[May 10, 2013] AVAYA INC - 10-Q - Management's Discussion and Analysis of Financial Condition and Results of Operations. Tweet (Edgar Glimpses Via Acquire Media NewsEdge) 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 Inc. and its subsidiaries. "Management's Discussion and Analysis of Financial Condition and Results of Operations" should be read in conjunction with the unaudited interim consolidated financial statements and the related notes included elsewhere in this Quarterly Report on Form 10-Q. The matters discussed in "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. Our accompanying unaudited interim consolidated financial statements as of March 31, 2013 and for the three and six months ended March 31, 2013 and 2012 have been prepared in accordance with accounting principles generally accepted in the United States of America ("GAAP") and the rules and regulations of the United States Securities and Exchange Commission, or the SEC, for interim financial statements, and should be read in conjunction with our consolidated financial statements and other financial information for the fiscal year ended September 30, 2012, which were included in our Annual Report on Form 10-K filed with the SEC on December 12, 2012. In our opinion, the unaudited interim consolidated financial statements reflect all adjustments, consisting of normal and recurring adjustments, necessary for a fair statement of the financial condition, results of operations and cash flows for the periods indicated. Certain prior period amounts have been reclassified to conform to the current interim period presentation. The consolidated results of operations for the interim periods reported are not necessarily indicative of the results to be experienced for the entire fiscal year. Overview We are a leading global provider of real-time business collaboration and communications solutions that bring people together with the right information at the right time in the right context, enabling businesses to improve their efficiency and quickly solve critical business challenges. Our solutions are designed to enable business users to work together more effectively internally and with their customers and suppliers, to accelerate decision-making and achieve business outcomes. These industry leading solutions are also designed to be flexible, reliable and secure, enabling simplified management and cost reduction while providing a platform for next-generation collaboration from Avaya. We are highly focused on serving our core business collaboration and communications markets with open and unifying, fit-for-purpose solutions and distributed software services and support models. We shape our portfolio to meet the demands of customers today and in the future. Our solutions and services are aimed at large enterprises, small- and mid-sized businesses and government organizations. We offer solutions in three key business collaboration and communications categories: • Real-Time Collaboration, Video and Unified Communications Software, Infrastructure and Endpoints for an increasingly mobile workforce;• Customer Experience Interaction Management, including Contact Center applications; and • Networking. These three categories are supported by Avaya's portfolio of services including product support, integration, and professional and managed services that enable customers to optimize and manage their communications networks worldwide and achieve enhanced business results. Acquisition of RADVISION Ltd. On June 5, 2012, Avaya acquired RADVISION Ltd. ("Radvision") for $230 million in cash. Radvision is a global provider of videoconferencing and telepresence technologies over internet protocol ("IP") and wireless networks. Through this acquisition, Avaya will expand its technology portfolio and provide customers a highly integrated and interoperable suite of cost-effective, easy to use, high-definition video collaboration products, with the ability to interoperate with multiple mobile devices including Apple iPad and Google Android. We have begun to integrate Radvision's enterprise video infrastructure and high value endpoints with Avaya's award winning Avaya Aura® Unified Communications ("UC") platform to create a compelling and differentiated solution designed to accelerate the adoption of video collaboration. Radvision brings to Avaya a portfolio that includes a full range of videoconferencing products, technologies and expertise serving large enterprises, small businesses, and service providers. It includes standards-based applications, open infrastructure and endpoints for ad-hoc and scheduled videoconferencing with room-based systems, desktop, and mobile consumer devices. The integrated Avaya and Radvision portfolios will extend intra-company business to business and business to consumer video 36-------------------------------------------------------------------------------- Table of Contents communications, and also support internal "Bring Your Own Device" ("BYOD") initiatives. See discussion in Note 3, "Business Combinations," to our unaudited interim consolidated financial statements for further details. Initial Registration Statement of Parent Avaya is a wholly owned subsidiary of Avaya Holdings Corp., a Delaware corporation ("Parent"). Parent was formed by affiliates of two private equity firms, Silver Lake Partners ("Silver Lake") and TPG Capital ("TPG") (collectively, the "Sponsors"). Silver Lake and TPG, through Parent, acquired Avaya in a transaction that was completed on October 26, 2007 (the "Merger"). See discussion in Note 1, "Background, Merger and Basis of Presentation - Merger," to our unaudited interim consolidated financial statements for further details. On June 9, 2011, Parent filed with the SEC a registration statement on Form S-1 (as it may be amended from time to time, the "registration statement") relating to a proposed initial public offering of its common stock. As contemplated in the registration statement, the net proceeds of the proposed offering are expected to be used, among other things, to repay a portion of our long-term indebtedness. The registration statement remains under review by the SEC and shares of common stock registered thereunder may not be sold nor may offers to buy be accepted prior to the time the registration statement becomes effective. This Form 10-Q and the pending registration statement shall not constitute an offer to sell or the solicitation of any offer to buy nor shall there be any sale of those securities in any State in which such offer, solicitation or sale would be unlawful prior to registration or qualification under the securities laws of any such State. Further, there is no way to predict whether or not Parent will be successful in completing the offering as contemplated and if it is successful, we cannot be certain if, or how much of, the net proceeds will be used for the purposes identified above. Refinancing of Debt During the six months ended March 31, 2013, the Company completed a series of transactions which allowed the Company to refinance (1) its senior secured term B-1 loans ("term B-1 loans") outstanding under its senior secured credit facility originally due October 26, 2014, and (2) $642 million of its 9.75% senior unsecured cash-pay notes and $742 million of its senor unsecured paid-in-kind ("PIK") toggle notes each originally due November 1, 2015 (collectively, the "Old Notes"). During the three months ended December 31, 2012, the Company completed three transactions which allowed the Company to refinance $848 million of its term B-1 loans. On October 29, 2012 the Company completed an amendment and restatement of the senior secured credit facility and senior secured multi-currency asset-based revolving credit facility along with the extension of the maturity date of $135 million aggregate principal amount of term B-1 loans from October 26, 2014 to October 26, 2017 by converting such loans into a new tranche of senior secured term B-4 loans ("term B-4 loans"). On December 21, 2012 the Company completed an amendment and restatement of the senior secured credit facility along with the extension of the maturity date of $713 million aggregate principal amount of term B-1 loans from October 26, 2014 to October 26, 2017 and $134 million aggregate principal amount of term B-4 loans from October 26, 2017 to March 31, 2018 in each case by converting such loans into a new tranche of senior secured term B-5 loans ("term B-5 loans"). On December 21, 2012 the Company issued $290 million of 9% senior secured notes due April 2019 (the "9% Senior Secured Notes"), the proceeds of which were used to repay $284 million principal amount of term B-5 loans and to pay related fees and expenses. On March 12, 2013 the Company refinanced the remaining $584 million of its term B-1 loans with the cash proceeds from the issuance of $589 million aggregate principal amount of term B-5 loans due October 26, 2017 under its senior secured credit facility. In connection with the amendments and restatements of the senior secured credit facility necessary to effectuate the transactions described above, the applicable interest rate for the portion of the term B-1 loans that were converted into term B-4 loans and term B-5 loans was also changed. On March 7, 2013, the Company completed an exchange offer in which $1,384 million of Old Notes were exchanged for $1,384 million of senior secured notes due 2021 (the "10.50% Senior Secured Notes"). The 10.50% Senior Secured Notes were issued at par, bear interest at a rate of 10.50% per annum and mature on March 1, 2021. Both the 9% Senior Secured Notes and the 10.50% Senior Secured Notes have not been, and will not be, registered under the Securities Act or applicable state securities laws and may not be offered or sold absent registration under the Securities Act or applicable state securities laws or applicable exemptions from registration requirements. See Note 7, "Financing Arrangements" to our unaudited interim consolidated financial statements for further details. 37-------------------------------------------------------------------------------- Table of Contents Major Business Areas Avaya conducts its business operations in three segments. Two of those segments, Global Communications Solutions ("GCS") and Avaya Networking ("Networking"), make up Avaya's Enterprise Collaboration Solutions ("ECS") product portfolio. The third segment contains Avaya's services portfolio and is called Avaya Global Services ("AGS"). Our Products Our product portfolio spans a broad range of unified communications, collaboration, customer service, video and data networking products designed to meet the diverse needs of small and mid-size businesses, as well as large enterprises. The majority of our portfolio comprises software products that reside on either a client or server. Client software resides on both our own and third-party devices, including desk phones, tablets, desktop PCs and mobile phones. Server-side software controls communication and collaboration for the enterprise, and delivers rich value-added applications such as messaging, telephony, voice, video and web conferencing, mobility and customer service. Hardware includes a broad range of desk phones, video endpoints, servers and gateways and LAN/WAN switching wireless access points and gateways. A portion of the portfolio has been subjected to rigorous interoperability and security testing and is approved for acquisition by the US Government. Highlights of our portfolio include: Avaya Aura Portfolio At the core of our next-generation collaboration solutions is the Avaya Aura platform, our session initiation protocol ("SIP") standards-based software suite of collaboration applications, including real-time voice, video, instant messaging, presence, conferencing, and non-real-time email, voicemail and social networking. The Avaya Aura platform is part of our infrastructure solutions portfolio. The Avaya Aura architecture simplifies complex communications networks and reduces infrastructure costs. Using this architecture, organizations are able to rapidly and cost-effectively deploy applications from a centralized data center to users regardless of the device they are using or the network to which they are connected. The Avaya Aura platform provides a simple means of connecting legacy, multi-vendor systems to new open standards SIP-based applications, helping enterprises to reduce costs and increase user productivity and choice simultaneously. We believe our Avaya Aura platform is one of the most reliable, secure and comprehensive offerings in the industry and that our commitment to open, standards-based solutions helps provide our customers with the flexibility to be more efficient and successful. At the heart of our Avaya Aura portfolio is Session Manager, which provides multimedia communications control and management. Multi-vendor voice, video and data communications can all be managed and controlled from one centralized software platform. The Avaya Aura platform uses virtualization technology across all applications to reduce the physical number of servers relative to existing offerings, reducing total cost of ownership for medium sized and large enterprises alike. The Avaya Aura portfolio allows business users to work from any location, on any device, by providing collaboration and communication capabilities on a broad variety of operating systems, devices, desktop, laptop and tablet computers, smart phones, mobile devices and dedicated deskphones. Highlights of the Avaya Aura portfolio include the following: • Avaya Aura Messaging, an application that enables migration from traditional voice messaging systems to SIP-based multimedia messaging with enterprise-class features, scalability and reliability. • Avaya Aura Presence Services, an application that provides contextual information and availability from across multiple devices and applications to users, delivering a richer collaboration experience. These capabilities are leveraged across the entire spectrum of communications applications, ranging from voice calls and instant messaging to customer services and business processes. • Avaya Aura Conferencing, which offers a rich set of scalable conferencing configurations and delivers audio conferencing, web conferencing, document-based collaboration and video-enabled web conferencing while letting users leverage familiar desktop applications and interfaces for increased conference control. • The Avaya Aura architecture supports communications and collaboration endpoints including telephones, speaker phones, personal video collaboration devices and client software designed to provide enterprise class communications and our Avaya Flare Experience, as discussed below, on our own devices as well as laptops, smartphones and tablets. • Avaya Aura Video Conferencing solutions, a wide suite of high-definition, low-bandwidth, SIP-based video endpoints combined with software applications to enable rich video conferencing to serve individual desktop users and small workgroups as well as large conference rooms. 