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AVAYA INC - 10-Q - Management's Discussion and Analysis of Financial Condition and Results of Operations.(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 June 30, 2014 and for the three and nine months ended June 30, 2014 and 2013 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, 2013, which were included in our Annual Report on Form 10-K filed with the SEC on November 22, 2013. 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. Overview We are a leading global provider of real-time business collaboration and communications products and services 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 products and services are designed to enable business users to work together more effectively internally and with their customers and suppliers, to accelerate decision-making and achieve enhanced business outcomes. These industry leading products and services 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 fit-for-purpose products and distributed software services and support models. We shape our portfolio to meet the demands of customers today and in the future. Our products are aimed at large enterprises, mid-market businesses and government organizations. We offer our products in four key business collaboration and communications categories: • Clients and Devices - which includes Unified Communications Desktop, Unified Communications for Mobile, Contact Center Agent Experience, Contact Center Supervisor Experience, Desk Phones, Wireless Phones, Conference Phones, and Video Endpoints; • Unified Communications and Contact Center Applications - which includes Conferencing, Messaging, Mobility, Contact Center Interaction, Contact Center Experience, and Contact Center Performance; • Collaboration Platforms - which includes Core Platform, Service Creation, Enterprise and Government Systems, Small/Mid-Market Systems, Management, Security, Video Infrastructure, and Gateways and Servers; and • Networking - which includes Unified Access, Edge, Wireless LAN, and Core & Center Switching. These four categories are supported by Avaya's portfolio of services including product support, integration, professional services and Cloud and managed services. These services enable customers to optimize and manage their communications networks worldwide and achieve enhanced business results. 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 included elsewhere in this Quarterly Report on Form 10-Q. On June 9, 2011, Parent filed with the SEC a registration statement on Form S-1 (as 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 or other jurisdiction in which such offer, solicitation or sale would be 28-------------------------------------------------------------------------------- Table of Contents unlawful prior to registration or qualification under the securities laws of any such State or other jurisdiction. 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. Divestiture of Government IT Professional Services Business On March 31, 2014, the Company completed the sale of its government IT Professional Services ("ITPS") business for an adjusted sales price of $101 million, inclusive of $3 million of working capital adjustments, and net of $2 million in costs to sell. See Note 4, "Divestitures - Government IT Professional Services Business," to our unaudited interim Consolidated Financial Statements for further details. As a result of management's plan to divest the ITPS business, the results of operations, cash flows and assets and liabilities of the ITPS business have been classified as discontinued operations in all periods presented. 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. Refinancing of Debt During fiscal 2013, the Company completed a series of transactions which allowed the Company to refinance (1) all of 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 senior unsecured paid-in-kind ("PIK") toggle notes each originally due November 1, 2015. These transactions extended the maturity date of the $2.8 billion of refinanced debt by an additional three to six years and increased the associated interest rate. During fiscal 2014, the Company entered into refinancing transactions which lowered the interest rate of certain debt. On February 5, 2014, the Company completed an amendment to the senior secured credit facility pursuant to which the Company refinanced $1,138 million aggregate principal amount of senior secured term B-5 loans ("term B-5 loans") with the cash proceeds from the issuance of senior secured term B-6 loans ("term B-6 loans"). On May 15, 2014, the Company redeemed 100% of the aggregate principal amount of its 9.75% senior unsecured cash-pay notes due 2015 and 10.125%/10.875% senior unsecured PIK toggle notes due 2015 at a redemption price of 100% of the principal amount thereof, plus accrued and unpaid interest, or $92 million and $58 million, respectively. The redemption price of $150 million was funded through cash on-hand of $10 million and borrowings of $140 million under the Company's revolving credit facilities. See Note 8, "Financing Arrangements" to our unaudited interim Consolidated Financial Statements and "Management's Discussion and Analysis - Liquidity and Capital Resources: Credit Facilities" for further details. As of June 30, 2014 our long-term debt consists of the following: In millions Variable rate senior secured multi-currency asset-based revolving credit facility due October 26, 2016 $ 40 Variable rate senior secured multi-currency revolver due October 26, 2016 100 Variable rate senior secured term B-3 loans due October 26, 2017 2,109 Variable rate senior secured term B-4 loans due October 26, 2017 1 Variable rate senior secured term B-6 loans due March 31, 2018 1,131 7% senior secured notes due April 1, 2019 1,009 9% senior secured notes due April 1, 2019 290 10.50% senior secured notes due March 1, 2021 1,384 Unaccreted discount (23 ) 6,041 Debt maturing within one year (32 ) Long-term debt $ 6,009 During the nine months ended June 30, 2013, the Company incurred $49 million in debt refinancing fees and expenses, of which $18 million was expensed as incurred and included in other expense, net and $31 million was deferred and is being amortized over the term of the related debt. During the nine months ended June 30, 2014, the Company incurred $15 million in debt refinancing fees and expenses, of which $2 million was expensed as incurred and included in other expense, net, $3 million was included in determination of the loss on extinguishment of debt, and $10 million was deferred and is being amortized over the term of the related debt. 29-------------------------------------------------------------------------------- Table of Contents The weighted average contractual interest rate of the Company's outstanding debt as of June 30, 2014 and September 30, 2013 was 6.9% and 7.4%, respectively. Annual maturities of debt (excluding unaccreted discount of $23 million), for the next five years ending September 30th and thereafter, consist of: In millions June 30, 2014 Remainder of fiscal 2014 $ 10 2015 38 2016 39 2017 178 2018 3,116 2019 and thereafter 2,683 Total $ 6,064 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 and Services Our products and services span four key business communications and collaboration families that may be purchased and implemented independently or together as a complementary and integrated solution: • Clients and Devices - this family of offerings is focused on enabling or providing the following products and functions to the mid-market and/or large enterprise: Unified Communications Desktop, Unified Communications for Mobile, Contact Center Agent Experience, Contact Center Supervisor Experience, Desk Phones, Wireless Phones, Conference Phones, and Video Endpoints; • Unified Communications and Contact Center Applications - this family of applications is focused on delivering the following functions to the mid-market and/or large enterprise: Conferencing, Messaging, Mobility, Contact Center Interaction, Contact Center Experience, and Contact Center Performance; • Collaboration Platforms - this family of platform offerings is focused on providing the following: Core Platform, Service Creation, Enterprise & Government Systems, Small/Mid-Market Systems, Management, Security, video Infrastructure, and Gateways & Servers; and • Networking - this family of products for network infrastructure covers: Unified Access, Edge, Wireless LAN and Core & Center Switching for data center, campus, branch, and wireless access to complement our business collaboration, unified communications and contact center portfolios. Our products and services are designed to meet the diverse needs of small and mid-size businesses, as well as large enterprises and government customers. We segment the market into enterprise - for organizations of more than 5,000 users and "mid-market" - for organizations of less than 5,000 users. Historically our channels and sales force have been more focused on the "enterprise" segment. We believe that, by dedicating more attention and resources to the mid-market, we can generate additional growth; we believe that this large and fragmented segment can be well-served by our enhanced product portfolio and increased market coverage. The majority of our product portfolio is comprised of 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, 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. Avaya's portfolio of services include product support, integration, cloud and managed services as well as professional services that enable customers to optimize and manage their communications networks worldwide and achieve enhanced business results. 30-------------------------------------------------------------------------------- Table of Contents Given the transformation in our business, market trends and customer buying preferences, we generally view each of our products and services as falling within one of the following three categories: • Flagship, which generally includes video, Avaya Aura®, Avaya IP Office, leading edge contact center, session border controller, Ethernet/fabric switching, cloud and managed services, and also maintenance and professional services revenue associated with all of the Flagship products; • Core, which generally includes phones, gateways, servers, core contact center, and other managed and maintenance support services; and • Legacy, which generally includes legacy products and services acquired as part of the NES acquisition and our 2004 acquisition of Tenovis, excluding networking. Our Products Real-Time Collaboration Platforms, Video and Unified Communications Enterprises of all sizes depend on Avaya for unified communications products and technology that help improve efficiency, collaboration and competitiveness. Our people-centric products integrate voice, video and data, enabling users to communicate and collaborate in real-time, in the mode best suited to each interaction. This eliminates inefficiencies in communications to help make organizations more productive and responsive. Video and Conferencing Avaya helps enable easier, faster, more effective collaboration inside the enterprise and externally with conferencing products for desktops, meeting rooms and mobile devices. • Avaya Scopia is a standards-based portfolio of hardware and software products that includes conference room systems, desktop and mobile video conferencing and infrastructure and management (see "-Platforms, Infrastructure and Phones" below for more information). Avaya Scopia High Definition, or HD, video conferencing room systems