8.6
%
(11)
(18)
%
Amortization
of intangible assets
39
40
9.3
%
5.6
%
(1)
(3)
%
Impairment charges
9
—
2.2
%
—
%
9
n/a
Restructuring
charges, net
10
7
2.4
%
1.0
%
3
43
%
Total operating expenses
$
329
$
370
78.8
%
51.9
%
$
(41)
(11)
%
Selling,
general and administrative expenses for the three months ended December 31, 2022 were $221 million compared to $262 million for the three months ended December 31, 2021. The decrease was primarily attributable to lower third party, lower employee related expenses, and lower marketing and advertisement costs driven by the cost cutting initiatives undertaken beginning in fiscal 2022. The decrease was also attributable to lower stock compensation expense and the favorable impact of foreign currency exchange rates. The decrease was partially offset by advisory fees in the current period to assist in the assessment of strategic and financial alternatives to improve the Company's capital structure.
Research and development expenses for the three months ended December 31, 2022 were $50 million compared to $61 million for the three months ended December 31, 2021. The decrease was primarily attributable to lower third party and employee related expenses driven by the cost cutting initiatives undertaken beginning in fiscal 2022.
Amortization of intangible assets for three months ended December 31, 2022 were $39 million compared to $40 million for three months ended December 31, 2021.
Impairment charges for three months ended December 31, 2022
were $9 million, consisting of a $9 million indefinite-lived intangible asset impairment charge. The Company concluded that a triggering event occurred during the three months ended December 31, 2022 as the Company was unable to reach an out-of-court resolution with certain holders of the Convertible Notes, Senior Notes, Exchangeable Notes, and the Term Loans outstanding under the Term Loan Credit Agreement, regarding one or more potential financings, refinancing, recapitalizations, reorganizations, restructurings, or investment transactions involving the Company. As a result, the
Company performed an interim quantitative indefinite-lived intangible asset impairment test as of December 31, 2022. The results of the Company's impairment test indicated that the carrying amount of the Company's indefinite-lived intangible asset, the Avaya Trade Name, exceeded its estimated fair value primarily due to a reduction in the Company's revenue in its updated outlook.
Restructuring charges, net were $10 million for the three months ended December 31, 2022 compared to $7 million for the three months ended December
31, 2021. Restructuring charges during the three months ended December 31, 2022 consisted of $8 million for employee separation actions primarily in the U.S. and EMEA, and $2 million for facility exit costs as the Company optimizes its real-estate footprint. Restructuring charges for the three months ended December 31, 2021 consisted of $5 million for facility exit costs and $2 million for employee separation actions primarily in the U.S. and EMEA. The Company anticipates additional restructuring charges in fiscal 2023 in connection with the cost-cutting actions described above.
Operating Loss
Operating loss
for the three months ended December 31, 2022 was $181 million compared to an operating loss of $1 million for the three months ended December 31, 2021. Our operating results for the three months ended December 31, 2022 as compared to the three months ended December 31, 2021 reflect, among other things, the following items which are described in more detail above:
•lower revenue and gross profit for the three months ended December 31, 2022; and
•lower selling, general and administrative and research and development costs for the three months ended December
31, 2022.
Interest Expense
Interest expense for the three months ended December 31, 2022 was $5 million compared to $54 million for the three months ended December 31, 2021. The decrease was primarily attributable to the settlement of the interest rate swaps and the adoption of ASU 2020-06; offset by an increase in LIBOR rates and the issuance of the Exchangeable Notes, and the associated embedded derivatives during the fourth quarter of the fiscal 2022.
Other (Expense) Income, Net
Other (expense) income, net for the three months ended December 31, 2022 was $(4) million compared to $7 million for the three months ended December
31, 2021. The decrease was mainly driven by the decrease in other pension and post-retirement benefit credits and an increase in foreign currency losses, partially offset by an increase in interest income during the current period.
Benefit from (Provision for) Income Taxes
The benefit from income taxes was $26 million for the three months ended December 31, 2022 compared to a provision for income taxes of $18 million for the three months ended December 31, 2021.
The Company's effective income tax rate for the three months ended December 31, 2022 differed from the U.S. federal tax rate by 7% or $14 million
principally related to deferred taxes (including losses) for which no benefit was recorded because it is more likely than not that the tax benefits would not be realized and the release of deferred taxes from Accumulated Other Comprehensive Income upon termination of interest rate swaps.