38-------------------------------------------------------------------------------- Table of Contents Radvision Scopia In June 2012, Avaya acquired RADVISION Ltd., a global provider of videoconferencing and telepresence technologies over IP and wireless networks. Through that transaction, Avaya acquired a video conferencing portfolio designed to help customers be more effective regardless of whether they are working from their desktop, a conference room or a mobile device. The Radvision Scopia infrastructure is designed to deliver flexibility and cost effectiveness as enterprises adopt the latest HD and Unified Communications technologies. The Radvision Scopia platform is an effective combination of hardware and software that supports media processing for advanced room system devices while delivering high scalability and distributed processing for desktops and mobile deployments. Our Radvision Scopia XT video conferencing room systems incorporate the latest video communications technology including dual 1080p/60fps video channels, H.264 high profile for bandwidth efficiency, H.264 scalable video coding for error resiliency, and Apple iPad device multi-touch control. The Radvision Scopia Desktop application extends a room system deployment to remote, mobile, and desktop users with a simple web-browser plug-in that is centrally managed, distributed and deployed. It allows for scheduled and ad hoc video conferences across a variety of devices and provides the ability to easily include participants from both inside and outside the organization. Radvision Scopia Mobile provides applications for video conferencing, conference control, and management for smart phones and tablets supporting Apple iOS when connected over mobile broadband or Wi-Fi. Avaya Contact Centers Avaya is a leader in the contact center market. Across the contact center our portfolio provides a foundation for managing voice interactions that has been extended to include multiple channels supporting instant messaging, video, email, and social media. Our Avaya Aura Contact Center is a SIP-based application that enables session based media, independent communications, and interactions. This session based approach allows for blended agent queues and assigns customer interactions specific to the incoming channel. Agents receive the request at the desktop through a single integrated queue, unified reporting is provided to the supervisor supported by analytics across activities, and users are administrated through a single unified tool. Avaya Aura Contact Center allows an agent to see all the information related to a customer and provides that customer with a seamless interaction as he or she traverses channels (e.g. telephone call, video, chat or email). With improved information, agents have the ability to provide better customer support for service related issues and support questions arising during sales and customer support. As a result, the combined portfolio not only optimizes agent skill sets to address multiple communication channels and customer needs, but enhances customer experience. Avaya Aura Contact Center is a scalable communications infrastructure that enables small, medium, and large enterprises that span global implementations. The capabilities of our contact center solutions include: • Assisted and Automated Experience Management, which provides intelligent routing of voice and multimedia contacts and a variety of applications for customer service agents, as well as outbound and self-service applications to manage collaboration and workflow between an enterprise and its customers; • Workforce Optimization, which includes call recording, quality monitoring and workforce management applications; and • Performance Management, which provides contact center reporting, analytics and operations performance management solutions, as well as agent performance management and scheduling to ensure optimal use of resources and improve customer satisfaction. In today's mobile and distributed environments, agents and supervisors benefit from the ability to move the delivery of their communications and customer support activities to the location of their choice (office, home, or remote location). Avaya Aura Contact Center also provides agents and supervisors with the ability to move from device to device (hard phone, soft phone and mobile phone). Avaya Flare Experience In September 2010, we unveiled the Avaya Flare Experience, a real-time, enterprise video communications and collaboration solution. The Avaya Flare Experience is part of our Unified Communication Applications or UC Applications solutions portfolio and helps break down the barriers between today's communications and collaboration tools with a distinctive user interface for quick, easy access to voice and video, social media, presence and instant messaging and audio/video/web conferencing, a consolidated view of multiple directories, context history and more. 39-------------------------------------------------------------------------------- Table of Contents The Avaya Flare Experience features a central spotlight that highlights active or in-progress collaboration sessions. Initiating a communication session is as easy as moving one or more contacts from the directory into the spotlight. For text messages, a pop-up keyboard appears when a user taps a text-based icon under a contact's photo. The Avaya Flare Experience combines contacts from multiple sources into a single "fan," synchronizes email/calendars with Microsoft ActiveSync and integrates collaboration activity into a common interaction history, providing context to any session. We believe these capabilities deliver a simpler, more compelling experience to end-users using video, voice and text. Currently, the Avaya Flare Experience runs on the Avaya Desktop Video Device, an Android-based, video-enabled desktop collaboration endpoint for executive desktops or power communicators that can also perform as a customer kiosk. In addition, in January 2012 we announced the availability of Avaya Flare Communicator for Apple iPad tablets. We are adapting the Avaya Flare software for other devices and operating systems such as Google Android tablets, Windows laptops and other consumer device classes and platforms. Overall, we believe our software-centric solutions are helping to enable customers to be more productive and compete more effectively by changing the way users collaborate. The Avaya Flare Experience complements the widely deployed Avaya one-X product line that provides mobile applications for smartphones (Google Android, Apple iPhone, RIM BlackBerry, Symbian), or any phone using natural speech commands, as well as desktop-integrated Microsoft Windows and Apple Mac clients. Avaya one-X clients are expected to evolve over time to incorporate Avaya Flare capabilities in a single software family. Avaya Flare and Avaya one-X Unified Collaboration and Communication clients provide flexibility that helps organizations to provide the right experience to the right users to drive faster decision-making, reduce costs and provide more streamlined communications. Avaya IP Office Avaya IP Office is our award-winning global flagship Small and Medium Enterprises, or SME, communications solution specially designed to meet communications challenges facing small and medium enterprises. Avaya IP Office is part of our infrastructure solutions portfolio. IP Office provides solutions that help simplify processes and streamline information exchange within systems. Communications capabilities can be added as needed, and IP Office connects to both traditional and the latest IP lines to give growing companies flexibility and the ability to retain and leverage their existing investment. We recently unveiled the latest version of our communications solution for this market - Avaya IP Office 8.1 - which adds innovative capabilities to tap the full potential of next-generation collaboration. This includes new mobility, management and security features, as well increased scalability, to help SMEs efficiently and securely take advantage of BYOD environments and advanced mobility. Avaya Agile Communication Environment (ACE) Avaya ACE offers a rich set of web application programming interfaces, or APIs, that enable developers to integrate communications into other business applications (such as CRM, ERP, BPM and social application frameworks) and business processes (such as dynamic team formation, business continuity planning and customer engagements). For more policy-based style customization on enterprise communications, the Avaya ACE Foundation Toolkit offers Java APIs to allow customers to build Java feature sets to influence the treatment of incoming and/or outbound communications leveraging the SIP architecture. These capabilities enable rapid development of custom applications, which helps reduce costs and increases flexibility for enterprises. Programmers with limited communications expertise can readily embed real-time communications in business applications and workflows, expanding both the ability and opportunity to use Avaya collaboration capabilities. Avaya ACE provides a versatile platform for the members of Avaya DevConnect, our developer ecosystem, to build applications. AvayaLive AvayaLive is our overall Avaya-provided cloud solutions portfolio, allowing our customers to procure, provision, and deploy unified collaboration solutions without the need for on-premise equipment. The AvayaLive portfolio is focused on providing feature-rich, user deployable, collaboration platforms in a Communications As a Service (Caas) model, without requiring additional IT staffing or training. AvayaLive Connect is a single-source for a complete unified communication experience for entrepreneurial businesses. The entrepreneurial business is defined by agility, creativity, and the rapid access to technology and the AvayaLive Connect solution is hallmarked by all three. The solution provides voice, video, conferencing, chat and messaging solutions in a simple, cloud-based solution. These services are accessible from mobile devices, personal computers, "hard" phones and tablets to enable collaboration from nearly anywhere a network is available. AvayaLive Connect is billed on a per-user/per month basis allowing businesses to add users to meet the demands of their customers. Utilizing the Amazon Elastic Compute Cloud (EC2), AvayaLive Connect scales to meet these demands with ease and without expensive resource or administrative overhead. AvayaLive Engage is an online, immersive conferencing and social collaboration environment that lets users collaborate as though they were face to face. AvayaLive Engage replicates real life interactions using personalized avatars, which users control to navigate through an online, three-dimensional environment, with the ability to talk, chat, share, collaborate and present in real-time. A cloud-based solution requiring only a web browser plug-in, the product allows collaboration between users from any browser, inside or outside of the enterprise. 