incorporate state-of-the-art video technology with capabilities required to support today's room system deployments. The Avaya Scopia XT5000 is ideal for large conference rooms, while the Avaya Scopia XT4200 is specifically designed for the needs of smaller and mid-sized conference rooms. We also offer desktop clients from the software Avaya Scopia Desktop to the Avaya Scopia XT Executive 240. These advanced HD personal video conferencing endpoints are cost effective for expanding the reach of the video deployment beyond the conference room. In all cases, video is optimized for both quality and bandwidth, in particular by supporting scalable video codecs on all endpoints, either hardware or software. Avaya Scopia Mobile extends the Avaya Scopia product to the latest mobile devices providing applications for video conferencing, control and management via smartphones and tablets supporting Apple iOS and Google Android. Avaya Scopia products are used by institutions, enterprises and service providers to create high quality, easy-to-use voice, video, and data collaboration environments, regardless of the communication network-IP, Session Initiation Protocol, or SIP, 3G, 4G, H.323, integrated services digital networks, or ISDNs, or next generation IP Multi-Media Subsystems, or IMS. • Avaya Aura Conferencing gives users simple access to multi-media collaboration. In the same application users can use voice, video, chat and web conferencing. Based on the Avaya Aura architecture, Avaya Aura Conferencing is distributed and scalable to thousands of users. Its modular conception allows the system to be dimensioned appropriately in terms of video or web content servers or voice communications manager. By utilizing HD and scalable video encoders/decoders and cascading (essentially multiplexing the video streams from one group of participants to another based on location) both increasing scale while preserving bandwidth consumed, we believe Avaya Aura Conferencing allows a more cost-effective solution for customers than our competitors' products while preserving quality. Avaya Aura Conferencing is accessed through an easy-to-use interface with one touch access to real time, enterprise wide audio, video and web collaboration known as the Avaya Flare Experience. Accessible via PCs, tablets, or smartphones, the Avaya Aura conferencing interfaces with Microsoft Exchange so that users can schedule conferences from Microsoft Outlook and send invitations with "click to join" links. Communication and Messaging Avaya applications deliver advanced enterprise communication and messaging tools to end users on their device of choice. Among others, Avaya offers Avaya one-X Unified Communications clients, which deliver software-based user experiences for consistent, enterprise-wide mobility and collaboration. Users can use their enterprise phone number and work from anywhere, 31-------------------------------------------------------------------------------- Table of Contents using virtually any device, including desktop and laptop computers, tablets and smartphones which helps enterprises lower expenses, increase productivity, enhance business continuity, and streamline customer support. • Avaya one-X Communicator is ideal for users who communicate frequently, manage multiple calls, set up ad-hoc conferencing and need to be highly reachable. Avaya one-X Communicator provides users with access to unified communications capabilities including voice and video calling, audio conferencing, instant messaging and presence, corporate directories and communication logs. This software client can be deployed on desktop or laptop computers running either Microsoft Windows or Apple OSX operating systems and is supported over VDI connections. Avaya one-X Communicator gives users single number/single identity for both inbound and outbound calls, even when using their desktop or laptop. • Avaya one-X Mobile enables users to access enterprise communications from a wide selection of mobile devices, including high-end smart phones and tablets. A choice of one-X Mobile clients is available for popular platforms including Apple iPhone, Google Android and BlackBerry. Through integration with Avaya one-X Client Enablement Services, Avaya one-X Mobile users have access to a broad range of unified communications capabilities such as visual voicemail, corporate directory, aggregated presence, VIP lists and synchronized call logs and contacts. Avaya one-X Mobile gives users single number/single identity for both inbound and outbound calls, even when using personal devices. • Avaya Client Applications provide access to Avaya voice and video services from business applications such as Microsoft Lync, Microsoft Office Communications Server, Microsoft Outlook, Microsoft Office, IBM Sametime, and customer relationship management, or CRM, applications such as Salesforce.com and Microsoft Dynamics. In addition to the above, Avaya's standards-based, IP unified messaging portfolio provides features such as call answering, voice messaging, and speech capabilities, each supporting specific business and end user needs. Platforms, Infrastructure and Phones Avaya's feature-rich applications have at their foundation platforms and infrastructure products designed to support and strengthen them. In addition, Avaya's product portfolio includes phones and other endpoints that are designed to showcase the benefits those applications provide to their users. • The Avaya Aura Core is a next-generation architecture powering our communications and collaboration services. Based on IMS, an industry standard defined by 3GPP, this core provides a flat communications control and management function utilizing SIP methods. Unlike point-to-point SIP, or even standard client server SIP approaches used by most of our competitors, the Avaya Aura Core uses the SIP-ISC, or IMS Service Control, signaling standard to allow multiple independent applications to serve communication sessions. Using an IMS capability that supports application sequencing, we provide the ability for Avaya Communication Manager to provide telephony features, Avaya Collaboration Environment to provide customer developed features, and industry standard SIP applications servers (like IBM Websphere) to provide partner developed services. As a 3-tier architecture, applications are logically partitioned from communication logic and network access layers, allowing for a variety of end clients (phones, soft phones, smart phones, tablets, kiosks, etc.), and supporting integration with legacy communications systems. This integration simplifies a customer's environment, leveraging Avaya Aura to wrap new and legacy infrastructure into one global system, with benefits such as global routing and dial plan, shared SIP trunking for reduced carrier access cost and complexity. By allowing the legacy systems to leverage many of the capabilities of Avaya Aura, we also simplify migration of legacy systems at the customer's desired pace, which helps to reduce one of the biggest traditional obstacles to migration of enterprise IT systems. • Avaya Aura Collaboration Environment is a software platform that reduces the complexity of embedding communications and collaboration capabilities into business applications, such as CRM or Enterprise Resources Planning, or ERP, making it possible to quickly develop creative new ways of doing business. It enables the integration of business applications with unified communications technology and contact center capabilities including voice, short message service or SMS, and email. An example would be a financial institution allowing its customers to reach out to an adviser by a video session from within the customer service application, or a customer service organization assembling a team of relevant experts on the fly and bringing them into a conference automatically. 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 IP Office is our award-winning, flagship solution for the mid-market. Avaya IP Office simplifies processes and 32-------------------------------------------------------------------------------- Table of Contents streamlines information exchange within systems. Communications capabilities can be added as needed. Avaya IP Office gives growing companies flexibility and the ability to retain and leverage their existing investment, by also connecting to their legacy infrastructure. The latest version of Avaya IP Office (9.0) offers increased scale, flexible deployment options, simplified management and support for branch deployments; it gives mid-market customers most features and functions that large enterprises use, but at a scale that is efficient and affordable for them. Avaya IP Office software extends Avaya innovation to the mid-market, delivering a seamless collaboration experience across voice, video and mobility for up to 2,000 users, and providing advanced contact center functionality. • Avaya Aura Messaging gives users a rich set of features that increase their reachability, add new message notification options, and provide more ways to access and receive messages - all controlled using an intuitive web portal. Avaya Aura Messaging adapts to enterprise environments with flexible per-user message storage options, resiliency options and deployment options for consolidation, centralization and scale. Avaya Aura Messaging helps to enable smooth migrations from legacy voicemail systems, with choice of telephone user interface, or TUI, and tools for migrations. • Avaya Messaging Service extends SMS messages to and from smartphones, tablets, notebooks and desktop devices, thereby enabling one-number communications via text messaging. By flowing through the corporate network, Avaya Messaging Service brings the same level of security, compliance and quality companies expect in email text messaging. With Avaya Messaging Service, a user can be reached by sending an SMS to his office number, without having to know his mobile number. This enhances reachability and privacy. • Avaya Session Border Controller, or SBC, for Enterprise provides enhanced security for collaboration within and outside of the enterprise, helping to protect the SIP trunks from multiple threats and allowing SIP remote users to simply and securely connect communication and collaboration applications to the enterprise without the need of VPN connection - for example a softphone or conferencing application. This provides security, simplifies the user experience and reduces cost. • Avaya Video Conferencing infrastructure includes Avaya Scopia Elite Multipoint Conferencing Units, or MCUs, which are reliable and highly scalable multi-party video conferencing platforms for enterprise and service provider environments. They offer advanced and easy-to-use multi-party infrastructure for video conferencing and are at the core of a high definition deployment. In addition, gateways for Microsoft Lync and SIP provide connectivity and interoperability with unified communications products to standards-based video conferencing systems and infrastructure. Avaya Scopia Gateways are ideal for connecting IP video networks with ISDN and public switched telephone networks, or PSTN, networks providing connectivity to ISDN endpoints or telephones. In addition to the above, Avaya Scopia Management provides a comprehensive management product for voice and video collaboration, while Avaya Scopia ECS Gatekeeper is a high-performance, H.323 Enhanced Communication Server, or ECS, Gatekeeper that provides intelligent, advanced backbone management for IP telephony and multimedia communication networks. Finally, Avaya's eVident