The Company's effective income tax rate for the three months ended December 31, 2021 differed from the U.S. federal tax rate by 59% or $28 million principally related to deferred taxes (including losses) generated for which no benefit was recorded because it is more likely than not that the tax benefits would not be realized; and nondeductible expenses.
Net loss was $164 million for the three months ended December 31, 2022 compared to a net loss of $66 million for the three months ended December 31, 2021 as a result of the items discussed above.
Liquidity and Capital Resources
The accompanying unaudited Condensed Consolidated Financial Statements of the Company have been prepared assuming the Company
will continue as a going concern and in accordance with GAAP. The going concern basis of presentation assumes that the Company will continue in operation one year after the date these Condensed Consolidated Financial Statements are issued and will be able to realize its assets and discharge its liabilities and commitments in the normal course of business.
During the fiscal year ended September 30, 2022, the Company experienced a significant slowdown in its operations and had operating cash outflows of $312 million. Additionally, prior to the Chapter 11 Cases, the Company had been involved in discussions with its lenders
relating to the financing transactions it completed in July 2022 (as described further in Note 7, "Financing Arrangements") and the scheduled June 2023 maturity of the Convertible Notes. In its Form 12b-25 in respect of the Quarterly Report on Form 10-Q for the period ended June 30, 2022 filed with the SEC on August 9, 2022, the Company indicated that in light of the Convertible Notes being characterized as a current liability and the related engagement with advisors to address the Convertible Notes, coupled with the decline in revenues during the third quarter, which represented substantially lower revenues than previous Company expectations, and the negative impact of significant operating losses on the
Company’s cash balance, the Company determined that there was substantial doubt about the Company’s ability to continue as a going concern.
The Company has completed certain restructuring actions and is working to complete its remaining restructuring plan as its operating cash flows are expected to remain negative through at least fiscal 2023. The Company may take additional actions, as needed. The Company’s plans are designed to reduce its operating expenses and improve cash flows in line with
its forecasted revenues. On the Emergence Date, the Company had approximately $585 million of cash and cash equivalents, and its post-Emergence debt profile was significantly improved (an aggregate principal amount of $810 million compared to $3,420 million at December 31, 2022), reducing its annual interest expense and extending the earliest maturity of its non-revolving long-term debt to 2028. This post-Emergence capital structure, coupled with restructuring actions that the Company executed to reduce its on-going operating expenses, have provided the Company with sufficient working capital to meet its operating cash flow requirements for at least one year from
the issuance of these financial statements. Accordingly, as a result of the successful Emergence, the Company has alleviated the substantial doubt that had previously existed regarding the Company's ability to continue as a going concern. The Company's longer term liquidity profile will depend on successfully implementing its strategic plan which includes enhancing its product offerings, successfully partnering with alliance companies and executing on remaining cost reductions.
Cash Flow Activity
The following table provides a summary of the statements of cash flows for the periods indicated:
Cash used for operating activities for the three
months ended December 31, 2022 was $65 million compared to $111 million three months ended December 31, 2021. The change was primarily due to lower incentive compensation payments, $40 million of net proceeds received from the termination of the Company's New Forward Swap Agreements described in Note 8, "Derivative Instruments and Hedging Activities," to our unaudited interim Condensed Consolidated Financial Statements and the timing of customer cash payments as the Company continues its transition to a cloud and subscription model, offset by
lower cash earnings and higher advisory fees associated with the assessment of strategic and financial alternatives to improve the Company's capital structure.
Investing Activities
Cash used for investing activities for the three months ended December 31, 2022 was $17 million compared to $27 million for the three months ended December 31, 2021 as a result of capital expenditures in each period.
Financing Activities
Cash provided by financing activities for the three months ended December
31, 2022 was $54 million compared to cash used for financing activities of $5 million for the three months ended December 31, 2021. The change was primarily due to net borrowings under the ABL Credit Agreement of $56 million during the three months ended December 31, 2022. The change was also driven by $7 million of shares repurchased and retired for tax withholdings on the vesting of restricted stock units and Stock Bonus Program shares and proceeds of $4 million from the Employee Stock Purchase Plan during the three months ended December 31, 2021 with no comparable transactions in the current period. See Note 7, "Financing Arrangements," and Note 12, "Share-based Compensation," to our unaudited interim Condensed Consolidated Financial Statements for additional information.
Financing
Arrangements
See Note 1, "Background and Basis of Presentation," Note 7, "Financing Arrangements," and Note 19, "Subsequent Events," to our unaudited interim Condensed Consolidated Financial Statements for additional information regarding the Company's Pre-Petition Debt Instruments, including the Term Loan Credit Agreement, the ABL Credit Agreement the Senior Notes, the Convertible Notes and the Exchangeable Notes, as well as the DIP Term Loan Facility, the DIP ABL Facility and the effects of the Chapter 11 Cases on the Pre-Petition Debt Instruments.