40-------------------------------------------------------------------------------- Table of Contents Avaya Networking In support of our data communications strategy, our networking product portfolio is designed to address and surpass competitors' products with respect to three key requirements: resiliency, efficiency and performance. Our networking portfolio is complementary to our business collaboration, unified communications and contact center portfolios based on the Avaya Aura architecture. We believe that customers today benefit from end-to-end solution design, testing and support. Over time we expect customers to benefit from development work in integrated provisioning, system management, quality of experience and bandwidth utilization. Our networking products focus on data center, branch and wireless access networking, and we believe these products provide better support for real-time collaboration. Our networking portfolio includes: • Ethernet Switching-a range of Local Area Network switches for data center, core, edge and branch applications; • Unified Branch-a range of routers and Virtual Private Network appliances that provide a secure connection for branches; • Wireless Networking-a cost-effective and scalable solution enabling enterprises to deploy wireless coverage; • Access Control-solutions that provide policy decision to enforce role-based access control to the network; • Unified Management-providing support for data and voice networks by simplifying the requirements associated across functional areas; and • Avaya VENA-an end-to-end virtualization strategy and architecture that helps simplify data center and campus networking and optimizes business applications and service deployments in and between data centers and campuses, while helping to reduce costs and improve time to service. We sell our portfolio of data networking products globally into enterprises of all types, with particular strength in healthcare, education, hospitality, financial services and local and state government. Our Technology We believe that technology enhances the way in which people collaborate. At Avaya, we work with customers, industry groups and technical bodies to foster innovation. Across our portfolio we leverage critical technology to our customers' advantage. Avaya is a leading innovator in leveraging the use of SIP for business collaboration. This open-standard based protocol shifts communications from having to coordinate multiple, independent media and communications systems toward session management based environments, where multiple media and resources can flexibly be brought into a fully-integrated, session-based interaction. This fundamental difference supports more fluid, effective and persistent collaboration across multiple media and modes of communications. Centralized SIP-Based Architecture At the core of our architecture, SIP based Avaya Aura Session Manager centralizes communications control and application integration. Session Manager orchestrates a wide array of communication and collaboration applications and systems by decoupling them from the network. Applications can be deployed to individual users based on their need, rather than by where they work or the capabilities of the system to which they are connected. Session Manager instantly reduces complexity and provides the foundation for broader unified communications and collaboration strategies. Unique SIP-Based Experiences The Avaya Flare Experience leverages the Avaya Aura technology and its session control and management, presence, unified communications features and services, application creation and enablement capabilities. Social network interfaces to services, such as Facebook, allow for integrated directories across platforms. Users can access Microsoft Exchange services, such as e-mail, contacts and calendar, directly from a user's contact card and, via the Avaya Aura Presence Services, can exchange instant message and presence information with Microsoft Lync users (i.e., Microsoft Communicator clients). Point-to-point video calls do not require a separate video conferencing server, and multi-party conferencing is enabled by Avaya Aura Conferencing. Additional Technologies In addition to SIP, we use technologies including: • SIP/SIMPLE and XMP: the Avaya Aura Presence Services collects, publishes, aggregates and federates using SIP/SIMPLE and XMPP standards, providing interoperability with systems from other vendors, including but not limited to Microsoft, IBM and Google; 41-------------------------------------------------------------------------------- Table of Contents • Service Oriented Architecture, or SOA, oriented web services, including SOAP, REST and WSDL, are used extensively in Avaya ACE, leveraging open, extensible standards and protocols to facilitate rapid deployment and deliver customer choice; • Operating System, or OS, Support: our software applications run on a broad range of operating systems including, but not limited to, Microsoft Windows, Apple MAC OS, Google Android and RIM Blackberry; • Virtualization Technology is used in our core Avaya Aura portfolio to reduce the physical server footprint using hypervisor technology to run multiple applications concurrently on a single physical platform; and • Resilient data networking: our data portfolio provides highly resilient IPv4 and IPv6 routing services, with redundant hardware components, forwarding and restart capabilities that minimize interruptions, including one of the industry's few sub second failover capabilities. Our Services AGS evaluates, plans, designs, implements, supports, manages and optimizes enterprise communications networks to help customers achieve enhanced business results both directly and through partners. Our award-winning portfolio of services includes product support, integration and professional and managed services that enable customers to optimize and manage their converged communications networks worldwide and achieve enhanced business results. AGS is supported by patented design and management tools and network operations and technical support centers around the world. Within AGS are Avaya Client Services and Professional Services. Avaya Client Services ("ACS") ACS is a market-leading organization that supports, manages and optimizes enterprise communications networks to help customers maximize the performance of their communications solutions. Avaya Client Services is supported by patented tools and by network operations and technical support centers around the world. The contracts for these services range between one and seven years, with three year terms being the most common. Custom or complex services contracts are typically five years in length. The portfolio of ACS services includes: • Global Support Services which provides a comprehensive suite of support options both directly and through partners, which enables customers to choose from modular options such as remote support, monitoring, parts, onsite, major upgrade subscription and more. We believe Avaya's solutions also enable customers to receive faster and better support than competitors can deliver, often with little or no additional costs. For example, through our new support site, customers now have access to live chat with agents, web based knowledge articles and "how-to" videos, virtual agent technology, and voice and online collaboration tools for faster resolution of customer issues. Secure Access Link is high speed network connectivity between the client and Avaya, capturing vital information to help ensure reliability, uptime and faster issue resolution of their Avaya systems and applications. Operations Intelligence Suite is a web-based portal that allows clients to have visibility to incidents if they occur to ensure rapid resolution. It also enhances and maintains the client's network by the ability to perform testing, root cause analysis and issue prevention. • Avaya Operations Services which provides holistic managed services for customers' communications environments. Avaya can manage complex multi-vendor, multi-technology and aging networks with Service Level Agreements (SLAs) to help optimize network performance. With AOS services, Avaya can manage a customer's mixed environment and gain the opportunity to upgrade it over time to the latest technology, at the pace and in an operational expense model that makes sense for the customer. Managed services can be procured in standard packages or in fully custom arrangements that include tailored SLAs, billing, reporting, or private cloud options. AOS has approximately 700 experts in managing communications environments, supporting hundreds of customers across the globe. Professional Services Our planning, design and integration specialists and communications consultants provide and implement solutions that help reduce costs and enhance business agility. We also provide vertical solutions designed to leverage existing product environments, contact centers and unified communications networks and our IT professional services ("ITPS") unit provides IT services to U.S. Government customers. Financial Results Summary Our revenues for the six months ended March 31, 2013 decreased 11% as compared to the corresponding period in the prior year. The decrease is primarily the result of lower customer spend on unified communications, contact center, and network products in a cautious spending environment. During the six months ended March 31, 2013, these factors impacting our 42-------------------------------------------------------------------------------- Table of Contents revenues across most of our product solutions also contributed to lower maintenance and professional services revenues. Further, the reduction in spending by government customers in the U.S. in anticipation of sequestration and budget cuts has also negatively impacted our product and services revenues. During the six months ended March 31, 2013, we experienced lower sales of our unified communications products, particularly gateways and legacy NES phones and platforms. We believe these declines are primarily attributable to customers delaying systems upgrades in a cautious spending environment. The decline in gateway sales may be in part impacted by better utilization of SIP technology, which enables our customers to do more with less hardware. We believe the decrease in our contact center product revenues is in part due to pricing pressures of the increasing competition in the marketplace as well as a growing market trend around Cloud consumption preferences with more customers exploring OPEX models for procuring services. Operating loss for the six months ended March 31, 2013 was $49 million as compared to operating income of $16 million for the six months ended March 31, 2012, a decrease of $65 million. The decrease in operating income is primarily attributable to the decrease in revenues described above and the impact of an impairment charge to goodwill, partially offset by the continued benefit from cost savings initiatives. Operating (loss) income for the six months ended March 31, 2013 and 2012 includes non-cash expenses for depreciation and amortization of $221 million and $286 million, goodwill impairment of $89 million and $0 and share-based compensation of $3 million and $5 million for each of the periods, respectively. Net loss for the six months ended March 31, 2013 and 2012 was $277 million and $188 million, respectively. The increase in our net loss is primarily attributable to the decrease in operating income as described above, as well as costs incurred in connection with the modifications to certain credit facilities, and a decrease in the benefit from income taxes, partially offset by higher foreign currency transaction gains for the six months ended March 31, 2013 as compared to the six months ended March 31, 2012. Results From Operations Three Months Ended March 31, 2013 Compared with Three Months Ended March 31, 2012 Revenue Our revenue for the three months ended March 31, 2013 and 2012 was $1,118 million and $1,257 million, respectively, a decrease of $139 million or 11%. Incremental revenue from the Radvision business for the current period was $20 million. The following table sets forth a comparison of revenue by portfolio: Three months ended March 31, Percentage of Total Revenue Yr. to Yr. Yr. to Yr. Percentage Percentage Change, net of Foreign Dollars in millions 2013 2012 2013 2012 Change Currency Impact GCS $ 473 $ 574 42 % 46 % -18 % -18 % Purchase accounting adjustments - (1 ) 0 % 0 % (1) (1) Networking 56 64 5 % 5 % -13 % -13 % Total ECS product revenue 529 637 47 % 51 % -17 % -17 % AGS 589 620 53 % 49 % -5 % -4 % Total revenue $ 1,118 $ 1,257 100 % 100 % -11 % -11 % GCS revenue for the three months ended March 31, 2013 and 2012 was $473 million and $574 million, respectively, a decrease of $101 million or 18%. The decrease in GCS revenue was primarily the result of lower customer spend on unified communications and contact center products in a cautious spending environment as discussed above. These decreases were partially offset by the incremental revenue from the Radvision business for the current period. Networking revenue for the three months ended March 31, 2013 and 2012 was $56 million and $64 million, respectively, a decrease of $8 million or 13%. The decrease in Networking revenue is primarily a result of lower demand. AGS revenue for the three months ended March 31, 2013 and 2012 was $589 million and $620 million, respectively, a decrease of $31 million or 5%. The decrease in AGS revenue was primarily due to lower maintenance and professional services revenues 43-------------------------------------------------------------------------------- Table of Contents as a result of lower product sales particularly in the U.S. and lower ITPS revenues associated with our U.S. government customers. These decreases were partially offset by an increase in revenues from managed services performed under SLAs entered into in prior periods. The following table sets forth a comparison of revenue by location: Three months ended March 31, Percentage of Total Revenue Yr. to Yr. Yr. to Yr. Percentage Dollars in Percentage Change, net of Foreign millions 2013 2012 2013 2012 Change Currency Impact U.S. $ 592 $ 678 53 % 54 % -13 % -13 % International: EMEA 298 327 27 % 26 % -9 % -9 % APAC - Asia Pacific 116 117 10 % 9 % -1 % 0 % Americas International - Canada and Latin America 112 135 10 % 11 % -17 % -15 % Total International 526 579 47 % 46 % -9 % -8 % Total revenue $ 1,118 $ 1,257 100 % 100 % -11 % -11 % Revenue in the U.S. for the three months ended March 31, 2013 and 2012 was $592 million and $678 million, respectively, a decrease of $86 million or 13%. The decrease in U.S. revenue was primarily attributable to lower sales of unified communications and contact center products, which contributed to lower revenues from maintenance and professional services, particularly with our U.S. Government customers. The decrease in U.S. revenue was also attributable to lower demand for networking products and was partially offset by the incremental revenues from the Radvision business. Revenue in EMEA for the three months ended March 31, 2013 and 2012 was $298 million and $327 million, respectively, a decrease of $29 million or 9%. The decrease in EMEA revenue was primarily attributable to lower sales of unified communications products and to a lesser extent our contact center products, and was partially offset by revenues from the Radvision business. Revenue in APAC for the three months ended March 31, 2013 and 2012 was $116 million and $117 million, respectively. The decrease in APAC revenue is primarily attributable to lower sales of our networking products and professional services, partially offset by higher maintenance services. Revenue in Americas International was $112 million and $135 million for the three months ended March 31, 2013 and 2012, respectively, a decrease of $23 million or 17%. The