monitoring technology helps enable enterprises and service providers to ensure network readiness before and after voice and video applications are deployed. • Endpoints comprise a range of models that suit employees and executives at every level, including IP and digital deskphones, digital enhanced cordless telecommunications, or DECT, handsets, wireless phones, and conference phones. Avaya phones are optimized for different use cases. They offer capabilities such as touch screen and applications such as integration to corporate calendar, directory and presence, enhanced audio quality for a "you-are-there" experience, customization and soft keys, and multiple lines appearances, to name a few. We believe that, in a number of industries, the desk phone is a critical business tool and provides an experience which cannot be replicated in software on generic platforms: in the contact center for example, quick access to core functionality via dedicated keys often is desired by our customers. Avaya Contact Center and Customer Experience Management Avaya is a leader in the contact center market providing enterprise and mid-market customers with the ability to communicate with their customers efficiently and effectively. The contact center portfolio provides a foundation for managing voice interactions that has been extended to include multiple channels supporting video, email, chat, SMS, and social media. Based on client engagements globally, we understand how to deliver world-class customer experience management to enable our customers to establish rich and informed relationships with their customers. Our approach is based on two core principles: • Awareness, which is the application of relevant available contextual information for each end customer; and • Persistent conversation, which connects all interactions with an end customer into a seamless experience. 33-------------------------------------------------------------------------------- Table of Contents Avaya believes there are five components to effective Customer Experience Management. Each component delivers value to an organization, and, when combined, they help improve customer acquisition, increase customer retention and growth, deliver high quality experiences and help enable efficient management. Avaya Contact Center products align along these five components: • Interaction, which involves connecting an enterprise with its end customers over their preferred media and modes such as web, social, mobile, voice and video. This also includes the desktop element that provides relevant information to agents and knowledge workers and facilitates collaboration across all the resources involved in delivering the customer experience. It includes products such as Customer Connections Mobile, Customer Connections Web, Social Media Manager, Automated Chat, One Touch Video, Avaya one-X Agent and Avaya Aura Agent Desktop. • Experience includes leveraging real-time awareness of end customer needs, business policies and resource availability to determine the next best action and best resource to address the customer needs at the right time based on target customer experience the organization wants to deliver. It is also responsible for integrating inbound and outbound self service, agent selection and workflows with back-office processes and operations to enable this holistic end customer experience. It includes products such as Intelligent Customer Routing, Dynamic Routing, Avaya Aura Call Center Elite Multichannel, Avaya Aura Contact Center, Avaya Interaction Center, Avaya Aura Experience Portal, Media Processing Server, Proactive Contact, Proactive Outreach Manager and Callback Assist. • Performance encompasses the collection, consolidation and analysis of data and information in order to gain insight into the customer experience and business performance. It includes reporting and analytics tools for improving overall workforce management, skills, efficiency and effectiveness. It includes products such as Avaya Call Management System, Avaya IQ, Avaya Operational Analyst, Speech Analytics, Call Recording, Quality Monitoring, Workforce Management, e-Learning and e-Coaching, Customer Feedback and Avaya Aura Performance Center. • Design includes open, standards-based tools for creating and managing applications and workflows that are integrated into back office processes, third party applications and customer databases. It includes products such as Avaya Aura Orchestration Designer and Application Enablement Services. • Management means enabling centralized management and administration for all the above systems, applications and resources within the framework as well as the ability to identify potential issues and perform root-cause analysis to prevent system outages and performance degradation. It includes products such as Avaya Contact Center Control Manager. In April 2014, Avaya announced the latest addition to its customer experience management solutions for mid-market, Avaya Contact Center Select, which works with the Avaya IP office platform and provides, among other things, multichannel support (voice, email, chat, SMS and fax), scalability for 30 - 250 agents and skills-based routing. Avaya Networking In support of our data communications strategy, our networking product portfolio is designed to address and compete on the basis of three key requirements: resiliency, efficiency and performance. Our networking portfolio is complementary to our unified communications and contact center portfolios based on the Avaya Aura architecture. We believe that customers today benefit from end-to-end product 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, campus, 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 Ethernet Switches for data center, core, edge and branch applications. • Unified Branch-a range of routers and Virtual Private Network, or VPN, appliances that provide a secure connection for branches. • Wireless Networking-cost-effective and scalable products that enable enterprises to support wireless connectivity and services; 34-------------------------------------------------------------------------------- Table of Contents • Access Control-products that enforce role- and policy-based access control to the network; and • Unified Management and Orchestration-providing support for data and voice networks by simplifying the requirements associated across functional areas. Avaya leverages these hardware platforms to deliver a range of next-generation networking capabilities that are collectively offered under the Virtual Enterprise Network Architecture, or VENA, banner. An end-to-end strategic framework, VENA helps simplify data center and campus networking and optimizes business applications and service deployments, while helping to reduce costs, improve time-to-service and enhance business agility. For example, Fabric Connect, part of the VENA portfolio, is a fully-integrated, end-to-end network virtualization offering based on the Shortest Path Bridge, or SPB, standard, designed to automate service provisioning, improve performance and reduce outages. This is made possible by mechanisms such as edge provisioning, unified control and forwarding (as opposed to multiple protocols in competitors' products), fast re-convergence (in milliseconds as opposed to seconds or more), and Layer 3 isolation. 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, where we believe requirements are better met by Fabric Connect. Avaya Services Avaya Global Services consult, enable, support, manage, optimize and even outsource enterprise communications products (applications and networks) to help customers achieve enhanced business results both directly and through partners. Avaya's portfolio of services enables customers to mitigate risk, reduce total cost of ownership, and optimize communication products for performance worldwide. Avaya Global Services is supported by patented design and management tools and network operations and technical support centers around the world. Avaya's Global Services portfolio spans three types of services, Avaya Professional Services, Avaya Global Support Services, and Avaya Cloud and Managed Services. Avaya Client Services is a business unit that encompasses Avaya Global Support Services and Avaya Cloud and Managed Services offers. • Avaya Professional Services, or APS, helps organizations leverage technologies effectively to meet their business objectives. Our strategic and technical consulting, as well as deployment and customization services, help customers accelerate business performance and deliver an improved customer experience. Whether deploying new products or optimizing existing capabilities, APS leverages its specialists globally and operates in three core areas: • Enablement Services, providing access to expertise and resources for defining and deploying Avaya products that maximize technology potential and helping assure they work as designed. Avaya Professional Services strives to exceed customers' expectations by providing the greatest possible benefit for their investment. • Optimization Services, to help drive increased value and greater business results from customers' existing technology. Leveraging best practices, Avaya consultants and product architects analyze a communications environment in the context of customer business priorities and strategies, helping develop a communications business case, expected results and technical considerations. • Innovation Services, to help an organization leverage communications to reach new levels of business potential and market competitiveness. Focused on leading technology and advanced services delivery, we offer a forward-thinking perspective to drive new business productivity, employee efficiency and superior levels of service. Our consultative approach and custom application services, from business planning through to execution and product integration, creates alignment with the customer's specific business objectives. • Avaya Client Services, or ACS, is a market-leading organization that supports, manages and optimizes enterprise communications networks to help customers mitigate risk, reduce total cost of ownership, and optimize product performance. ACS is supported by patented tools and by network operations and technical support centers around the world. The contracts for these services range from one to multiple-years, with three year terms being the most common. Custom or complex services contracts are typically five years in length. The portfolio of ACS services includes: • Global Support Services provides a comprehensive suite of support options both directly and through partners to proactively resolve issues and improve uptime. Support offers and capabilities include 24x7 remote support, proactive remote monitoring, parts replacement and onsite response. Recent innovations include our Avaya Support Web site that quickly connects customers to advanced Avaya technicians via live chat, voice or video. 