Future Cash Requirements
Our primary future cash requirements will be to fund operations, debt service, capital expenditures, benefit obligations, restructuring payments and bankruptcy
filing stays payments. We may also use cash in the future to make strategic acquisitions or investments.
In connection with the Company’s Emergence, our pre-petition debt was extinguished and we are currently operating under the Exit Term Loan and Exit ABL Loan and our interest expense will adjust in accordance with such facilities. We have no debt maturing in the near term.
In addition, the Company agreed to purchase seats of Avaya Cloud Office ("ACO") in the event certain volumes of ACO sales are not met over the term of its agreement with RingCentral, Inc. ("RingCentral"), which is described further in Note 18, "Commitments and Contingencies." In the event that the cumulative number of
ACO seats sold as of the end of each calendar quarter is lower than the agreed upon threshold for such quarter, the Company will be required to purchase a number of ACO seats equal to such shortfall from RingCentral. Any such ACO seats purchased are subject to certain limitations and must be purchased for a two-year paid term with payments made monthly and pricing that is variable based on sales volumes by jurisdiction, contract size and product tier. The Company may resell such ACO seats to end customers or maintain them for internal use. In the event of any such requirement to purchase ACO seats, the required cash payments to RingCentral could have a significant adverse impact on the
Company's financial position, results of operations and operating cash flows. Based on the variable nature of the commitment, the Company is not able to estimate the ultimate future cash flow impact, if any, of these increasing volume commitments.
In the ordinary course of business, the Company is involved in litigation, claims, government inquiries, investigations and proceedings relating to intellectual property, commercial, employment, environmental and regulatory matters, including but not limited to a suit filed by Solaborate Inc. and Solaborate LLC described in Note 18, "Commitments and Contingencies," to our unaudited interim Condensed Consolidated Financial Statements. On February 3, 2023,
the Company reached an agreement to settle the lawsuit with Solaborate which will not have a material adverse effect on the Company's future cash requirements or cash flow.
Future Sources of Liquidity
Our existing cash balance and proceeds from the Exit Term Loan and Exit ABL Loan are our primary sources of future liquidity. As a result of the extinguishment of a significant amount of our debt in the Chapter 11 Cases, our annual interest expense was significantly reduced upon Emergence when compared to our pre-petition capital structure.
Both the Exit Term Loan and the Exit ABL Loan include conditions precedent, representations and warranties, affirmative and negative
covenants, and events of default customary for financings of this type and size. See Note 7, "Financing Arrangements,” for additional information on the Exit Term Loan and the Exit ABL Loan.
As of December 31, 2022, our cash and cash equivalent balances were $225 million, which includes unrestricted net proceeds from the July 12, 2022 financings, as well as borrowings under our ABL Credit Agreement. During the three months ended December 31, 2022, the
Company borrowed $90 million and repaid $34 million under the ABL Credit Agreement. During the second quarter of fiscal 2023, the Company repaid the remainder of the ABL Credit Agreement.
As of both December 31, 2022 and September 30, 2022, our cash and cash equivalent balances held outside the U.S. were $117 million. As of December 31, 2022, the Company's cash and cash equivalents held outside the U.S. may need to be repatriated to fund the Company's operations in the U.S. based on our expected future sources of liquidity.
At
December 31, 2022, the Company had issued and outstanding letters of credit and guarantees of $38 million under the ABL Credit Agreement and had $56 million of borrowings outstanding under its ABL Credit Agreement.
Off-Balance Sheet Arrangements
See discussion in Note 18, "Commitments and Contingencies," to our unaudited interim Condensed Consolidated Financial Statements for further details.
Critical Accounting Policies and Estimates
Management has reassessed the critical accounting policies and estimates disclosed in the
Company's Annual Report on Form 10-K filed with the SEC on September 8, 2023 and determined that there were no significant changes to our critical accounting policies and estimates during the three months ended December 31, 2022 except for the changes discussed in more detail below.