decrease in Americas International revenue was primarily attributable to Canada, Brazil and the Andean Region and was primarily attributable to lower sales of unified communications products and contact center products, as well as an unfavorable impact of foreign currency. We sell our solutions directly to end users and through an indirect sales channel. The following table sets forth a comparison of revenue from sales of products by channel: Three months ended March 31, Percentage of Total ECS Product Revenue Yr. to Yr. Yr. to Yr. Percentage Dollars in Percentage Change, net of Foreign millions 2013 2012 2013 2012 Change Currency Impact Direct $ 125 $ 166 24 % 26 % -25 % -25 % Indirect 404 471 76 % 74 % -14 % -14 % Total ECS product revenue $ 529 $ 637 100 % 100 % -17 % -17 % 44-------------------------------------------------------------------------------- Table of Contents Gross Profit The following table sets forth a comparison of gross profit by segment: Three months ended March 31, Gross Profit Gross Margin Change Dollars in millions 2013 2012 2013 2012 Amount Pct. GCS $ 270 $ 318 57.1 % 55.4 % $ (48 ) (15 )% Networking 23 27 41.1 % 42.2 % (4 ) (15 )% ECS 293 345 55.4 % 54.2 % (52 ) (15 )% AGS 308 296 52.3 % 47.7 % 12 4 % Unallocated amounts (15 ) (28 ) (1 ) (1 ) 13 (1 ) Total $ 586 $ 613 52.4 % 48.8 % $ (27 ) (4 )% (1) Not meaningful Gross profit for the three months ended March 31, 2013 and 2012 was $586 million and $613 million, respectively, a decrease of $27 million or 4%. The decrease was primarily attributable to a decrease in sales volume and lower pricing partially offset by the success of our gross margin improvement initiatives and the impact of lower amortization of technology intangible assets. Our gross margin improvement initiatives include exiting facilities, reducing the workforce, relocating positions to lower-cost geographies, productivity improvements, and obtaining better pricing from our contract manufacturers and transportation vendors. As a result of the above factors, gross margin increased to 52.4% for the three months ended March 31, 2013 from 48.8% for the three months ended March 31, 2012. GCS gross profit for the three months ended March 31, 2013 and 2012 was $270 million and $318 million, respectively, a decrease of $48 million or 15%. The decrease in GCS gross profit is primarily due to the decrease in sales volume and lower pricing partially offset by the success of our gross margin improvement initiatives discussed above. As a result of the above factors, GCS gross margin increased to 57.1% for the three months ended March 31, 2013 compared to 55.4% for the three months ended March 31, 2012. Networking gross profit for the three months ended March 31, 2013 and 2012 was $23 million and $27 million, respectively, a decrease of $4 million or 15%. Networking gross margin decreased to 41.1% for the three months ended March 31, 2013 from 42.2% for the three months ended March 31, 2012. The decreases in Networking gross profit and margin were due to lower revenues which did not allow us to leverage our fixed costs. AGS gross profit for the three months ended March 31, 2013 and 2012 was $308 million and $296 million, respectively, an increase of $12 million or 4%. The increase in AGS gross profit is primarily due to the success of our gross margin improvement initiatives discussed above. We have redesigned the Avaya support website and continue to transition our customers from an agent-based support model to a self-service/web-based support model. These improvements have allowed us to reduce the workforce and relocate positions to lower-cost geographies. These increases in AGS gross profit were partially offset by a decrease in services revenue. As a result of the above factors, AGS gross margin increased to 52.3% for the three months ended March 31, 2013 compared to 47.7% for the three months ended March 31, 2012. Unallocated amounts for the three months ended March 31, 2013 and 2012 include the effect of the amortization of acquired technology intangibles related to the acquisition of NES and the Merger, costs that are not core to the measurement of segment management's performance, but rather are controlled at the corporate level, and certain purchase accounting adjustments in connection with the Merger. Unallocated costs for three months ended March 31, 2013 also included the effect of the amortization of acquired technology intangible assets related to the acquisition of Radvision in June 2012. The decrease in unallocated costs is primarily due to the impact of lower amortization associated with technology intangible assets acquired prior to fiscal 2012. 45-------------------------------------------------------------------------------- Table of Contents Operating expenses Three months ended March 31, Percentage of Revenue Change Dollars in millions 2013 2012 2013 2012 Amount Pct. Selling, general and administrative $ 381 $ 414 34.1 % 32.9 % $ (33 ) (8 )% Research and development 113 117 10.1 % 9.3 % (4 ) (3 )% Amortization of intangible assets 57 56 5.1 % 4.5 % 1 2 % Goodwill impairment 89 - 8.0 % - % 89 - Restructuring and impairment charges, net 18 90 1.6 % 7.2 % (72 ) (80 )% Acquisition-related costs - 2 - % 0.2 % (2 ) (100 )% Total operating expenses $ 658 $ 679 58.9 % 54.1 % $ (21 ) (3 )% Selling, general and administrative ("SG&A") expenses for the three months ended March 31, 2013 and 2012 were $381 million and $414 million, respectively, a decrease of $33 million. The decrease was primarily due to lower expenses as a result of our cost savings initiatives and lower selling expenses. Our cost savings initiatives include exiting facilities, reducing the workforce and relocating positions to lower-cost geographies. These decreases were partially offset by the incremental expenses associated with the Radvision business. Research and development ("R&D") expenses for the three months ended March 31, 2013 and 2012 were $113 million and $117 million, respectively, a decrease of $4 million. The decrease was primarily due to a decrease in costs of new product development and cost savings initiatives. These decreases were partially offset by the incremental expenses associated with the Radvision business and a lower portion of product development costs that were capitalized in the current period. Capitalized software development costs for the three months ended March 31, 2013 and 2012 were $3 million and $7 million, respectively, a decrease of $4 million. Because the projects in our product development portfolio for the three months ended March 31, 2012 were generally further along in the development cycle than those for the three months ended March 31, 2013, we capitalized a lower portion of our current period R&D spend. Amortization of intangible assets was $57 million and $56 million for the three months ended March 31, 2013 and 2012, respectively. Goodwill impairment associated with our ITPS reporting unit for the three months ended March 31, 2013 was $89 million. The ITPS reporting unit provides specialized information technology services exclusively to U.S. government customers and has experienced a decline in revenues as compared to previous periods and a reduction in its forecasts for the remainder of fiscal 2013. The reporting unit was impacted by reduced government spending in anticipation of sequestration and general budget cuts. Additionally, there is much uncertainty regarding how sequestration cuts will be implemented and the impact they will have on contractors supporting the government. As a result of these events, the Company determined that an interim impairment test of the reporting unit's goodwill should be performed. Based on our performance of step one of the goodwill impairment test, we determined that the estimated fair value of the ITPS reporting unit was less than the carrying value of its net assets (including goodwill). Based on the second step of the goodwill impairment test, we determined that the book value of the reporting unit's goodwill exceeded its implied fair value. Accordingly, we wrote down the goodwill balance by $89 million. The impairment was primarily the result of budgetary constraints, sequestration and uncertainty regarding spending on the part of the U.S. government. The reduced valuation of the reporting unit reflects additional market risks and lower sales forecasts for the reporting unit, which is consistent with economic trends at that time. During the three months ended March 31, 2012, the Company tested goodwill for impairment and determined that no impairment existed. During the three months ended March 31, 2012, the Company experienced a decline in revenue as compared to the same period of the prior year and sequential quarters. This revenue decline impacted the Company's forecasts for the remainder of fiscal 2012. As a result of these events, the Company determined that an interim impairment test of goodwill should be performed. Using the revised forecasts as of March 31, 2012, we performed step one of the impairment test of goodwill. Although the revised forecasts provided for lower cash flows, the respective book values of each reporting unit did not exceed their estimated fair values and therefore no impairment was identified. Restructuring and impairment charges, net, for the three months ended March 31, 2013 and 2012 were $18 million and $90 million, respectively, a decrease of $72 million. The Company continued to identify opportunities to streamline its operations and generate cost savings which included consolidating and exiting facilities and eliminating employee positions. Restructuring charges recorded during the three months ended March 31, 2013 include employee separation costs of $9 million and lease 46-------------------------------------------------------------------------------- Table of Contents obligations of $9 million. The employee separation costs are primarily associated with employee severance actions in EMEA and the U.S. Restructuring charges recorded during the three months ended March 31, 2012 include employee separation costs of $87 million and lease obligations of $3 million. Employee separation charges for this period are primarily associated with employee severance actions in Germany. In April 2013, the Company initiated a voluntary employee severance program in the U.S. and will recognize the expense associated with this program during the quarter ending June 30, 2013. The Company is also evaluating the potential for additional employee severance actions to reduce headcount globally and could initiate these actions during the quarter ending June 30, 2013. The Company continues to evaluate opportunities to streamline its operations and identify cost savings globally and may take additional restructuring actions in the future and the costs of those actions could be material. Acquisition-related costs for the three months ended March 31, 2012 was $2 million and include third-party legal and other costs related to business acquisitions in fiscal 2012. There were no acquisition-related costs for the three months ended March 31, 2013. Operating Loss For the three months ended March 31, 2013, operating loss was $72 million compared to $66 million for the three months ended March 31, 2012. Operating loss for the three months ended March 31, 2013 and 2012 includes non-cash expenses for depreciation and amortization of $107 million and $143 million, goodwill impairment of $89 million and $0, and share-based compensation of $1 million and $2 million for each of the periods, respectively. Interest Expense Interest expense for the three months ended March 31, 2013 and 2012 was $116 million and $108 million, respectively, which includes non-cash interest expense of $6 million in each period. Non-cash interest expense for each period includes amortization of debt issuance costs and accretion of debt discount. Cash interest expense for the three months ended March 31, 2013 compared to the three months ended March 31, 2012 increased as a result of certain debt refinancing transactions partially offset by a decrease in interest expense associated with the expiration of certain unfavorable interest rate swap contracts. During the six months ended March 31, 2013, the Company completed a series of transactions which allowed the Company to refinance term loans under its senior secured credit facilities that originally matured October 26, 2014 and senior unsecured notes that originally matured on November 1, 2015. As a result of these debt refinancing transactions, the interest rate associated with the portion of the Company's debt that was refinanced increased. See Note 7, "Financing Arrangements" to our unaudited interim consolidated financial statements for further details. Loss on Extinguishment of Debt In connection with the refinancing of $584 million of outstanding term B-1 loans, we recognized a loss on extinguishment of debt for the three months ended March 31, 2013 of $3 million. The loss represents the difference between the reacquisition price and the carrying value (including unamortized discount and debt issue costs) of the debt. See Note 7, "Financing Arrangements" to our unaudited interim consolidated financial statements for further details on the refinancing of our term B-1 loans. Other Income (Expense), Net Other income, net for the three months ended March 31, 2013 was $2 million as compared to other expense, net of $12 million for the three months ended March 31, 2012. Other income, net, for the three months ended March 31, 2013 includes net foreign currency transaction gains of $17 million, partially offset by third party fees incurred in connection with debt modifications of $14 million. Also included in other income, net for the three months ended March 31, 2013 is a $1 million translation loss recognized in connection with the devaluation of the bolivar by the Venezuela government in February 2013. Other expense, net for the three months ended March 31, 2012 includes net foreign currency transaction losses of $11 million. (Provision