35-------------------------------------------------------------------------------- Table of Contents The web site also provides access to "Ava," an interactive virtual chat agent that quickly searches our knowledge base and a wide range of "how-to" videos to answer customer support questions. Ava learns with each customer interaction and can make the decision to transition the chat to an Avaya technician-often without the customer realizing the change is taking place. All new support solutions are published to the web by our engineers, generally within 90 minutes of finding a resolution, adding value for customers by providing known solutions for potential issues rapidly. Most of our customers also benefit from real-time monitoring of diagnostic and system status to proactively identify potential issues to improve reliability, uptime and faster issue resolution. • Avaya Cloud and Managed Services, which provides IT Infrastructure Library, or ITIL, aligned, multivendor managed and outsourcing services for customers' communications environments. Managed services can be procured in standard packages or in fully custom arrangements that include on-premise or private Cloud options, Service Level Agreements, or SLAs, billing and reporting. Avaya can manage existing infrastructure of any age and from any communications vendor, and many customers leverage this model as a way to manage complex existing environments while they upgrade their entire communication network to the latest technology. This model provides customers with an operational expense option, or OpEx model, rather than a capital expenditure option, or CapEx model, for upgrading to the latest technology. In these types of deals, the underlying solutions and infrastructure are owned by the equipment vendor, or managed services/Cloud provider and are often included in the managed services pricing/revenue. In addition, managed services can take the form of one of three Cloud models offered by Avaya: • Avaya Powered Partner Cloud, supporting public and private products offered by service providers and system integrators; • Avaya Cloud for Customers and Partners, an Avaya-hosted multi-customer public cloud option; and • Private Cloud, a private cloud model for individual customers. Our Technology We believe that technology enhances the way in which people communicate and collaborate. We work with customers, industry groups and technical bodies to foster innovation. Across our portfolio we leverage critical technology and open standards to our customers' advantage. One of these standards is SIP, and Avaya is a leading innovator in leveraging its use for business collaboration. We distinguish ourselves from competition by exploiting advanced SIP capabilities as opposed to only exploiting basic features. Avaya 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 such as voice, video and text and modes of communications such as calls or conferences. Multimedia Session Management At the core of our architecture, SIP based Avaya Aura Session Manager centralizes communications control and application integration. Avaya Aura 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. Avaya Aura Session Manager reduces complexity and provides the foundation for broader unified communications and collaboration strategies. We believe the SIP protocol has long term potential, given its interoperability and functional depth. Unique End User Experiences The Avaya Flare Experience, Avaya one-X Communicator and Avaya one-X Mobile clients leverage the Avaya Aura technology and its session control and management, presence, unified communications features and services, and 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. The Avaya Collaboration Environment is a middle-ware platform that abstracts the core Avaya Aura system and allows developers with common web and JAVA programming skills to develop innovative applications that can be sequenced into a communications session. For example a customer escalation registered in an insurance claims application could start an Avaya Collaboration Environment workflow that would automatically find and join the customer, the claims adjuster and claims 36-------------------------------------------------------------------------------- Table of Contents manager via email or SMS and bring them into a video conferencing session. Tens of calling, messaging, video and conferencing functions can be invoked and combined by applications. We believe this allows our customers to generate more business value from their Avaya products while increasing Avaya's business relevance and visibility. Management and Orchestration Ease of management and operations are essential to customers. Whether in Contact Center or Networking or Video, we believe our management products permit efficiency of operations and better overall performance. Our management products cover a wide range of functions, from initial provisioning to monitoring and orchestration of components to enable networking of communications services. Simple and consistent management is integral part of our design philosophy and our current products result from accumulated experience and long term investments. Enterprise and Cloud Deployment Options While Avaya's unified communication offerings, including its comprehensive video portfolio and Avaya's contact center products, have traditionally been deployed on a customer's premise, the underlying distributed architecture enables a broader range of deployment options. Supporting customers looking to shift all or a portion of their communication and collaboration investment from capital expense to operating expense, Avaya's unified communications and contact center products and services can be deployed in public, private, hybrid and managed cloud models by small, to mid-market, to large enterprises and by service providers and systems integrators. Further, through comprehensive monitoring technologies, these products and services can also be deployed as managed services. Advanced Routing and Switching Protocols Avaya offers routing switches and wireless products that embed advanced protocols such as SPB that are at the forefront of the networking industry to help address issues that we believe are present in the marketplace, such as multicast of large numbers of video streams and network isolation. We believe our continued investment in this domain contributes to our differentiation and ability to compete in the networking space. Additional Technologies In addition to Session Management, we use technologies including: • Messaging and Presence via SIP/SIMPLE and XMPP: the Avaya Aura Presence Services collects, publishes, aggregates and federates rich presence and enables instant messaging using SIP/SIMPLE and XMPP standards, providing interoperability with systems from other vendors, including but not limited to Microsoft and IBM. • Platform Services: Avaya's products are designed for extensibility, allowing customers, systems integrators, and ISVs using industry standard protocols and interfaces to develop new applications and to seamlessly integrate with the underlying capabilities of the communication and collaboration infrastructure; we provide REST APIs and connectors so that developers can build applications that use Avaya Aura functionality to make calls, create videoconferences, send SMS and more. • Cross 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 Blackberry. We also support virtualization to not only reduce the physical server footprint using hypervisor technology to run multiple applications concurrently on a single physical platform but also facilitate certain tasks such as system expansion or recovery. • High Quality/Low Bandwidth Video: Avaya's Video products and services are able to deliver high quality video while minimizing bandwidth consumption and responding to adverse network conditions through the use of dual 1080p/60fps video channels, H.264 High Profile for bandwidth efficiency and cascading media to optimize bandwidth between sites and H.264 Scalable Video Coding, or SVC, technology to maintain quality video during times of intermittent network congestion or packet loss situations. • Virtualization is used in our core Avaya Aura portfolio to decrease the supporting hardware cost but also to enable operations resilience and facilitate scalability. • 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. 37-------------------------------------------------------------------------------- Table of Contents • WebRTC is a new evolving technology that Avaya intends to leverage to evolve a new stage of Unified Communications. Using the client server approach, WebRTC allows for dynamically instantiated communication clients to be supported directly from HTML 5 browsers supporting the capability. High resolution codecs transport real time voice and video, and the user interface can be customized via server software based on the needs of the user. This flexibility allows for built for purpose user interface making unified communications fit the need of specific businesses, indeed, the specific need of the user within the business. • Big Data: by leveraging the power of large unstructured data stores, important information streams from multi-vendor systems and customer support infrastructure can be aggregated. Unleashing powerful analytic algorithms then provides specialized information for the user. The end result is the ability to have customer specific applications that bridge beyond the silos presented by the current version of Unified Communication or Contact Center technology. Avaya's speech analytics capability, the Advanced Phonetic Speech Tool, analyzes recordings of contact center calls, conference calls, client meetings, and employee sessions-essentially any live or recorded communications content. It helps to ensure that agents are adhering to any required scripts and can check against industry regulations or corporate security requirements. For example, insurers may need to tell buyers they have up to 14 days to cancel a purchase, financial analysts may need to notify clients about transaction processing times, and medical entities must comply with HIPAA requirements or other regulatory mandates. Avaya's product automates testing these processes and provides a compliance record. New applications based on analytics are expected to include Internet of Things, machine to machine and machine to person communications. Our Go-To-Market Strategy Our global go-to-market strategy is designed to focus and strengthen our reach and impact on large multinational enterprises, mid-market and more regional enterprises and small businesses. We are a business-to-business, or B2B, sales model. Our flexible go-to-market strategy is to serve our customers the way they prefer to work with us, either directly with Avaya or through our indirect sales channel, which includes our global network of alliance partners, distributors, dealers, value-added resellers, telecommunications service providers and system integrators. Our sales organizations are equipped with a broad product and software portfolio, complemented with services offerings including product support, integration and professional and managed services. The Avaya sales organization is globally deployed with direct and indirect (e.g., channel partner) presence in more than 160 countries. We continue to focus on efficient deployment of Avaya sales resources, both directly and indirectly, for maximum market penetration and global growth. Our investment in our sales organization includes training curricula to support the evolution of our sales strategy toward a solutions-based sales process targeted at helping businesses reduce costs, lower risk, be competitive, and grow their revenues. The program includes sales process, skills and solutions curricula for all roles within our sales organization. We continue to better align our go-to-market strategy for our products and services with the enterprise and mid-market customer bases. We have been deploying new customer segmentation and enhanced geographic emphasis while leveraging our existing and new channel partners. This has generated momentum in our mid-market efforts. Throughout fiscal 2014, we have brought additional