Indefinite-lived Intangible Assets
As announced in a Form 8-K dated December 13, 2022, the Company was unable to reach an out-of-court resolution with certain holders of the Convertible Notes, Senior Notes, Exchangeable Notes, and the Term Loans outstanding under the Term Loan Credit Agreement, regarding one or more potential financings, refinancings, recapitalizations,
reorganizations, restructurings, or investment transactions involving the Company. As a result, the Company revised its outlook to reflect the increased likelihood of a solvency event. The Company concluded that a triggering event had occurred and performed an interim quantitative impairment test for its indefinite-lived intangible asset, the Avaya Trade Name, as of December 31, 2022 to compare the fair value of the Avaya Trade Name to its carrying amount. The fair value of the Avaya Trade Name was estimated using the relief-from-royalty model, a form of the income approach. Under this methodology, the fair value of the trade name was estimated by applying a royalty
rate to forecasted net revenues which was then discounted using a risk-adjusted rate of return on capital. The model relies on assumptions regarding revenue growth rates, royalty rate, discount rate and terminal growth rate. Revenue growth rates inherent in the forecast were based on input from internal and external market intelligence research sources that compare factors such as growth in global economies, regional industry trends and product evolutions. The royalty rate was determined using a set of observed market royalty rates. The discount rate the Company used represents the estimated weighted average cost of capital, which reflects the overall level of inherent risk and the rate of return an outside investor would expect to earn. To estimate royalty cash flows beyond the final year of its model, the
Company used a terminal value approach. Under this approach, the Company applied a perpetuity growth assumption to determine the terminal value. The Company incorporated the present value of the resulting terminal value into its estimate of fair value. The result of the interim impairment test of the Avaya Trade Name as of December 31, 2022 indicated that the carrying amount of the Avaya Trade Name exceeded its estimated fair value primarily due to the updated outlook. As a result, the Company recorded an indefinite-lived intangible asset impairment charge of $9 million within the Impairment charges line item in the Condensed Consolidated Statements of Operations,
representing the amount by which the carrying amount of the Avaya Trade Name exceeded its fair value. As of December 31, 2022, the remaining carrying amount of the Avaya Trade Name was $178 million.
Based on the estimates used in the interim impairment test of the Avaya Trade Name as of December 31, 2022, an increase in the discount rate or a decrease in the long-term growth rate of 50 basis points would have resulted in an incremental impairment charge of approximately $7 million and $2 million, respectively.
To
the extent that business conditions deteriorate further or if changes in key assumptions and estimates differ significantly from management's expectations, it may be necessary to record additional impairment charges in the future.
Embedded Derivatives
The fair value of the debt-related embedded derivatives is determined using the with-and-without model which compares the estimated fair value of the underlying debt instrument with the embedded features to the estimated fair value of the underlying debt instrument without the embedded features, with the difference representing the estimated fair value of the embedded derivative features. The with-and-without model includes significant unobservable estimates, including estimated market yield, an estimation of the Company’s probability of default
and creditor recovery rates, and the probability of the occurrence of a change of control event or asset sale. Market yields are estimated using the risk-free rate commensurate with the remaining term of the instrument, an implied credit-spread based on the issuance price and the change in option adjusted spread of the traded debt instruments. The Company uses observable trading prices of its existing debt instruments to imply a probability of default and uses the S&P recovery rating to determine the creditor recovery rate each period. Management estimates the probability of the change of control or asset sale based on its assessment of entity specific factors and the status of on-going transaction negotiations, if any. Changes in the inputs into the valuation model may have a significant impact on the estimated fair value of the Debt-related embedded derivatives.
As
of December 31, 2022, the aggregate fair value of the Debt-related embedded derivatives was $56 million, which was recorded within Debt maturing within one year.
As of December 31, 2022, a hypothetical 100 basis point change in the estimated market yield would have resulted in an immaterial change in the aggregate fair value of the Debt-related embedded derivatives. A hypothetical 1000 basis point increase in the estimated probability of default would have resulted in an immaterial change in the aggregate fair value of the Debt-related embedded derivatives. A hypothetical 1000 basis point decrease in the estimated probability of default would have resulted in a change in the aggregate fair value of the Debt-related embedded derivatives of $(1) million. A hypothetical 1000 basis point change in the estimated probability of a
change of control/asset sale for the Tranche B-3 Term Loans and a hypothetical 500 basis point change in the estimated probability of a change of control/asset sale for the Exchangeable Notes would have resulted in an immaterial change in the aggregate fair value of the Debt-related derivatives.
New Accounting Pronouncements
See discussion in Note 2, "Recent Accounting Pronouncements," to our unaudited interim Condensed Consolidated Financial Statements for further details.
EBITDA and Adjusted EBITDA
We present below the
Company's EBITDA and Adjusted EBITDA, each of which is a non-GAAP measure.