for) Benefit from Income Taxes The provision for income taxes for the three months ended March 31, 2013 was $3 million, as compared to a benefit from income taxes of $24 million for the three months ended March 31, 2012. The effective rate for the three months ended March 31, 2013 differs from the statutory U.S. Federal income tax rate primarily due to (1) the effect of tax rate differentials on foreign income/loss, (2) changes in the valuation allowance established against the Company's deferred tax assets, and (3) a $14 million release of valuation allowance associated with tax expense on net gains in other comprehensive income. The effective rate for the three months ended March 31, 2012 differs from the statutory U.S. Federal income tax rate primarily due to (1) the effect of tax rate differentials on foreign income/loss, (2) changes in the valuation allowance established against 47-------------------------------------------------------------------------------- Table of Contents the Company's deferred tax assets and (3) a $6 million increase in the valuation allowance associated with tax expense on net gains in other comprehensive income. During the three months ended March 31, 2012, the Company recorded a tax benefit of $6 million to other comprehensive income primarily relating to pension benefits. The benefit to other comprehensive income and increase in related deferred tax assets resulted in the recording of an income tax expense in continuing operations related to the increase of the corresponding valuation allowance. Six Months Ended March 31, 2013 Compared with Six Months Ended March 31, 2012 Revenue Our revenue for the six months ended March 31, 2013 and 2012 was $2,358 million and $2,644 million, respectively, a decrease of $286 million or 11%. Incremental revenue from the Radvision business for the current period was $44 million. The following table sets forth a comparison of revenue by portfolio: Six months ended March 31, Percentage of Total Revenue Yr. to Yr. Yr. to Yr. Percentage Percentage Change, net of Foreign Dollars in millions 2013 2012 2013 2012 Change Currency Impact GCS $ 1,046 $ 1,241 44 % 47 % -16 % -16 % Purchase accounting adjustments - (1 ) 0 % 0 % (1) (1) Networking 114 146 5 % 5 % -22 % -22 % Total ECS product revenue 1,160 1,386 49 % 52 % -16 % -16 % AGS 1,198 1,258 51 % 48 % -5 % -4 % Total revenue $ 2,358 $ 2,644 100 % 100 % -11 % -10 % GCS revenue for the six months ended March 31, 2013 and 2012 was $1,046 million and $1,241 million, respectively, a decrease of $195 million or 16%. The decrease in GCS revenue was primarily the result of lower customer spend on unified communications and contact center products in a cautious spending environment as discussed above. These decreases were partially offset by the incremental revenue from the Radvision business for the current period. Networking revenue for the six months ended March 31, 2013 and 2012 was $114 million and $146 million, respectively, a decrease of $32 million or 22%. The decrease in Networking revenue is primarily a result of lower demand. AGS revenue for the six months ended March 31, 2013 and 2012 was $1,198 million and $1,258 million, respectively, a decrease of $60 million or 5%. The decrease in AGS revenue was primarily due to lower maintenance and professional services revenues as a result of lower product sales particularly in the U.S. and lower ITPS revenues associated with our U.S. government customers. These decreases were partially offset by an increase in revenues from operational services performed under SLAs entered into in prior periods. 48-------------------------------------------------------------------------------- Table of Contents The following table sets forth a comparison of revenue by location: Six months ended March 31, Percentage of Total Revenue Yr. to Yr. Yr. to Yr. Percentage Dollars in Percentage Change, net of Foreign millions 2013 2012 2013 2012 Change Currency Impact U.S. $ 1,262 $ 1,426 54 % 54 % (12 )% (12 )% International: EMEA 629 692 27 % 26 % (9 )% (8 )% APAC - Asia Pacific 239 243 10 % 9 % (2 )% (1 )% Americas International - Canada and Latin America 228 283 9 % 11 % (19 )% (18 )% Total International 1,096 1,218 46 % 46 % (10 )% (9 )% Total revenue $ 2,358 $ 2,644 100 % 100 % (11 )% (10 )% Revenue in the U.S. for the six months ended March 31, 2013 and 2012 was $1,262 million and $1,426 million, respectively, a decrease of $164 million or 12%. The decrease in U.S. revenue was primarily attributable to lower sales associated with our unified communications and contact center products, which contributed to lower revenues from maintenance and professional services, particularly with our U.S. Government customers. The decrease is also attributable to lower sales associated with our contact center and networking products and was partially offset by the incremental revenues from the Radvision business. Revenue in EMEA for the six months ended March 31, 2013 and 2012 was $629 million and $692 million, respectively, a decrease of $63 million or 9%. The decrease in EMEA revenue was primarily attributable to lower sales associated with our unified communications and contact center products and to a lesser extent an unfavorable impact of foreign currency and was partially offset by the incremental revenues from the Radvision business. Revenue in APAC for the six months ended March 31, 2013 and 2012 was $239 million and $243 million, respectively, a decrease of $4 million or 2%. The decrease in APAC revenue is primarily attributable to lower revenues associated with our unified communications products and professional services, and an unfavorable impact of foreign currency, partially offset by higher maintenance services. Revenue in Americas International was $228 million and $283 million for the six months ended March 31, 2013 and 2012, respectively, a decrease of $55 million or 19%. The decrease in Americas International revenue was particularly attributable to Canada and Brazil and was associated primarily with our unified communications and contact center products, as well as an unfavorable impact of foreign currency. We sell our solutions directly to end users and through an indirect sales channel. The following table sets forth a comparison of revenue from sales of products by channel: Six months ended March 31, Percentage of Total ECS Product Revenue Yr. to Yr. Yr. to Yr. Percentage Dollars in Percentage Change, net of Foreign millions 2013 2012 2013 2012 Change Currency Impact Direct $ 266 $ 333 23 % 24 % (20 )% (20 )% Indirect 894 1,053 77 % 76 % (15 )% (15 )% Total ECS product revenue $ 1,160 $ 1,386 100 % 100 % (16 )% (16 )% 49-------------------------------------------------------------------------------- Table of Contents Gross Profit The following table sets forth a comparison of gross profit by segment: Six months ended March 31, Gross Profit Gross Margin Change Dollars in millions 2013 2012 2013 2012 Amount Pct. GCS $ 619 $ 718 59.2 % 57.9 % (99 ) (14 )% Networking 45 64 39.5 % 43.8 % (19 ) (30 )% ECS 664 782 57.2 % 56.4 % (118 ) (15 )% AGS 626 609 52.3 % 48.4 % 17 3 % Unallocated amounts (38 ) (74 ) (1) (1) 36 (1) Total $ 1,252 $ 1,317 53.1 % 49.8 % (65 ) (5 )% (1) Not meaningful Gross profit for the six months ended March 31, 2013 and 2012 was $1,252 million and $1,317 million, respectively, a decrease of $65 million or 5%. The decrease is primarily attributable to a decrease in sales volume and lower pricing partially offset by the success of our gross margin improvement initiatives, the impact of lower amortization of technology intangible assets, and a $5 million benefit associated with the release of a contingent liability related to a labor matter in EMEA that we released as a result of a favorable court ruling. Our gross margin improvement initiatives include exiting facilities, reducing the workforce, relocating positions to lower-cost geographies, productivity improvements, and obtaining better pricing from our contract manufacturers and transportation vendors. As a result of the above factors, gross margin increased to 53.1% for the six months ended March 31, 2013 from 49.8% for the six months ended March 31, 2012. GCS gross profit for the six months ended March 31, 2013 and 2012 was $619 million and $718 million, respectively, a decrease of $99 million or 14%. The decrease in GCS gross profit is primarily due to the decrease in sales volume and lower pricing partially offset by the success of our gross margin improvement initiatives discussed above. As a result of the above factors, GCS gross margin increased to 59.2% for the six months ended March 31, 2013 compared to 57.9% for the six months ended March 31, 2012. Networking gross profit for the six months ended March 31, 2013 and 2012 was $45 million and $64 million, respectively, a decrease of $19 million or 30%. Networking gross margin decreased to 39.5% for the six months ended March 31, 2013 from 43.8% for the six months ended March 31, 2012. The decreases in Networking gross profit and margin were due to lower revenues which did not allow us to leverage our fixed costs. AGS gross profit for the six months ended March 31, 2013 and 2012 was $626 million and $609 million, respectively, an increase of $17 million or 3%. The increase in AGS gross profit is primarily due to the continued benefit from our gross margin improvement initiatives discussed above, and a $5 million benefit associated with the release of a contingent liability related to a labor matter in EMEA that we released as a result of a favorable court ruling. We have redesigned the Avaya support website and continue to transition our customers from an agent-based support model to a self-service/web-based support model. These improvements have allowed us to reduce the workforce and relocate positions to lower-cost geographies. These increases in AGS gross profit were partially offset by a decrease in services revenue. As a result of the above factors, AGS gross margin increased to 52.3% for the six months ended March 31, 2013 compared to 48.4% for the six months ended March 31, 2012. Unallocated amounts for the six months ended March 31, 2013 and 2012 include the effect of the amortization of acquired technology intangibles related to the acquisition of NES and the Merger, costs that are not core to the measurement of segment management's performance, but rather are controlled at the corporate level, and certain purchase accounting adjustments in connection with the Merger. Unallocated costs for six months ended March 31, 2013 also included the effect of the amortization of acquired technology intangible assets related to the acquisition of Radvision in June 2012. The decrease in unallocated costs is primarily due to the impact of lower amortization associated with technology intangible assets acquired prior to fiscal 2012. 50-------------------------------------------------------------------------------- Table of Contents Operating expenses Six months ended March 31, Percentage of Revenue Change Dollars in millions 2013 2012 2013 2012 Amount Pct. Selling, general and administrative $ 765 $ 847 32.4 % 32.0 % $ (82 ) (10 )% Research and development 231 228 9.8 % 8.6 % 3 1 % Amortization of intangible assets 114 112 4.8 % 4.2 % 2 2 % Goodwill impairment 89 - 3.8 % - % 89 - Restructuring and impairment charges, net 102 111 4.3 % 4.2 % (9 ) (8 )% Acquisition-related costs - 3 - % 0.1 % (3 ) (100 )% Total operating expenses $ 1,301 $ 1,301 55.1 % 49.1 % $ - - % SG&A expenses for the six months ended March 31, 2013 and 2012 were $765 million and $847 million, respectively, a decrease of $82 million. The decrease was primarily due to lower expenses as a result of our cost savings initiatives, lower selling expenses, and a $3 million benefit associated with the release of a contingent liability related to a labor matter in EMEA that we released as a result of a favorable court ruling. Our cost savings initiatives include exiting facilities, reducing the workforce and relocating positions to lower-cost geographies. These decreases were partially offset by the incremental expenses associated with the Radvision business. R&D expenses for the six months ended March 31, 2013 and 2012 were $231 million and $228 million, respectively, an increase of $3 million. The increase was primarily due to the incremental expenses associated with the Radvision business and a lower portion of product development costs that were capitalized in the current period. These increases were partially offset by lower expenses associated with our cost savings initiatives discussed above. Capitalized software development costs for the six months ended March 31, 2013 and 2012 were $10 million and $19 million, respectively, a decrease of $9 million. Because the projects in our product development portfolio for the six months ended March 31, 2012 were generally further along in the development cycle than those for the six months ended March 31, 2013, we capitalized a lower portion of our current period R&D spend. Amortization of intangible assets was $114 million and $112 million for the six months ended March 31, 2013 and 2012, respectively. Goodwill impairment associated with our ITPS reporting unit for the six months ended March 31, 2013 was $89 million. The ITPS reporting unit provides specialized information technology services exclusively to U.S. government customers and has experienced a decline in revenues as compared to previous periods and a reduction in its forecasts for the remainder of fiscal 2013. The reporting unit was impacted by reduced government spending in anticipation of sequestration and general budget cuts. Additionally, there is much uncertainty regarding how sequestration cuts will be implemented and the impact they will have on contractors supporting the government. As a result of these events, the Company determined that an interim impairment test of the reporting unit's goodwill should be performed. Based on our performance of step one of the goodwill impairment test, we determined that the estimated