industry-seasoned sales and technical personnel into customer and partner facing roles. Financial Results Summary Our revenue for the nine months ended June 30, 2014 and 2013 was $3,245 million and $3,409 million, respectively, a decrease of $164 million or 5%. Our revenue for the nine months ended June 30, 2014 decreased as compared to the corresponding period in the prior year, primarily as a result of lower customer spending on unified communications products, particularly gateways and legacy phones and platform products, including Nortel and Tenovis, which in turn contributed to lower maintenance and professional services revenues. We believe these declines are primarily attributable to customers choosing not to upgrade their systems 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 run their communications networks more efficiently. We believe the decrease in our product revenues may also be due in part to a growing market trend around Cloud consumption preferences with more customers exploring OpEx models as opposed to CapEx models for procuring technology. Increasingly, to manage costs and efficiencies, customers are exploring a shift to OpEx models, also referred to as "spend-as-you-go" models, where they pay a fee for business collaboration and communications services but the underlying solutions, infrastructure and personnel are owned and managed by the equipment vendor or a managed services or Cloud provider, as opposed to CapEx models that require them to invest in and own the solutions, infrastructure and personnel. We believe the market trend toward OpEx models will continue as we see an increasing number of opportunities and requests for proposal based on the OpEx 38-------------------------------------------------------------------------------- Table of Contents model, where contract values are usually larger, but for which the associated revenues are recognized over a longer period, typically three to seven years. The Company has maintained its focus on profitability levels and investing in future results and continued to initiate cost savings programs designed to streamline its operations, generate cost savings, and eliminate overlapping processes and expenses associated with various acquisitions and in response to the global economic downturn. These cost savings programs have included: (1) reducing headcount, (2) relocating certain job functions to lower cost geographies, including service delivery, customer care, research and development, human resources and finance, (3) eliminating real estate costs associated with unused or under-utilized facilities and (4) implementing gross margin improvement and other cost reduction initiatives. During the nine months ended June 30, 2014 and 2013, the Company incurred restructuring charges of $94 million and $165 million, respectively. 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. Operating income for the nine months ended June 30, 2014 and 2013 was $135 million and $36 million, respectively, an increase of $99 million. The increase in operating income is primarily attributable to lower restructuring charges and the continued benefit from our cost savings initiatives partially offset by the decrease in revenues described above and $35 million of additional depreciation associated with the Company's Westminster, Colorado facility which we are in the process of vacating as we move to a more cost efficient facility in Colorado. Operating income for the nine months ended June 30, 2014 and 2013 includes non-cash expenses for depreciation and amortization of $336 million and $332 million and share-based compensation of $20 million and $7 million for each of the periods, respectively. On March 31, 2014, the Company completed the sale of its government ITPS business for an adjusted sales price of $101 million, inclusive of $3 million of working capital adjustments, and net of $2 million in costs to sell. As a result of management's plan to divest the ITPS business, the results of operations and assets and liabilities of the ITPS business have been classified as discontinued operations in all periods presented. Income from discontinued operations for the nine months ended June 30, 2014 was $32 million and compares to a loss from discontinued operations for the nine months ended June 30, 2013 of $68 million. Income from discontinued operations for the nine months ended June 30, 2014 included the gain on the sale of the ITPS business of $52 million. Loss from discontinued operations for the nine months ended June 30, 2013 included an $89 million impairment charge to the goodwill of the ITPS business. Net loss for the nine months ended June 30, 2014 and 2013 was $212 million and $387 million, respectively. The decrease in our net loss is primarily attributable to the increases in operating income and income from discontinued operations as described above, partially offset by an increase in income taxes for the nine months ended June 30, 2014 as compared to the nine months ended June 30, 2013. Net loss for the nine months ended June 30, 2014 and 2013 also includes losses on extinguishment of debt of $5 million and $6 million and costs incurred in connection with modifications to certain credit facilities of $2 million and $18 million for each of the periods, respectively. Results From Operations Three Months Ended June 30, 2014 Compared with Three Months Ended June 30, 2013 Revenue Our revenue for the three months ended June 30, 2014 and 2013 was $1,054 million and $1,116 million, respectively, a decrease of $62 million or 6%. The following table sets forth a comparison of revenue by portfolio: Three months ended June 30, Percentage of Yr. to Yr. Yr. to Yr. Percentage Total Revenue Percentage Change, net of Foreign In millions 2014 2013 2014 2013 Change Currency Impact GCS $ 450 $ 497 42 % 44 % (9 )% (9 )% Purchase accounting adjustments - (1 ) 0 % 0 % (1) (1) Networking 61 64 6 % 6 % (5 )% (3 )% Total ECS product revenue 511 560 48 % 50 % (9 )% (9 )% AGS 543 556 52 % 50 % (2 )% (3 )% Total revenue $ 1,054 $ 1,116 100 % 100 % (6 )% (6 )% (1) Not meaningful 39-------------------------------------------------------------------------------- Table of Contents GCS revenue for the three months ended June 30, 2014 and 2013 was $450 million and $497 million, respectively, a decrease of $47 million or 9%. The decrease in GCS revenue is primarily attributable to lower sales of our unified communications products. Networking revenue for the three months ended June 30, 2014 and 2013 was $61 million and $64 million, respectively a decrease of $3 million or 5%. The decrease in networking revenue is primarily attributable to lower demand for our established networking products and the unfavorable impact of foreign currency, partially offset by the revenues from three new products introduced in prior periods. AGS revenue for the three months ended June 30, 2014 and 2013 was $543 million and $556 million, respectively, a decrease of $13 million or 2%. The decrease in AGS revenue was primarily due to lower maintenance and professional services revenues as a result of lower product sales in prior periods and were partially offset by the favorable impact of foreign currency. These decreases in AGS revenue were partially offset by higher revenues from Cloud and managed services performed under contracts entered into in prior periods. The following table sets forth a comparison of revenue by location: Three months ended June 30, Percentage of Yr. to Yr. Yr. to Yr. Percentage Total Revenue Percentage Change, net of Foreign In millions 2014 2013 2014 2013 Change Currency Impact U.S. $ 543 $ 605 52 % 54 % (10 )% (10 )% International: EMEA 297 297 28 % 27 % 0 % (2 )% APAC - Asia Pacific 108 105 10 % 9 % 3 % 4 % Americas International - Canada and Latin America 106 109 10 % 10 % (3 )% 4 % Total International 511 511 48 % 46 % 0 % 0 % Total revenue $ 1,054 $ 1,116 100 % 100 % (6 )% (6 )% Revenue in the U.S. for the three months ended June 30, 2014 and 2013 was $543 million and $605 million, respectively, a decrease of $62 million or 10%. The decrease in U.S. revenue was primarily attributable to lower sales of our unified communications products and lower revenues from maintenance and professional services. Revenue in EMEA for the three months ended June 30, 2014 and 2013 was $297 million and $297 million, respectively. Increases in EMEA revenue associated with higher revenues from maintenance and professional services and the favorable impact of foreign currency were offset by lower sales of our unified communications and contact center products. Revenue in APAC for the three months ended June 30, 2014 and 2013 was $108 million and $105 million, respectively, an increase of $3 million or 3%. The increase in APAC revenue is primarily attributable to higher revenues from Cloud and managed services and were partially offset by the unfavorable impact of foreign currency. Revenue in Americas International was $106 million and $109 million for the three months ended June 30, 2014 and 2013, respectively, a decrease of $3 million or 3%. The decrease in Americas International revenue was primarily attributable to the unfavorable impact of foreign currency and was partially offset by higher sales associated with our contact center and networking products. We sell our products 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 June 30, Percentage of Total Yr. to Yr. Yr. to Yr. Percentage ECS Product Revenue Percentage Change, net of Foreign In millions 2014 2013 2014 2013 Change Currency Impact Direct $ 132 $ 139 26 % 25 % (5 )% (6 )% Indirect 379 421 74 % 75 % (10 )% (10 )% Total ECS product revenue $ 511 $ 560 100 % 100 % (9 )% (9 )% 40-------------------------------------------------------------------------------- Table of Contents Gross Profit The following table sets forth a comparison of gross profit by segment: Three months ended June 30, Gross Profit Gross Margin Change In millions 2014 2013 2014 2013 Amount Pct. GCS $ 287 $ 298 63.8 % 60.0 % $ (11 ) (4 )% Networking 27 28 44.3 % 43.8 % (1 ) (4 )% ECS 314 326 61.4 % 58.2 % (12 ) (4 )% AGS 309 307 56.9 % 55.2 % 2 1 % Unallocated amounts (16 ) (15 ) (1 ) (1 ) (1 ) (1) Total $ 607 $ 618 57.6 % 55.4 % $ (11 ) (2 )% (1) Not meaningful Gross profit for the three months ended June 30, 2014 and 2013 was $607 million and $618 million, respectively, a decrease of $11 million or 2%. The decrease is primarily attributable to the decrease in revenues and is partially offset by the success of our gross margin improvement initiatives. 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. Primarily as a result of our gross margin improvement initiatives, gross margin increased to 57.6% for the three months ended June 30, 2014 from 55.4% for the three months ended June 30, 2013. GCS gross profit for the three months ended June 30, 2014 and 2013 was $287 million and $298 million, respectively, a decrease of $11 million or 4%. The decrease in GCS gross profit is primarily attributable to the decrease in revenues and is partially offset by the success of our gross margin improvement initiatives discussed above. Primarily as a result of our gross margin improvement initiatives, GCS gross margin increased to 63.8% for the three months ended June 30, 2014 compared to 60.0% for the three months ended June 30, 2013. Networking gross profit for the three months ended June 30, 2014 and 2013 was $27 million and $28 million, respectively, a decrease of $1 million or 4%. Networking gross margin increased to 44.3% for the three months ended June 30, 2014 from 43.8% for the three months ended June 30, 2013. AGS gross profit for the three months ended June 30, 2014 and 2013 was $309 million and $307 million, respectively, an increase of $2 million or 1%. The increase in AGS gross profit is primarily due to the benefit from our gross margin improvement initiatives discussed above partially offset by lower maintenance and professional services revenue. 