EBITDA is defined as net income (loss) before income taxes, interest expense, interest income and depreciation and amortization and excludes the results of discontinued operations. EBITDA provides us with a measure of operating performance that excludes certain non-operating and/or non-cash expenses, which can differ significantly from company to company depending on capital structure, the tax jurisdictions in which companies operate and capital investments.
Adjusted EBITDA is EBITDA as further adjusted by the items noted in the reconciliation table below. We believe Adjusted EBITDA provides a measure of our financial performance based on operational factors that management can impact in the short-term, such as our pricing strategies, volume, costs and expenses of the organization, and therefore presents
our financial performance in a way that can be more easily compared to prior quarters or fiscal years. In addition, Adjusted EBITDA serves as a basis for determining certain management and employee compensation. We also present EBITDA and Adjusted EBITDA because we believe analysts and investors utilize these measures in analyzing our results. Under the Company's debt agreements, the ability to engage in activities such as incurring additional indebtedness, making investments and paying dividends is tied in part to ratios based on a measure of Adjusted EBITDA.
EBITDA and Adjusted EBITDA have limitations as analytical tools. EBITDA measures do not represent net income (loss) or cash flow from operations as those terms are defined by GAAP and do not necessarily indicate whether cash flows will be sufficient to fund cash needs. While EBITDA
measures are frequently used as measures of operations and the ability to meet debt service requirements, these terms are not necessarily comparable to other similarly titled captions of other companies due to the potential inconsistencies in the method of calculation. Further, Adjusted EBITDA excludes the impact of earnings or charges resulting from matters that we consider not to be indicative of our ongoing operations that still affect our net income (loss). In particular, our formulation of Adjusted EBITDA adjusts for certain amounts that are included in calculating net income (loss) as set forth in the following table including, but not limited to, restructuring charges, impairment charges, resolution of certain legal matters and a portion of our pension costs and post-retirement benefits costs, which represents the amortization of prior service costs (credits) and actuarial (gains) losses associated with these benefits. However, these are expenses that may recur,
may vary and/or may be difficult to predict.
The reconciliation of net loss, which is a GAAP measure, to EBITDA and Adjusted EBITDA, which are non-GAAP measures, is presented below for the periods indicated:
Three
months ended December 31,
(In millions)
2022
2021
Net loss
$
(ii164/)
$
(i66)
Interest
expense
5
54
Interest income
(4)
—
(Benefit from) provision for income taxes
(26)
18
Depreciation and amortization
99
104
EBITDA
(90)
110
Restructuring
charges(a)
10
7
Advisory fees(b)
33
—
Share-based compensation
1
14
Impairment
charges(c)
9
—
Pension and post-retirement benefit costs
(4)
(1)
Change in fair value of the 2017 Emergence Date Warrants
—
(1)
Loss on foreign
currency transactions
10
—
Adjusted EBITDA
$
(31)
$
129
(a)Restructuring charges represent employee separation costs and facility exit costs (excluding the impact of accelerated depreciation expense) related to the Company's restructuring programs, net of sublease
income.
(b)Advisory fees represent costs incurred to assist in the assessment of strategic and financial alternatives to improve the Company's capital structure.
(c)Impairment charges include an indefinite-lived intangible asset impairment charge of $i9 million. See Note 4, "Intangible Assets, net" for additional information.
Certain statements in this Quarterly Report on Form 10-Q, including statements containing words such as "anticipate,""believe,""estimate,""expect,""intend,""plan,""project,""target,""model,""can,""could,""may,""should,""will,""would" or similar words or the negative thereof, constitute "forward-looking statements." These forward-looking statements, which are based on our current plans, expectations, estimates and projections about future events, should not be unduly relied upon. These statements involve known and unknown risks, uncertainties and other factors that may cause our actual results, performance and achievements to materially differ from any future
results, performance and achievements expressed or implied by such forward-looking statements. We caution you therefore against relying on any of these forward-looking statements.