fair value of the ITPS reporting unit was less than the carrying value of its net assets (including goodwill). Based on the second step of the goodwill impairment test, we determined that the book value of the reporting unit's goodwill exceeded its implied fair value. Accordingly, we wrote down the goodwill balance by $89 million. The impairment was primarily the result of budgetary constraints, sequestration and uncertainty regarding spending on the part of the U.S. government. The reduced valuation of the reporting unit reflects additional market risks and lower sales forecasts for the reporting unit, which is consistent with economic trends at that time. During the three months ended March 31, 2012, the Company tested goodwill for impairment and determined that no impairment existed. During the three months ended March 31, 2012, the Company experienced a decline in revenue as compared to the same period of the prior year and sequential quarters. This revenue decline impacted the Company's forecasts for the remainder of fiscal 2012. As a result of these events, the Company determined that an interim impairment test of goodwill should be performed. Using the revised forecasts as of March 31, 2012, we performed step one of the impairment test of goodwill. Although the revised forecasts provided for lower cash flows, the respective book value of each reporting unit did not exceed their estimated fair values and therefore no impairment existed. Restructuring and impairment charges, net, for the six months ended March 31, 2013 and 2012 were $102 million and $111 million, respectively, a decrease of $9 million. The Company continued to identify opportunities to streamline its operations and generate cost savings which included consolidating and exiting facilities and eliminating employee positions. Restructuring 51-------------------------------------------------------------------------------- Table of Contents charges recorded during the six months ended March 31, 2013 include employee separation costs of $79 million and lease obligations of $23 million. The employee separation costs are primarily associated with employee severance actions in EMEA and the U.S. The EMEA approved plan provides for the elimination of 234 positions and resulted in a charge of $47 million. The separation charges include, but are not limited to, social pension fund payments and health care and unemployment insurance costs to be paid to or on behalf of the affected employees. A voluntary program offered to certain management employees in the U.S. resulted in the elimination of 195 positions and resulted in a charge of $9 million. Restructuring charges for the six months ended March 31, 2013 includes lease obligations primarily related to the Company's Maidenhead, United Kingdom, Guilford, United Kingdom, and Highlands Ranch, Colorado facilities. Restructuring charges recorded during the six months ended March 31, 2012 include employee separation costs of $107 million and lease obligations of $4 million. Employee separation charges for this period are primarily associated with employee severance actions in the EMEA, U.S., and Canada. In April 2013, the Company initiated a voluntary employee severance program in the U.S. and will recognize the expense associated with this program during the quarter ending June 30, 2013. The Company is also evaluating the potential for additional employee severance actions to reduce headcount globally and could initiate these actions during the quarter ending June 30, 2013. The Company continues to evaluate opportunities to streamline its operations and identify cost savings globally and may take additional restructuring actions in the future and the costs of those actions could be material. Acquisition-related costs for the six months ended March 31, 2012 was $3 million and include third-party legal and other costs related to business acquisitions in fiscal 2012. There were no acquisition-related costs for the six months ended March 31, 2013. Operating (Loss) Income For the six months ended March 31, 2013, operating loss was $49 million compared to operating income of $16 million for the six months ended March 31, 2012. Operating (loss) income for the six months ended March 31, 2013 and 2012 includes non-cash expenses for depreciation and amortization of $221 million and $286 million, goodwill impairment of $89 million and $0, and share-based compensation of $3 million and $5 million for each of the periods, respectively. Interest Expense Interest expense for the six months ended March 31, 2013 and 2012 was $224 million and $217 million, respectively, which includes non-cash interest expense of $12 million in each period. Non-cash interest expense for each period includes amortization of debt issuance costs and accretion of debt discount. Cash interest expense for the six months ended March 31, 2013 compared to the six months ended March 31, 2012 increased as a result of certain debt refinancing transactions partially offset by a decrease in interest expense as a result of the expiration of certain unfavorable interest rate swap contracts. During the six months ended March 31, 2013, the Company completed a series of transactions which allowed the Company to refinance term loans under its senior secured credit facilities that originally matured October 26, 2014 and senior unsecured notes that originally matured on November 1, 2015. As a result of these debt refinancing transactions, the interest rate associated with the portion of the Company's debt that was refinanced increased. See Note 7, "Financing Arrangements" to our unaudited interim consolidated financial statements for further details. Loss on Extinguishment of Debt In connection with (1) the issuance of our 9% Senior Secured Notes and the payment of $284 million of our term B-5 loans and (2) the refinancing of $584 million of outstanding term B-1 loans, we recognized a loss on extinguishment of debt for the six months ended March 31, 2013 of $6 million. The loss represents the difference between the reacquisition price and the carrying value (including unamortized discount and debt issue costs) of the debt. See Note 7, "Financing Arrangements" to our unaudited interim consolidated financial statements for further details. Other Expense, Net Other expense, net, for the six months ended March 31, 2013 was $4 million as compared to $13 million for the six months ended March 31, 2012. Other expense, net, for the current period includes third party fees incurred in connection with debt modifications of $18 million, partially offset by net foreign currency transaction gains of $15 million. Also included in other expense, net for the six months ended March 31, 2013 is a $1 million translation loss recognized in connection with the devaluation of the bolivar by the Venezuela government in February 2013. Other expense, net for the six months ended March 31, 2012 includes net foreign currency transaction losses of $12 million. Benefit from Income Taxes The benefit from income taxes for the six months ended March 31, 2013 was $6 million, as compared to a benefit from income taxes of $26 million for the six months ended March 31, 2012. The effective rate for the six months ended March 31, 2013 differs from the statutory U.S. Federal income tax rate primarily due to (1) the effect of tax rate differentials on foreign income/loss, (2) changes in the valuation allowance established against the 52-------------------------------------------------------------------------------- Table of Contents Company's deferred tax assets, (3) $17 million of income tax benefit recognized upon the expiration of certain interest rate swaps, and (4) $16 million release of valuation allowance associated with tax expense on net gains in other comprehensive income. During the six months ended March 31, 2013, the Company recognized $17 million of income tax benefit related to the elimination of the tax effect of certain interest rate swaps in other comprehensive income. The tax effect of such interest rate swaps was recognized in other comprehensive income prior to the establishment of a valuation allowance against the Company's U.S. net deferred tax assets and was eliminated following the expiration of the final interest rate swap upon which the tax effect was established. During the six months ended March 31, 2013, the Company recorded a tax charge of $16 million to other comprehensive income primarily relating to pension benefits. The charge to other comprehensive income and decrease in related deferred tax assets resulted in the recording of an income tax benefit in continuing operations related to the release of the corresponding valuation allowance. The effective rate for the six months ended March 31, 2012 differs from the statutory U.S. Federal income tax rate primarily due to (1) the effect of tax rate differentials on foreign income/loss, (2) changes in the valuation allowance established against the Company's deferred tax assets and (3) $6 million release of valuation allowance associated with tax expense on net gains in other comprehensive income. During the six months ended March 31, 2012, the Company recorded a tax charge of $6 million to other comprehensive income primarily relating to pension benefits. The charge to other comprehensive income and decrease in related deferred tax assets resulted in the recording of an income tax benefit in continuing operations related to the release of the corresponding valuation allowance. Liquidity and Capital Resources Cash and cash equivalents decreased by $35 million to $302 million at March 31, 2013 from $337 million at September 30, 2012. Our existing cash balance, cash generated by operations and borrowings available under our credit facilities are our primary sources of short-term liquidity. Based on our current level of operations, we believe these sources will be adequate to meet our liquidity needs for at least the next 12 months. Our ability to meet our cash requirements will depend on our ability to generate cash in the future, which is subject to general economic, financial, competitive, legislative, regulatory and other factors that are beyond our control. As part of our analysis, we have assessed the implications of recent financial events on our current business and determined that these market conditions have not affected our ability to meet our obligations as they come due in the ordinary course of business and have not had a significant impact on our liquidity as of March 31, 2013. However, we cannot assure you that our business will generate sufficient cash flows from operations or that future borrowings will be available to us under our credit facilities in an amount sufficient to enable us to repay our indebtedness or to fund our other liquidity needs. Sources and Uses of Cash A condensed statement of cash flows for the six months ended March 31, 2013 and 2012 follows: Six months ended March 31, In millions 2013 2012 Net cash (used for) provided by: Net loss $ (277 ) $ (188 ) Adjustments to net loss for non-cash items 308 324 Changes in operating assets and liabilities 57 (105 ) Operating activities 88 31 Investing activities (59 ) (63 ) Financing activities (59 ) (20 )Effect of exchange rate changes on cash and cash equivalents (5 ) 7 Net decrease in cash and cash equivalents (35 ) (45 ) Cash and cash equivalents at beginning of period 337 400 Cash and cash equivalents at end of period $ 302 $ 355 53-------------------------------------------------------------------------------- Table of Contents Operating Activities Cash provided by operating activities was $88 million for the six months ended March 31, 2013 compared to cash provided by operating activities of $31 million for the six months ended March 31, 2012. Adjustments to reconcile net loss to net cash provided by operations for the six months ended March 31, 2013 and 2012 were $308 million and $324 million, respectively and primarily consisted of depreciation and amortization of $221 million and $286 million, respectively. Adjustments to reconcile net loss to net cash provided by operations during the six months ended March 31, 2013 also included goodwill impairment of $89 million and third-party fees expensed in connection with our debt modifications of $18 million, which were partially offset by unrealized gains on foreign currency exchanges of $27 million. During the six months ended March 31, 2013, changes in our operating assets and liabilities resulted in a net increase in cash and cash equivalents of $57 million. The net increase was driven by improvements in the collection of receivables, increases in deferred revenues attributable to a significant number of annual prepaid maintenance contracts closed in January 2013, and the effects of non-cash business restructuring reserves net of cash payments against our reserves. These increases in cash and cash equivalents were partially offset by payment of accrued interest, payments associated with our employee incentive programs and the pay down of accounts payable. During the six months ended March 31, 2012, changes in our operating assets and liabilities resulted in a net decrease in cash and cash equivalents of $105 million. The net decrease was primarily driven by the payment of accrued interest, payments associated with our business restructuring reserves and payments associated with our employee incentive programs. Investing Activities Cash used for investing activities was $59 million and $63 million for the six months ended March 31, 2013 and 2012, respectively. The primary use of cash for investing activities for the six months ended March 31, 2013 was related to capital expenditures and capitalized software development costs of $47 million and $10 million, respectively. These uses of cash for investing activities for the six months ended March 31, 2013 were partially offset by $9 million of cash proceeds from the sales of long-lived assets. Cash used for investing activities for the six months ended March 31, 2012 included capital expenditures