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. Primarily as a result of these factors, AGS gross margin increased to 56.9% for the three months ended June 30, 2014 compared to 55.2% for the three months ended June 30, 2013. Unallocated amounts for the three months ended June 30, 2014 and 2013 include the effect of the amortization of acquired technology intangibles and other costs that are not core to the measurement of segment management's performance, but rather are controlled at the corporate level. Operating Expenses Three months ended June 30, Percentage of Revenue Change In millions 2014 2013 2014 2013 Amount Pct. Selling, general and administrative $ 365 $ 379 34.6 % 34.0 % $ (14 ) (4 )% Research and development 93 112 8.8 % 10.0 % (19 ) (17 )% Amortization of intangible assets 56 57 5.3 % 5.1 % (1 ) (2 )% Restructuring charges, net 45 63 4.3 % 5.6 % (18 ) (29 )% Acquisition-related costs - 1 - % 0.1 % (1 ) (100 )% Total operating expenses $ 559 $ 612 53.0 % 54.8 % $ (53 ) (9 )% Selling, general and administrative ("SG&A") expenses for the three months ended June 30, 2014 and 2013 were $365 million and $379 million, respectively, a decrease of $14 million. The decrease was primarily due to lower expenses associated with our cost savings initiatives discussed above and lower depreciation expense in fiscal 2014. 41-------------------------------------------------------------------------------- Table of Contents Research and development ("R&D") expenses for the three months ended June 30, 2014 and 2013 were $93 million and $112 million, respectively, a decrease of $19 million. The decrease was primarily due to lower expenses associated with our cost savings initiatives discussed above. Amortization of intangible assets for the three months ended June 30, 2014 and 2013 was $56 million and $57 million, respectively. Restructuring charges, net, for the three months ended June 30, 2014 and 2013 were $45 million and $63 million, respectively, a decrease of $18 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 June 30, 2014 include employee separation costs of $39 million and lease obligations of $6 million primarily related to two facilities in the U.S. The EMEA charges include a plan approved during the three months ended June 30, 2014 for the elimination of 121 positions and resulted in a charge of $19 million, for which the related payments are expected to be completed in fiscal 2016. 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. Restructuring charges recorded during the three months ended June 30, 2013 include employee separation costs of $48 million and lease obligations of $15 million. These costs primarily include the payments associated with employee severance actions in the U.S. and the lease obligation associated with the vacated portion of a facility in Germany, which the Company completely vacated during the fourth quarter of fiscal 2013. In April 2013, the Company initiated an employee severance program in the U.S. that resulted in the elimination of 456 positions and a charge of $21 million. 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 were $1 million for the three months ended June 30, 2013 and include third-party legal and other costs related to business acquisitions in fiscal 2013. Operating Income Operating income for the three months ended June 30, 2014 and 2013 was $48 million and $6 million, respectively. Operating income for the three months ended June 30, 2014 and 2013 includes non-cash expenses for depreciation and amortization of $99 million and $110 million and share-based compensation of $6 million and $4 million, respectively. Interest Expense Interest expense for the three months ended June 30, 2014 and 2013 was $112 million and $122 million, respectively, which includes non-cash interest expense of $6 million and $4 million, respectively. 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 June 30, 2014 and 2013, was $106 million and $118 million, respectively, a decrease of $12 million. The decrease was primarily due to certain debt refinancing transactions during fiscal 2014 combined with the expiration of certain unfavorable interest rate swap contracts in prior periods. During fiscal 2014, the Company entered into a transaction to refinance term loans under its senior secured credit facility with a new tranche of term loans that bear interest at a lower rate per annum than the debt they replaced while maintaining the same maturity and redeemed its senior unsecured notes due 2015 through cash on-hand and borrowings under the Company's revolving credit facilities. See Note 8, "Financing Arrangements" to our unaudited interim Consolidated Financial Statements for further details. Loss on Extinguishment of Debt During the three months ended June 30, 2014, we recognized a $1 million loss on extinguishment of debt associated with the redemption of 100% of the aggregate principal amount of the 10.125%/10.87% senior unsecured PIK toggles notes and the 9.75% senior unsecured cash-pay notes. The loss represents the difference between the reacquisition price and the carrying value (including unamortized discount and debt issues costs) of the debt. See Note 8, "Financing Arrangements" to our unaudited interim Consolidated Financial Statements for further details. Other Expense, Net Other expense, net for the three months ended June 30, 2014 and 2013 was $7 million and $5 million, respectively, and for the three months ended June 30, 2014 includes charges associated with certain tax indemnifications of $8 million. Other expense, net also includes $1 million of net foreign currency transaction gains for the three months ended June 30, 2014 compared to $5 million of net foreign currency transaction losses for the three months ended June 30, 2013. 42-------------------------------------------------------------------------------- Table of Contents Benefit from Income Taxes of Continuing Operations The benefit from income taxes of continuing operations for the three months ended June 30, 2014 and 2013 was $8 million and $3 million, respectively. The effective rate for the three months ended June 30, 2014 differs from the statutory U.S. Federal income tax rate primarily due to (1) the effect of tax rate differentials on foreign income/loss in the Consolidated Statements of Operations (2) changes in the valuation allowance established against the Company's deferred tax assets, (3) reductions in the Company's unrecognized tax benefits of $35 million resulting from the settlement of certain international tax exams, (4) recognition of a $7 million income tax benefit related to the correction of prior year deferred tax assets and liabilities for certain non-U.S. legal entities, and (5) recognition of a $3 million income tax benefit as a result of net gains in other comprehensive income. The effective rate for the three months ended June 30, 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 in the Consolidated Statement of Operations, (2) changes in the valuation allowance established against the Company's deferred tax assets, and (3) the recognition of a $27 million income tax benefit as a result of net gains in other comprehensive income. During the three months ended June 30, 2014 and 2013, the Company recorded a tax charge of $3 million and $27 million, respectively to other comprehensive income primarily relating to gains associated with the Company's pension benefits. As a result of the charge to other comprehensive income for this tax effect the Company recognized an income tax benefit in continuing operations and less current period valuation allowance was required against the Company's deferred tax assets. Income from Discontinued Operations, Net of Income Taxes Income from discontinued operations, net of income taxes for the three months ended June 30, 2014 was $2 million compared to$8 million for the three months ended June 30, 2013. On March 31, 2014, the Company completed the sale of its government ITPS business for an adjusted sales price of $101 million, inclusive of $3 million of working capital adjustments, and net of $2 million in costs to sell. Income from discontinued operations for the three months ended June 30, 2014 reflects the $3 million adjustment to the gain on the sale of the ITPS business resulting from the working capital adjustments identified during the period net of income taxes of $1 million. See Note 4, "Divestitures - Government IT Professional Services Business," to our unaudited interim Consolidated Financial Statements for further details. Nine Months Ended June 30, 2014 Compared with Nine Months Ended June 30, 2013 Revenue Our revenue for the nine months ended June 30, 2014 and 2013 was $3,245 million and $3,409 million, respectively, a decrease of $164 million or 5%. The following table sets forth a comparison of revenue by portfolio: Nine months ended June 30, Percentage of Total Revenue Yr. to Yr. Yr. to Yr. Percentage Percentage Change, net of Foreign In millions 2014 2013 2014 2013 Change Currency Impact GCS $ 1,433 $ 1,543 44 % 45 % (7 )% (7 )% Purchase accounting adjustments - (1 ) 0 % 0 % (1) (1) Networking 184 178 6 % 5 % 3 % 4 % Total ECS productrevenue 1,617 1,720 50 % 50 % (6 )% (6 )% AGS 1,628 1,689 50 % 50 % (4 )% (3 )% Total revenue $ 3,245 $ 3,409 100 % 100 % (5 )% (5 )% (1) Not meaningful GCS revenue for the nine months ended June 30, 2014 and 2013 was $1,433 million and $1,543 million, respectively, a decrease of $110 million or 7%. The decrease in GCS revenue was primarily attributable to lower customer spend on unified communications products in a cautious spending environment as discussed above. Networking revenue for the nine months ended June 30, 2014 and 2013 was $184 million and $178 million, respectively, an increase of $6 million or 3%. The increase in Networking revenue is primarily attributable to the Company's successful completion of its networking deployment at the Sochi Olympics partially offset by the unfavorable impact of foreign currency. AGS revenue for the nine months ended June 30, 2014 and 2013 was $1,628 million and $1,689 million, respectively, a decrease of $61 million or 4%. 