The forward-looking statements included herein are based upon our assumptions, estimates and beliefs and involve judgments with respect to, among other things, future economic, competitive and market conditions, the anticipated impact of our previously announced cost-cutting initiatives and future business decisions, all of which are difficult or impossible to predict accurately and many of which are beyond our control. Although we believe that the expectations reflected in such forward-looking statements are based on reasonable assumptions, our actual results and performance could differ materially from those set forth in the forward-looking statements and may be affected by a variety of risks, uncertainties and other factors, which may cause our
actual results, performance or achievements to differ materially from any future results, performance or achievements expressed or implied by these forward-looking statements. Risks, uncertainties and other factors that may cause these forward-looking statements to be inaccurate include, among others: the effect of Emergence on our business; the sufficiency of the Exit Term Loan Facility and the Exit ABL Facility for our future liquidity needs; our ability to continue implementing operating efficiencies and technical developments; our ability to capitalize on the reorganization and emerge as a stronger and more competitive enterprise; potential adverse effects of the Emergence on the Company's operations, third-party relationships and employee attrition; the impact and timing of any cost-savings measures and related local law requirements in various jurisdictions; the effectiveness
of our internal control over financial reporting and disclosure controls and procedures, and the potential for additional material weaknesses in our internal controls over financial reporting or other potential weaknesses of which we are not currently aware or which have not been detected; the impact of litigation and regulatory proceedings; the findings of the Audit Committee’s investigations; the impact of litigation and regulatory proceedings; the impact and timing of any cost-savings measures; and the risks and other factors discussed in Part I, Item 2, "Management's Discussion and Analysis of Financial Condition and Results of Operations" and Part II, Item 1A "Risk Factors" in this Quarterly Report on Form 10-Q, as well as Part I, Item 1A "Risk Factors" and Part II, Item 7 "Management's Discussion and Analysis of Financial Condition and Results of Operations" in our Annual Report on Form 10-K filed with the SEC on September 8,
2023.
All forward-looking statements are made as of the date of this Quarterly Report on Form 10-Q and the risk that actual results will differ materially from the expectations expressed in this Quarterly Report will increase with the passage of time. Except as otherwise required by the federal securities laws, we undertake no obligation to publicly update or revise any forward-looking statements after the date of this Quarterly Report, whether as a result of new information, future events, changed circumstances or any other reason. In light of the significant uncertainties inherent in the forward-looking statements included in this Quarterly Report, the inclusion of such forward-looking statements should not be regarded as a representation by us or any other person that the objectives and plans set forth in this Quarterly Report will be achieved.
Item 3.
Quantitative
and Qualitative Disclosures About Market Risk
Interest Rate Risk
The Company had exposure to changing interest rates primarily under the Term Loan Credit Agreement and ABL Credit Agreement, each of which bore interest at variable rates. The Company had $1,949 million of variable rate loans outstanding as of December 31, 2022.
The Company maintained interest rate swap agreements with a net notional amount of $1,543 million which fixed a portion of the variable interest due under its Term Loan Credit Agreement (the
"Original Swap Agreements"). Under the terms of the Original Swap Agreements, which matured on December 15, 2022, the Company paid a fixed rate of 2.935% and received a variable rate of interest based on one-month LIBOR.
The Company also had forward starting swap agreements to fix a portion of the variable rate interest due on its Term Loan Credit Agreement from December 15, 2022 (the maturity date of the Original Swap Agreements) through June 15, 2027 (the "New Forward Swap Agreements"). Under the terms of the forward starting swap agreements, the
Company paid a fixed rate of 2.5480% and received a variable rate of interest based on one-month SOFR. The forward swap agreements had a notional amount of $1,000 million.
In December 2022, the Company terminated its New Forward Swap Agreements and received $40 million of net cash proceeds as a result of the termination. Additionally, the frozen deferred gains of $63 million related to the Company's interest rate swap agreements were reclassified to
Interest expense during the first quarter of fiscal 2023.
Subsequent to the termination of the New Forward Swap Agreements, the Company’s variable rate debt will no longer be hedged. Based on the Company's variable rate debt outstanding at December 31, 2022, a hypothetical one percent change in interest rates would affect interest expense by approximately $20 million over the twelve months following December 31, 2022.
For the three months ended December 31, 2022 and 2021, the
Company recognized a gain (loss) on the interest rate swap agreements of $49 million and $(13) million, respectively, which is reflected in Interest expense in the Condensed Consolidated Statements of Operations.
See Note 1, "Background and Basis of Presentation", Note 7, "Financing Arrangements" and Note 8, "Derivative Instruments and Hedging Activities," to our Condensed Consolidated Financial Statements included in Part I, Item I of this Quarterly Report on Form 10-Q for additional information related to the Company's variable rate Pre-Petition Debt Instruments and interest rate swap agreements.
Foreign Currency Risk
Foreign currency risk is the potential change in value, income and cash flow arising from adverse changes
in foreign currency exchange rates. Each of our non-U.S. ("foreign") operations maintains capital in the currency of the country of its geographic location consistent with local regulatory guidelines. Each foreign operation may conduct business in its local currency, as well as the currency of other countries in which it operates. The primary foreign currency exposures for these foreign operations are the Euro, Canadian Dollar, Chinese Renminbi, British Pound Sterling and Australian Dollar.