and capitalized software development costs of $38 million and $19 million, respectively. Further, during the six months ended March 31, 2013 and 2012, the Company advanced to Parent $10 million and $8 million, respectively, in exchange for notes receivable. The principal amount of these notes plus any accrued and unpaid interest are due in full October 3, 2015 and October 3, 2014 with interest at the rate of 0.93% and 1.63% per annum, respectively. The proceeds of these notes were used by Parent to partially fund an acquisition in October 2011. Once the acquisition was complete, Parent immediately merged the acquired entity with and into the Company, with the Company surviving the merger. Also included in cash used for investing activities for the six months ended March 31, 2012 is $4 million for other acquisitions and $8 million of cash proceeds for the sale of investments and long-lived assets. Financing Activities Net cash used for financing activities was $59 million and $20 million for the six months ended March 31, 2013 and 2012. Cash from financing activities for the six months ended March 31, 2013 includes proceeds of $589 million from the issuance of senior secured term B-5 loans and proceeds of $290 million from the issuance of 9% Senior Secures Notes. The proceeds from the issuance of the senior secured term B-5 loans were used to repay $584 million principal amount of our senior secured term B-1 loans and the proceeds from the issuance of the 9% Senior Secured Notes were used to repay $284 million principal amount of our term B-5 loans. Cash used for financing activities for the six months ended March 31, 2013 also includes cash paid for debt issuance and modification costs of $49 million. Included in cash used for financing activities is $19 million in scheduled debt payments for each of the six months ended March 31, 2013 and 2012. See Note 7, "Financing Arrangements" to our unaudited consolidated financial statements for further details on the debt refinancing transactions entered into during the six months ended March 31, 2013. Credit Facilities We have entered into borrowing arrangements and further amended the arrangements with several financial institutions in connection with the Merger on October 26, 2007 and the acquisitions of the enterprise solutions business ("NES"). See Note 7, "Financing Arrangements" to our unaudited consolidated financial statements for further details. During the three months ended December 31, 2012, the Company completed three transactions which allowed the Company to refinance $848 million of term loans under its senior secured credit facilities that originally matured October 26, 2014. These transactions were (1) an amendment and restatement of the senior secured credit facility and the senior secured multi-currency asset-based revolving credit facility on October 29, 2012 along with the extension of the maturity date of $135 million aggregate principal amount of senior secured term B-1 loans ("term B-1 loans"), (2) an amendment and restatement of the senior secured credit facility on December 21, 2012 along with the extension of the maturity date of $713 million aggregate 54-------------------------------------------------------------------------------- Table of Contents principal amount of term B-1 loans and $134 million aggregate principal amount of senior secured term B-4 loans, and (3) the issuance on December 21, 2012 of $290 million of 9% senior secured notes due April 2019. During the three months ended March 31, 2013, the Company refinanced the remaining $584 million of term B-1 loans outstanding under its senior secured credit facility with the cash proceeds of $589 million aggregate principal amount of term B-5 loans under the senior secured credit facility. Additionally, during the three months ended March 31, 2013, the Company refinanced $1,384 million of senior unsecured notes, through (1) amendments to the senior secured credit facility and the senior secured multi-currency asset-based revolving credit facility permitting the refinancing of the 9.75% senior unsecured notes due 2015 and 10.125%/10.875% senior unsecured PIK toggle notes due 2015 (collectively, the "Old Notes") with indebtedness secured by a lien on certain collateral on a junior-priority basis and (2) the exchange of $1,384 million of Old Notes for $1,384 million of 10.50% senior secured notes due 2021. As of March 31, 2013, term loans outstanding under the Cash Flow Credit Agreement include term B-3 loans, term B-4 loans and term B-5 loans with remaining face values (after all principal payments through March 31, 2013) of $2,139 million, $1 million, and $1,148 million respectively. The Company regularly evaluates market conditions, its liquidity profile, and various financing alternatives for opportunities to enhance its capital structure. If opportunities are favorable, the Company may refinance existing debt or issue additional debt securities. In connection with the acquisition of Radvision, the Company borrowed $60 million under its senior secured asset-based credit facility. Following the completion of the acquisition, all amounts borrowed were repaid in full. See Note 7, "Financing Arrangements," to our unaudited interim consolidated financial statements for further details. Future Cash Requirements Our primary future cash requirements will be to fund benefit obligations, debt service, capital expenditures and restructuring payments. In addition, we may use cash in the future to make strategic acquisitions. Specifically, we expect our primary cash requirements for the remainder of fiscal 2013 to be as follows: • Benefit obligations-We estimate we will make payments under our pension and postretirement obligations totaling $104 million during the remainder of fiscal 2013. These payments include: $67 million to satisfy the minimum statutory funding requirements of our U.S. qualified plans, $4 million of payments under our U.S. benefit plans which are not pre-funded, $8 million under our non-U.S. benefit plans which are predominately not pre-funded, $21 million under our U.S. retiree medical benefit plan which is not pre-funded and $4 million under the agreements for represented retirees to post-retirement health trusts. See discussion in Note 11, "Benefit Obligations" to our unaudited interim consolidated financial statements for further details of our benefit obligations. • Debt service-As discussed above and in Note 7, "Financing Arrangements" to our unaudited interim consolidated financial statements, the Company entered into certain refinancing transactions during the six months ended March 31, 2013. We expect to make payments of $242 million during the remainder of fiscal 2013 for principal and interest associated with our long-term debt, as refinanced. We will also make payments associated with our interest rate swaps used to reduce the Company's exposure to variable-rate interest payments. • Capital expenditures-We expect to spend approximately $62 million for capital expenditures and capitalized software development costs during the remainder of fiscal 2013. • Restructuring payments-We expect to make payments of approximately $56 million during the remainder of fiscal 2013 for employee separation costs and lease termination obligations associated with restructuring actions we have implemented through March 31, 2013. 55-------------------------------------------------------------------------------- Table of Contents As discussed above and in Note 7, "Financing Arrangements" to our unaudited interim consolidated financial statements, the Company entered into certain refinancing transactions during the six months ended March 31, 2013. Annual maturities of debt, based on our debt profile as of March 31, 2013 and September 30, 2012, for the next five years ending September 30th and thereafter consist of: In millions March 31, 2013 September 30, 2012 2013 $ 19 $ 38 2014 38 38 2015 53 1,442 2016 174 1,542 2017 38 23 2018 and thereafter 5,799 3,046 Total $ 6,121 $ 6,129 We and our subsidiaries, affiliates and significant shareholders may from time to time seek to retire or purchase our outstanding debt (including publicly issued debt) through cash purchases and/or exchanges, in open market purchases, privately negotiated transactions, by tender offer or otherwise. Such repurchases or exchanges, if any, will depend on prevailing market conditions, liquidity requirements, contractual restrictions and other factors. The amounts involved may be material. Future Sources of Liquidity We expect our existing cash balance, cash generated by operations and borrowings available under our credit facilities to be our primary sources of short-term liquidity. We expect that revenues from higher margin products and services and continued focus on accounts receivable, inventory management and cost containment will enable us to generate positive net cash from operating activities. Further, we continue to focus on cost reductions and have initiated restructuring plans during fiscal 2013 designed to reduce overhead and provide cash savings. We are currently party to (a) a senior secured credit facility which consists of both term loans and a senior secured multi-currency revolver allowing for borrowings of up to $200 million, and (b) a multi-currency asset-based revolving credit facility which provides senior secured revolving financing of up to $335 million, subject to availability under a borrowing base - see Note 7, "Financing Arrangements" to our unaudited interim consolidated financial statements. Our existing cash and cash equivalents and net cash provided by operating activities may be insufficient if we face unanticipated cash needs such as the funding of a future acquisition or other capital investment. If we do not generate sufficient cash from operations, face unanticipated cash needs such as the need to fund significant strategic acquisitions or do not otherwise have sufficient cash and cash equivalents, we may need to incur additional debt or issue additional equity. In order to meet our cash needs we may, from time to time, borrow under our credit facilities or issue long-term or short-term debt or equity, if the market and our credit facilities and the indentures governing our notes permit us to do so. Furthermore, if we acquire a business in the future that has existing debt, our debt service requirements may increase. We regularly evaluate market conditions, our liquidity profile, and various financing alternatives for opportunities to enhance our capital structure. If opportunities are favorable, we may refinance our existing debt or issue additional securities. On June 9, 2011, Parent filed with the SEC a registration statement on Form S-1 (as it may be amended from time to time, the "registration statement") relating to a proposed initial public offering of its common stock. As contemplated in the registration statement, the net proceeds of the proposed offering are expected to be used, among other things, to repay a portion of our long-term indebtedness. The registration statement remains under review by the SEC and shares of common stock registered thereunder may not be sold nor may offers to buy be accepted prior to the time the registration statement becomes effective. This document shall not constitute an offer to sell or the solicitation of any offer to buy nor shall there be any sale of those securities in any State in which such offer, solicitation or sale would be unlawful prior to registration or qualification under the securities laws of any such State. Further, there is no way to predict whether or not Parent will be successful in completing the offering as contemplated and if it is successful, we cannot be certain if, or how much of, the net proceeds will be used for the purposes identified above. During the fourth quarter of fiscal 2012, the Company changed its indefinite reinvestment of undistributed foreign earnings assertion with respect to its non-U.S. subsidiaries. This change in assertion reflects the Company's intention and ability to maintain flexibility with respect to sourcing of funds from non-U.S. locations. 