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 and the favorable impact of foreign currency. These decreases in AGS revenue were partially offset by higher revenue from Cloud and managed services performed under contracts entered into in prior periods. The following table sets forth a comparison of revenue by location: Nine months ended June 30, Percentage of Yr. to Yr. Yr. to Yr. Percentage Total Revenue Percentage Change, net of Foreign In millions 2014 2013 2014 2013 Change Currency Impact U.S. $ 1,679 $ 1,802 52 % 53 % (7 )% (7 )% International: EMEA 913 926 28 % 27 % (1 )% (3 )% APAC - Asia Pacific 334 344 10 % 10 % (3 )% (1 )% Americas International - Canada and Latin America 319 337 10 % 10 % (5 )% 1 % Total International 1,566 1,607 48 % 47 % (3 )% (2 )% Total revenue $ 3,245 $ 3,409 100 % 100 % (5 )% (5 )% Revenue in the U.S. for the nine months ended June 30, 2014 and 2013 was $1,679 million and $1,802 million, respectively, a decrease of $123 million or 7%. The decrease in U.S. revenue was primarily attributable to lower sales associated with our unified communications products which contributed to lower revenues from maintenance and professional services. These decreases in U.S. revenue were partially offset by higher revenue from Cloud and managed services performed under contracts entered into in prior periods. Revenue in EMEA for the nine months ended June 30, 2014 and 2013 was $913 million and $926 million, respectively, a decrease of $13 million or 1%. The decrease in EMEA 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. These decreases in EMEA revenue were partially offset by the favorable impact of foreign currency, higher revenue from Cloud and managed services performed under contracts entered into in prior periods, and the Company's successful completion of its networking deployment at the Sochi Olympics. Revenue in APAC for the nine months ended June 30, 2014 and 2013 was $334 million and $344 million, respectively, a decrease of $10 million or 3%. The decrease in APAC revenue was primarily attributable to lower sales associated with our unified communications products and the unfavorable impact of foreign currency. These decreases in APAC revenue were partially offset by higher revenue from Cloud and managed services performed under contracts entered into in prior periods. Revenue in Americas International was $319 million and $337 million for the nine months ended June 30, 2014 and 2013, respectively, a decrease of $18 million or 5%. The decrease in Americas International revenue was primarily attributable to the unfavorable impact of foreign currency and lower sales associated with our unified communications products. The decreases in Americas International revenue were partially offset by higher sales of our contact center products and higher revenue from Cloud and managed services performed under contracts entered into in prior periods. We sell our products 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: Nine months ended June 30, Percentage of Total Yr. to Yr. Yr. to Yr. Percentage ECS Product Revenue Percentage Change, net of Foreign In millions 2014 2013 2014 2013 Change Currency Impact Direct $ 412 $ 405 25 % 24 % 2 % 1 % Indirect 1,205 1,315 75 % 76 % (8 )% (8 )% Total ECS product revenue $ 1,617 $ 1,720 100 % 100 % (6 )% (6 )% 44-------------------------------------------------------------------------------- Table of Contents Gross Profit The following table sets forth a comparison of gross profit by segment: Nine months ended June 30, Gross Profit Gross Margin Change In millions 2014 2013 2014 2013 Amount Pct. GCS $ 905 $ 917 63.2 % 59.4 % (12 ) (1 )% Networking 85 73 46.2 % 41.0 % 12 16 % ECS 990 990 61.2 % 57.6 % - - % AGS 907 919 55.7 % 54.4 % (12 ) (1 )% Unallocated amounts (53 ) (53 ) (1) (1) - (1) Total $ 1,844 $ 1,856 56.8 % 54.4 % (12 ) (1 )% (1) Not meaningful Gross profit for the nine months ended June 30, 2014 and 2013 was $1,844 million and $1,856 million, respectively, a decrease of $12 million or 1%. The decrease is primarily attributable to a decrease in sales volume, as well as $6 million of additional depreciation related to the change in the estimates of salvage value and useful life of the Company's Westminster, Colorado facility, and the effect of a $5 million benefit associated with the release of a contingent liability during the nine months ended June 30, 2013 related to a labor matter in EMEA that we released as a result of a favorable court ruling. These decreases in gross profit were partially offset by the success of our gross margin improvement initiatives, the improvement in our customer discount discipline, and the impact of lower amortization of acquired 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 our gross margin improvement initiatives and the improvement in our customer discount discipline, gross margin increased to 56.8% for the nine months ended June 30, 2014 from 54.4% for the nine months ended June 30, 2013. GCS gross profit for the nine months ended June 30, 2014 and 2013 was $905 million and $917 million, respectively, a decrease of $12 million or 1%. The decrease in GCS gross profit is primarily due to the decrease in sales volume. This decrease in gross profit was partially offset by the success of our gross margin improvement initiatives discussed above and the improvement in our customer discount discipline. As a result of our gross margin improvement initiatives and the improvement in our customer discount discipline, GCS gross margin increased to 63.2% for the nine months ended June 30, 2014 compared to 59.4% for the nine months ended June 30, 2013. Networking gross profit for the nine months ended June 30, 2014 and 2013 was $85 million and $73 million, respectively, an increase of $12 million or 16%. Networking gross margin increased to 46.2% for the nine months ended June 30, 2014 from 41.0% for the nine months ended June 30, 2013. The increases in Networking gross profit and margin were due to higher revenues associated with several new product launches beginning in July 2013 and the Company's successful completion of its networking deployment at the Sochi Olympics. AGS gross profit for the nine months ended June 30, 2014 and 2013 was $907 million and $919 million, respectively, a decrease of $12 million or 1%. The decrease in AGS gross profit is primarily due to lower services revenue and the effect of a $5 million benefit associated with the release of contingent liability during nine months ended June 30, 2013, related to a labor matter in EMEA that we released as a result of a favorable court ruling. These decreases in AGS gross profit were partially offset by the continued benefit from 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. As a result of the above factors, AGS gross margin increased to 55.7% for the nine months ended June 30, 2014 from 54.4% for the nine months ended June 30, 2013. Unallocated amounts for the nine months ended June 30, 2014 and 2013 include the effect of the amortization of acquired technology intangibles and costs that are not core to the measurement of segment management's performance, but rather are controlled at the corporate level. The decrease in unallocated amounts is attributable to lower amortization associated with technology intangible assets acquired prior to fiscal 2013 offset by $6 million of additional depreciation related to the change in the estimates of salvage value and useful life of the Company's Westminster, Colorado facility. 45-------------------------------------------------------------------------------- Table of Contents Operating Expenses Nine months ended June 30, Percentage of Revenue Change In millions 2014 2013 2014 2013 Amount Pct. Selling, general and administrative $ 1,155 $ 1,139 35.6 % 33.4 % $ 16 1 % Research and development 289 343 8.9 % 10.1 % (54 ) (16 )% Amortization of intangible assets 171 172 5.3 % 5.0 % (1 ) (1 )% Restructuring charges, net 94 165 2.9 % 4.8 % (71 ) (43 )% Acquisition-related costs - 1 - % - % (1 ) (100 )% Total operating expenses $ 1,709 $ 1,820 52.7 % 53.3 % $ (111 ) (6 )% SG&A expenses for the nine months ended June 30, 2014 and 2013 were $1,155 million and $1,139 million, respectively, an increase of $16 million. The increase was primarily due to $24 million of additional depreciation related to the change in the estimates of salvage value and useful life of the Company's Westminster, Colorado facility, the expense of the marketing rights we obtained to the Sochi Olympics and additional selling expenses to support our go-to-market strategy within the enterprise and mid-market customer bases. These increases in SG&A expenses were partially offset by our cost savings initiatives. Our cost savings initiatives include exiting and consolidating facilities, reducing the workforce and relocating positions to lower-cost geographies. R&D expenses for the nine months ended June 30, 2014 and 2013 were $289 million and $343 million, respectively, a decrease of $54 million. The decrease was primarily due to lower expenses associated with our cost savings initiatives discussed above. This decrease in R&D expense was partially offset by $5 million of additional depreciation related to the change in the estimates of salvage value and useful life of the Company's Westminster, Colorado facility. Amortization of intangible assets for the nine months ended June 30, 2014 and 2013 was $171 million and $172 million, respectively. Restructuring charges, net, for the nine months ended June 30, 2014 and 2013 were $94 million and $165 million, respectively, a decrease of $71 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 nine months ended June 30, 2014 include employee separation costs of $83 million and lease obligations of $11 million primarily related to two facilities in the U.S. The employee separation costs are primarily associated with employee severance actions in EMEA and the U.S. The EMEA charges include a plan approved during the three months ended June 30, 2014 for the elimination of 121 positions and resulted in a charge of $19 million, for which the related payments are expected to be completed in fiscal 2016. 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 172 positions and resulted in a charge of $10 million. Restructuring charges recorded during the nine months ended June 30, 2013 include employee separation costs of $127 million and lease obligations of $38 million. These costs primarily include the payments associated with employee severance actions in EMEA and the U.S. and lease obligations associated with the vacated portion of a facility in Germany, which the Company completely vacated in the fourth quarter of fiscal 2013, and facilities in the United Kingdom and the U.S. The severance actions in EMEA provided for the elimination of 234 positions and resulted in a charge of $46 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. Enhanced severance plans were offered to certain management employees in the U.S. in the first and third quarter of fiscal 2013 and resulted in the elimination of 195 and 456 positions and restructuring charges of $9 million and $21 million, respectively, for which the related payments were completed in fiscal 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 were $1 million for the nine months ended June 30, 2013 and include third-party legal and other costs related to business acquisitions in fiscal 2013. Operating Income For the nine months ended June 30, 2014, operating income was $135 million compared to $36 million for the nine months ended June 30, 2013. Operating income for the nine months ended June 30, 2014 and 2013 includes non-cash expenses for depreciation and amortization of $336 million and $332 million and share-based compensation of $20 million and $7 million for each of the periods, respectively. 