Non-U.S. denominated revenue was $104 million for the three months ended December 31, 2022. We estimate a 10% change in the value of the U.S. dollar relative to all foreign currencies would have affected our revenue for the three months ended December 31, 2022 by $10 million.
The
Company, from time-to-time, utilizes foreign currency forward contracts primarily to hedge fluctuations associated with certain monetary assets and liabilities including receivables, payables and certain intercompany balances. These foreign currency forward contracts are not designated for hedge accounting treatment. As a result, changes in the fair value of these contracts are recorded as a component of Other income, net to offset the change in the value of the underlying assets and liabilities. As of December 31, 2022, the Company had no open foreign exchange
contracts. For each of the three months ended December 31, 2022 and 2021, the Company's loss on foreign exchange contracts was not material.
As of December 31, 2022, the end of the period covered by this report,
the Company, under the supervision and with the participation of the Company's management, including the Company's Chief Executive Officer and Chief Financial Officer, evaluated the effectiveness of the design and operation of the Company's disclosure controls and procedures (as such term is defined in Rules §240.13a-15(e) and §240.15d-15(e) under the Securities Exchange Act of 1934, as amended (the "Exchange Act")). Based on that evaluation, due to the material weaknesses in internal control over financial reporting described below, our Chief Executive Officer and Chief Financial Officer have concluded that our disclosure
controls and procedures were not effective as of December 31, 2022. Nevertheless, based on the completion of the Audit Committee's planned procedures with respect to its investigations, and the performance of additional procedures by management designed to ensure the reliability of our financial reporting, we believe that the condensed consolidated financial statements in this Quarterly Report fairly present, in all material respects, our financial position, results of operations and cash flows as of the dates, and for the periods, presented, in conformity with generally accepted accounting principles in the United States of America ("U.S. GAAP").
Material Weaknesses in Internal Control Over Financial Reporting
A material weakness is a deficiency, or a combination of deficiencies, in internal control over financial reporting,
such that there is a reasonable possibility that a material misstatement of our annual or interim financial statements will not be prevented or detected on a timely basis.
The following material weaknesses have been identified and continue to exist as of December 31, 2022:
The Company did not design and maintain an effective control environment as former senior management failed to set an appropriate tone at the top. Specifically, former senior management applied pressure to individuals to achieve financial targets
which created an environment where employees were hesitant to express dissent or communicate concerns to others within the organization. The ineffective control environment contributed to the following additional material weaknesses:
The Company did not design and maintain effective controls related to the information and communication component of the COSO framework. Specifically, the Company did not design and maintain effective controls to ensure appropriate communication between certain functions within the Company. This material weakness contributed to an additional material
weakness, that the Company did not design and maintain effective controls over the ethics and compliance program.
These material weaknesses did not result in any material misstatements of the Company's financial statements or disclosures, but did result in an immaterial interim out-of-period correction during fiscal 2022. Additionally, each of the material weaknesses described above could result in a misstatement of substantially all account balances or disclosures that would result in a material misstatement to the annual or interim consolidated financial statements that would not be prevented or detected.
Remediation Plan
Management is actively engaged and committed
to taking steps necessary to remediate the control deficiencies that constituted the material weaknesses. To date, the Company made the following enhancements to our internal control over financial reporting:
▪On July 28, 2022, Avaya removed James M. Chirico, Jr. as Chief Executive Officer and appointed Alan B. Masarek as new Chief Executive Officer, effective August 1, 2022;
▪It was determined that Stephen D. Spears would step down from his role as Chief Revenue Officer on October 18, 2022 and he departed the
Company effective November 1, 2022;
▪Avaya appointed Rebecca A. Roof as Interim Chief Financial Officer, effective November 9, 2022, and on June 16, 2023, the Company appointed Amy O'Keefe as its Chief Financial Officer;
▪Alan
B. Masarek has held multiple "All Hands" meetings with Avaya employees where he reinforces his expectations of an environment grounded in transparency;
▪Alan B. Masarek has held executive coaching sessions with leadership team to align on effective communication and a culture that includes a safe environment for transparent communication; and
▪Enhanced inquiries within the scope of internal management representation letters.
Our remediation activities are continuing during fiscal 2023. In addition to the above actions, Avaya is in the process of designing and implementing additional activities, including but not limited to:
▪Enhancing its policies and procedures related to appropriate maintenance of
its whistleblower log and the proper dissemination of related information and materials, including those received by members of the Board.