56-------------------------------------------------------------------------------- Table of Contents Debt Ratings As of March 31, 2013, we had a long-term corporate family rating of B3 with a negative outlook from Moody's and a corporate credit rating of B- with a stable outlook from Standard & Poor's. Our ability to obtain additional external financing and the related cost of borrowing may be affected by our debt ratings, which are periodically reviewed by the major credit rating agencies. The ratings are subject to change or withdrawal at any time by the respective credit rating agencies. Critical Accounting Policies and Estimates Management has reassessed the critical accounting policies as disclosed in our Annual Report on Form 10-K filed with the SEC on December 9, 2012 and determined that there were no significant changes to our critical accounting policies in the three months ended March 31, 2013 except for recently adopted accounting guidance as discussed in Note 2, "Recent Accounting Pronouncements" to our unaudited interim consolidated financial statements. Goodwill, Intangible and Long-lived Assets March 31, 2013 During the second quarter of fiscal 2013, the Company tested the long-lived assets and goodwill of its ITPS reporting unit for impairment. The ITPS reporting unit provides specialized information technology services exclusively to government customers in the U.S. During the three months ended March 31, 2013, ITPS experienced a decline in revenues as a result of reduced government spending in anticipation of sequestration and budget cuts. Additionally there is uncertainty regarding how the sequestration and budget cuts will be implemented and the impact they will have on contractors supporting the government. As a result of these events, the Company determined that an interim impairment test of the reporting unit's long-lived assets and goodwill should be performed. Using the revised forecasts, the Company tested the intangible assets and other long-lived assets of the ITPS reporting unit for impairment during the three months ended March 31, 2013 and no impairment was identified. The test of goodwill for impairment began with preparing a valuation of the ITPS reporting unit utilizing our latest near-term and long-term cash flow forecasts. The valuation was prepared based on a discounted cash flow model, consistent with the methodology used as part of the annual goodwill impairment test. This valuation reflected additional market risks and lower sales forecasts for the reporting unit, which are consistent with the government events and economic trends at that time. Specifically, the discounted cash flow model used a discount rate of 13% and did not provide for long-term growth. The results of step one of the goodwill impairment test indicated that the estimated fair value of the ITPS reporting unit was less than the carrying value of its net assets (including goodwill) and as such, the Company performed step two of the impairment test. The second step of the impairment test compares the implied fair value of the reporting unit's goodwill with the carrying value of that goodwill. If the carrying amount of the reporting unit's goodwill exceeds the implied fair value of the goodwill, an impairment loss is recognized in an amount equal to that excess. The implied fair value is determined in the same manner as the amount of goodwill recognized in a business combination. That is, the fair value of the reporting unit is allocated to all of the assets and liabilities of that unit as if the reporting unit had been acquired in a business combination and the fair value of the reporting unit was the purchase price paid to acquire the reporting unit. This allocation is performed only for purposes of assessing goodwill for impairment; accordingly Avaya did not adjust the net book value of the assets and liabilities on its Consolidated Balance Sheets other than goodwill as a result of this process. As a result of the application of step two of the goodwill impairment test, the Company estimated the implied fair value of the goodwill to be $44 million as compared with a carrying value of $133 million and recorded an impairment to goodwill of $89 million. See Note 4, "Goodwill and Intangible Assets" to our consolidated interim financial statements. The financial forecast utilized for purposes of the impairment analysis is based on estimated future cash flows that a market participant would expect the reporting unit to generate in the future. While the Company believes the assumptions used in the impairment analysis are reasonable, changes in the projected cash flows, the discount rate, and short-term and long-term growth rates could produce significantly different results for the impairment analysis. Internal and external factors could result in changes in these assumptions which may result in future impairment tests and charges. The Company will continue to monitor any changes in circumstances for indicators of impairment. The Company determined that no events occurred or circumstances changed during the six months ended March 31, 2013 that would more likely than not reduce the fair value of its other reporting units below their respective carrying amounts. As part of the annual goodwill impairment test at September 30, 2012, the Company applied a hypothetical 10% decrease to the fair value of each reporting unit in order to evaluate the sensitivity of the fair value calculations on the goodwill impairment test. This hypothetical decrease in the fair value of each reporting unit at September 30, 2012 indicated that no other reporting unit was at risk for failing step one of the goodwill impairment assessment. 57-------------------------------------------------------------------------------- Table of Contents New Accounting Pronouncements See discussion in Note 2, "Recent Accounting Pronouncements" to our unaudited interim consolidated financial statements for further details. CAUTIONARY NOTE REGARDING FORWARD-LOOKING STATEMENTS This Quarterly Report on Form 10-Q contains "forward-looking statements." All statements other than statements of historical fact are "forward-looking" statements for purposes of the U.S. federal and state securities laws. These statements may be identified by the use of forward looking terminology such as "anticipate," "believe," "continue," "could," "estimate," "expect," "intend," "may," "might," "plan," "potential," "predict," "should" or "will" or the negative thereof or other variations thereon or comparable terminology. In particular, statements about our expectations, beliefs, plans, objectives, assumptions or future events or performance contained in this report under Part II, Item 1A, "Risk Factors," and Part I, Item 2, "Management's Discussion and Analysis of Financial Condition and Results of Operations," are forward-looking statements. We have based these forward-looking statements on our current expectations, assumptions, estimates and projections. While we believe these expectations, assumptions, estimates and projections are reasonable, such forward-looking statements are only predictions and involve known and unknown risks and uncertainties, many of which are beyond our control. These and other important factors, including those discussed in this report, may cause our actual results, performance or achievements to differ materially from any future results, performance or achievements expressed or implied by these forward-looking statements. Some of the key factors that could cause actual results to differ from our expectations include: • our ability to develop and sell advanced communications products and services, including unified communications, data networking solutions and contact center applications; • the market for our products and services, including unified communications solutions; • our ability to remain competitive in the markets we serve; • economic conditions and the willingness of enterprises to make capital investments; • our reliance on our indirect sales channel; • the ability to protect our intellectual property and avoid claims of infringement; • the ability to retain and attract key employees; • our degree of leverage and its effect on our ability to raise additional capital and to react to changes in the economy or our industry; • our ability to manage our supply chain and logistics functions; • liquidity and our access to capital markets; • risks relating to the transaction of business internationally; • our ability to effectively integrate acquired businesses into ours, including Radvision; • an adverse result in any significant litigation, including antitrust, intellectual property or employment litigation; • our ability to maintain adequate security over our information systems; • environmental, health and safety laws, regulations, costs and other liabilities; • climate change; and • pension and post-retirement healthcare and life insurance liabilities. We caution you that the foregoing list of important factors may not contain all of the material factors that are important to you. In addition, in light of these risks and uncertainties, the matters referred to in the forward-looking statements contained in this report may not in fact occur. We undertake no obligation to publicly update or revise any forward-looking statement as a result of new information, future events or otherwise, except as otherwise required by law. 58-------------------------------------------------------------------------------- Table of Contents EBITDA and Adjusted EBITDA EBITDA is defined as net income (loss) before income taxes, interest expense, interest income and depreciation and amortization. EBITDA provides us with a measure of operating performance that excludes items that are outside the control of management, which can differ significantly from company to company depending on capital structure, the tax jurisdictions in which companies operate and capital investments. Under the Company's debt agreements, the ability to draw down on the revolving credit facilities or engage in activities such as incurring additional indebtedness, making investments and paying dividends is tied in part to ratios based on Adjusted EBITDA. As defined in our debt agreements, Adjusted EBITDA is a non-GAAP measure of EBITDA further adjusted to exclude certain charges and other adjustments permitted in calculating covenant compliance under our debt agreements. We believe that including supplementary information concerning Adjusted EBITDA is appropriate to provide additional information to investors to demonstrate compliance with our debt agreements and because it serves as a basis for determining management compensation. In addition, we believe Adjusted EBITDA provides more comparability between our historical results and results that reflect purchase accounting and our new capital structure following the Merger. Accordingly, Adjusted EBITDA measures our financial performance based on operational factors that management can impact in the short-term, namely the Company's pricing strategies, volume, costs and expenses of the organization. EBITDA and Adjusted EBITDA have limitations as analytical tools. Adjusted EBITDA does not represent net income (loss) or cash flow from operations as those terms are defined by GAAP and does not necessarily indicate whether cash flows will be sufficient to fund cash needs. While Adjusted EBITDA and similar 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. Adjusted EBITDA does not reflect the impact of earnings or charges resulting from matters that we consider not to be indicative of our ongoing operations. In particular, based on our debt agreements the definition of Adjusted EBITDA allows us to add back certain non-cash charges that are deducted in calculating net income (loss). Our debt agreements also allow us to add back restructuring charges, Sponsor monitoring fees and other specific cash costs and expenses as defined in the agreements and that portion of our pension costs, other post-employment benefits costs, and non-retirement post-employment benefits costs representing the amortization of pension service costs and actuarial gain or loss associated with these employment benefits. However, these are expenses that may recur, may vary and are difficult to predict. Further, our debt agreements require that Adjusted EBITDA be calculated for the most recent four fiscal quarters. As a result, the measure can be disproportionately affected by a particularly strong or weak quarter. Further, it may not be comparable to the measure for any subsequent four-quarter period or any complete fiscal year. 59-------------------------------------------------------------------------------- Table of Contents The unaudited reconciliation of net loss, which is a GAAP measure, to EBITDA and Adjusted EBITDA is presented below: Three months ended March 31, Six months ended March 31, (In millions) 2013 2012 2013 2012 Net loss $ (192 ) $ (162 ) $ (277 ) $ (188 ) Interest expense 116 108 224 217 Interest income - (1 ) (1 ) (2 ) Provision for (benefit from) income taxes 3 (24 ) (6 ) (26 ) Depreciation and amortization 107 143 221 286 EBITDA 34 64 161 287 Impact of purchase accounting adjustments - 1 - 1 Restructuring charges, net 18 90 102 111 Sponsors' fees (a) 2 2 4 4 Acquisition-related costs (b) - 2 - 3 Integration-related costs (c) 5 3 9 8 Loss on extinguishment of debt (d) 3 - 6 - Third-party fees expensed in connection with the debt modification (e) 14 - 18 - Non-cash share-based compensation 1 2 3 5 Loss on investments and sale of long-lived assets, net - 2 - 3 Goodwill impairment 89 - 89 - Venezuela hyperinflationary and devaluation charges 1 - 1 - (Gain) loss on foreign currency transactions (17 ) 11 (15 ) 12 Pension/OPEB/nonretirement postemployment benefits and long-term disability costs (f) 22 23 45 45 Adjusted EBITDA $ 172 $ 200 $ 423 $ 479 (a) Sponsors' fees represent monitoring fees payable to affiliates of the Sponsors pursuant to a management services agreement entered into at the time of the Merger. (b) Acquisition-related costs include legal and other costs related to Radvision, the acquisition of NES and other acquisitions. (c) Integration-related costs primarily represent third-party consulting fees and other administrative costs associated with consolidating and coordinating the operations of Avaya with Radvision, NES and other acquisitions. In fiscal 2013, the costs primarily relate to developing compatible IT systems and internal processes with NES and consolidating and coordinating the operations of Avaya with Radvision and other acquisitions. In fiscal 2012, the costs primarily relate to developing compatible IT systems and internal processes with NES. (d) Loss on extinguishment of debt represents the loss recognized in connection with the repayment of $284 million of term B-5 loans and $584 million of term B-1 loans. The loss is based on the difference between the reacquisition price and the carrying value (including unamortized debt issue costs) of the debt. See Note 7, "Financing Arrangements," to our unaudited interim consolidated financial statements located elsewhere in this Form 10-Q. (e) The third-party fees expensed in connection with debt modification represent fees paid to third parties in connection with modifications of the senior secured credit facility and the exchange of $1,384 million of senior unsecured notes for senior secured notes. See Note 7, "Financing Arrangements," to our unaudited interim consolidated financial statements located elsewhere in this Form 10-Q. (f) Represents that portion of our pension costs, other post-employment benefit costs and non-retirement post-employment benefit costs representing the amortization of prior service costs and net actuarial gains/losses associated with these employment benefits. 60-------------------------------------------------------------------------------- Table of Contents [ Back To TMCnet.com's Homepage ]