▪Providing additional and continuing training for employees and members of management to ensure information is appropriately communicated to all relevant personnel in connection with SEC filings and/or the preparation of our consolidated financial statements or other matters.
▪Enhancing internal disclosure control processes and related internal management representation letter processes and training to improve communication.
▪To ensure employees fully understand the Company's commitment to establishing and maintaining an effective
control environment and appropriate tone at the top, management will continue to execute against a communications plan that includes the following:
•Board level participation in messaging across the organization that reinforces a safe environment for raising concerns without fear of retaliation;
•Conducting in-depth special training courses for the Company's entire sales team and personnel involved in the forecasting process regarding the importance of the Company establishing and maintaining effective disclosure controls. Management intends to include these principles as an ongoing component of our new hire training and other on-going training courses; and
•Enhancement
of future employee engagement surveys to monitor for negative indicators of tone at the top.
▪To ensure effective information and communication controls and enhanced controls related to the ethics and compliance program, management is developing a program to address the following remediation activities:
•Enhance Board of Directors manual to define communications process related to allegations of fraud or misconduct;
•Reinforce management Disclosure Committee procedures
with respect to the evaluation of potential allegations of fraud or misconduct; and
•Develop employee training to improve awareness of fraud and misconduct allegations that should be included in internal management representation letters.
Changes in Internal Control Over Financial Reporting
There were no changes in our internal control over financial reporting (as such term is defined in Rules §240.13a-15(f) and §240.15d-15(f) of the Exchange Act) during the quarter ended December 31, 2022 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
The information set forth under Note 18, "Commitments and Contingencies," to the unaudited interim Condensed Consolidated Financial Statements is incorporated herein by reference.
Item 1A.
Risk
Factors
There have been no material changes during the quarterly period ended December 31, 2022 to the risk factors previously disclosed in the Company's Form 10-K filed with the Securities and Exchange Commission on September 8, 2023.
Item 2.
Unregistered Sales of Equity Securities and Use of Proceeds
Purchases
of Equity Securities by the Issuer
The following table provides information with respect to purchases by the Company of shares of common stock during the three months ended December 31, 2022:
Period
Total
Number of Shares (or Units) Purchased(1)
Average Price Paid per Share (or Unit)
Total Number of Shares (or Units) Purchased as Part of Publicly Announced Plans or Programs
Maximum Number (or Approximate Dollar Value) of Shares (or Units) That May Yet Be Purchased Under Plans or Programs(2)(3)
October 1 - 31, 2022
—
$
—
—
$
147,473,425
November
1 - 30, 2022
—
$
—
—
$
147,473,425
December 1 - 31, 2022
—
$
—
—
$
132,473,425
Total
—
$
—
—
(1)During
the fourth quarter of fiscal 2022, the Company suspended distribution of shares of its common stock which vested pursuant to awards issued under the 2019 Equity Incentive Plan until the Company's related registration statement is reinstated. As such, no shares of common stock were withheld for taxes on restricted stock units that vested during the three months ended December 31, 2022. Refer to Note 12, "Share-based Compensation," for further details.
(2)The Company maintained a warrant repurchase program which authorized it to repurchase the
Company's outstanding warrants to purchase shares of the Company's common stock for an aggregate expenditure of up to $15 million. The Company's 2017 Emergence Date Warrants expired on December 15, 2022, and none of the 2017 Emergence Date Warrants were repurchased.
(3)The Company maintained a share repurchase program which authorized it to repurchase the Company's common stock for an aggregate expenditure of up to $500 million. The repurchases were to be made from time to time in the open market, through
block trades or in privately negotiated transactions. Upon implementation of the Plan, the common stock was canceled.
Item 3.
Defaults Upon Senior Securities
See Note 1, “Background and Basis of Presentation,” and our current report on Form 8-K filed with the SEC on February 14, 2023 for a description of our previously disclosed defaults under our Pre-Petition Debt Instruments.
XBRL
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104
Cover Page Interactive Data File (formatted as Inline XBRL in Exhibit 101)
*Indicates management contract or compensatory plan or arrangement.
+Portions of this exhibit have been omitted pursuant to Item 601(b)(10)(iv) of Regulation S-K, which portions will be furnished to the Securities and Exchange Commission upon request.
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
AVAYA HOLDINGS CORP.
By:
/s/ AMY
O'KEEFE
Name:
Amy O'Keefe
Title:
Executive Vice President and Chief Financial Officer