46-------------------------------------------------------------------------------- Table of Contents Interest Expense Interest expense for the nine months ended June 30, 2014 and 2013 was $347 million and $346 million, respectively, which includes non-cash interest expense of $15 million and $16 million, respectively. Non-cash interest expense for each period includes amortization of debt issuance costs and accretion of debt discount. Cash interest expense for the nine months ended June 30, 2014 and 2013, was $332 million and $330 million, respectively, an increase of $2 million. Cash interest expense for the nine months ended June 30, 2014 compared to the nine months ended June 30, 2013 increased as a result of certain debt refinancing transactions that occurred during fiscal 2013 partially offset by a decrease in interest expense as a result of the expiration of certain unfavorable interest rate swap contracts. During fiscal 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 substantially all of its senior unsecured notes that were scheduled to mature 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 8, "Financing Arrangements" to our unaudited interim Consolidated Financial Statements for further details. Loss on Extinguishment of Debt During the nine months ended June 30, 2014, we recognized a $5 million loss on extinguishment of debt in connection with (1) the refinancing of $1,138 million aggregate principal amount of term B-5 loans with the cash proceeds from the issuance of term B-6 loans and (2) the redemption of 100% of the aggregate principal amount of the 10.125%/10.87% senior unsecured PIK toggles notes and the 9.75% senior unsecured cash-pay notes. During the nine months ended June 30, 2013, we recognized a $6 million 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. In each period, the loss represents the difference between the reacquisition price and the carrying value (including unamortized discount and debt issues costs) of the debt. See Note 8, "Financing Arrangements" to our unaudited interim Consolidated Financial Statements for further details. Other Expense, Net Other expense, net for the nine months ended June 30, 2014 and 2013 was $8 million and $9 million, respectively. Other expense, net, for the nine months ended June 30, 2014 includes $5 million of net charges associated with certain tax indemnifications, $2 million of third party fees incurred in connection with debt modifications, and a $2 million charge associated with the remeasurement of the monetary assets and liabilities of our Venezuelan subsidiary. Based on developments related to the foreign exchange process in Venezuela, the Company has changed the exchange rate used to remeasure its Venezuelan subsidiary's monetary assets and liabilities from the official exchange rate as established by the Venezuelan government to the "Complimentary System of Foreign Currency Acquirement" or SICAD rate. Other expense, net for the nine months ended June 30, 2013 includes $18 million of third party fees incurred in connection with debt modifications and a $1 million translation loss recognized in connection with the devaluation of the bolivar by the Venezuela government in February 2013. These other expenses were partially offset by net foreign currency transaction gains of $10 million. (Provision for) Benefit from Income Taxes of Continuing Operations The provision for income taxes of continuing operations for the nine months ended June 30, 2014 was $19 million as compared to the benefit from income taxes of continuing operations of $6 million for the nine months ended June 30, 2013. The effective income tax rate for the nine months ended June 30, 2014 differs from the statutory U.S. Federal income tax rate primarily due to (1) the effect of tax rate differentials on foreign income/loss in the Consolidated Statements of Operations, (2) changes in the valuation allowance established against the Company's deferred tax assets, (3) reductions in the Company's unrecognized tax benefits of $35 million resulting from the settlement of certain international tax exams, (4) recognition of a $22 million income tax benefit as a result of net gains in income from discontinued operations, (5) recognition of an $11 million income tax benefit as a result of net gains in other comprehensive income, and (6) recognition of a $7 million income tax benefit related to the correction of prior year deferred tax assets and liabilities for certain non-U.S. legal entities. During the nine months ended June 30, 2014, the Company recorded a tax charge of $11 million to other comprehensive income primarily relating to gains associated with the Company's pension benefits and a tax charge of $22 million to discontinued operations. As a result of the charge to other comprehensive income and discontinued operations for these tax effects the Company recognized an income tax benefit in continuing operations and less current period valuation allowance was required against the Company's deferred tax assets. The effective rate for the nine months ended June 30, 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 in the Consolidated Statement of Operations, (2) changes in the 47-------------------------------------------------------------------------------- Table of Contents valuation allowance established against the Company's deferred tax assets, (3) the recognition of a $43 million income tax benefit as a result of net gains in other comprehensive income, and (4) $17 million of income tax benefit recognized upon the expiration of certain interest rate swaps. During the nine months ended June 30, 2013, the Company recorded a tax charge of $43 million to other comprehensive income primarily relating to gains associated with the Company's pension benefits. As a result of the charge to other comprehensive income for this tax effect the Company recognized an income tax benefit in continuing operations and less current period valuation allowance was required against the Company's deferred tax assets. During the nine months ended June 30, 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. Income (Loss) from Discontinued Operations, Net of Income Taxes Income from discontinued operations for the nine months ended June 30, 2014 was $32 million and compares to a loss from discontinued operations for the nine months ended June 30, 2013 of $68 million. On March 31, 2014, the Company completed the sale of its government ITPS business for an adjusted sales price of $101 million, inclusive of $3 million of working capital adjustments, and net of $2 million in costs to sell. Income from discontinued operations for the nine months ended June 30, 2014 includes the gain on the sale of the ITPS business of $52 million. Loss from discontinued operations for the nine months ended June 30, 2013 included the impact of an $89 million impairment charge to goodwill. See Note 4, "Divestitures - Government IT Professional Services Business," to our unaudited interim Consolidated Financial Statements for further details. Liquidity and Capital Resources Cash and cash equivalents increased by $27 million to $315 million at June 30, 2014 from $288 million at September 30, 2013. 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. Based on our current level of operations, we believe these sources will be adequate to meet our liquidity needs for at least the next twelve 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 resulted in an inability 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 June 30, 2014. 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. 48-------------------------------------------------------------------------------- Table of Contents Sources and Uses of Cash The following table provides the condensed statements of cash flows for the nine months ended June 30, 2014 and 2013: Nine months ended June 30, In millions 2014 2013 Net cash (used for) provided by: Net loss $ (212 ) $ (387 ) Income (loss) from discontinued operations, net of income taxes 32 (68 ) Loss from continuing operations (244 ) (319 ) Adjustments to net loss for non-cash items 338 330 Changes in operating assets and liabilities (73 ) 72 Continuing operating activities 21 83 Discontinued operating activities 4 16 Operating activities 25 99 Continuing investing activities (57 ) (89 ) Discontinued investing activities 98 - Investing activities 41 (89 ) Financing activities (39 ) (68 ) Effect of exchange rate changes on cash and cash equivalents - (8 ) Net increase (decrease) in cash and cash equivalents 27 (66 ) Cash and cash equivalents at beginning of period 288 337 Cash and cash equivalents at end of period $ 315 $ 271 Operating Activities Cash provided by operating activities was $25 million and $99 million for the nine months ended June 30, 2014 and 2013, respectively. Adjustments to reconcile net loss to net cash provided by operations for the nine months ended June 30, 2014 and 2013 were $338 million and $330 million, and primarily consisted of depreciation and amortization of $336 million and $332 million, respectively. During the nine months ended June 30, 2014, changes in our operating assets and liabilities resulted in a net decrease in cash and cash equivalents of $73 million. The net decrease was driven by payments associated with our employee incentive programs and benefit obligations and the pay down of accounts payable. These decreases were partially offset by improvements in collection of accounts receivable and reductions in our inventory levels. During the nine months ended June 30, 2013, changes in our operating assets and liabilities resulted in a net increase in cash and cash equivalents of $72 million. The net increase was driven by improvements in collection of accounts receivable, 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 the payment of accrued interest, payments associated with our employee incentive programs, and the pay down of accounts payable. Investing Activities Cash provided by investing activities was $41 million for the nine months ended June 30, 2014 as compared to cash used by investing activities of $89 million for the nine months ended June 30, 2013. On March 31, 2014, the Company completed the sale of its government ITPS business and received the initial proceeds of $98 million. Subsequent to the sale, positive working capital adjustments of $3 million were identified, the proceeds of which the Company expects to receive during the fourth quarter of fiscal 2014. During the nine months ended June 30, 2014 and 2013, cash used for investing activities also included capital expenditures of $94 million and $78 million, capitalized software development costs of $1 million and $12 million, and acquisitions of businesses, net of cash acquired of $14 million and $1 million, respectively. Also, during the nine months ended June 30, 2014 the Company invested $10 million for less than a 6% equity interest in an unaffiliated privately-held company. During the nine months ended June 30, 2014 and 2013, proceeds from the sales of long-lived assets were $61 million and $12 million, respectively. Further, during the nine months ended June 30, 2013, the Company advanced to Parent $10 million in exchange for a note receivable. The principal amount of this note plus any accrued and unpaid interest is due in full October 3, 49-------------------------------------------------------------------------------- Table of Contents 2015 with interest at the rate of 0.93% per annum. The proceeds of this note were used by Parent to partially fund the second and final installment payment associated with an acquisition done 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. Financing Activities Cash used for financing activities was $39 million and $68 million for the nine months ended June 30, 2014 and 2013, respectively and includes $28 million in scheduled debt repayments in each period. Cash flows from financing for the nine months ended June 30, 2014 includes proceeds of $1,136 million from the issuance of term B-6 loans and $140 million from borrowing under the Company's revolving credit facilities. The proceeds from the issuance of the term B-6 loans were used to repay $1,138 million of term B-5 loans and the proceeds from borrowings under the Company's revolving credit facilities, together with cash on-hand of $10 million, were used to redeem $92 million of 10.125%/10.875% senior unsecured PIK toggle notes and $58 million of 9.75% senior unsecured cash-pay notes. The redemption of the $92 million of 10.125%/10.875% senior unsecured PIK toggle notes includes $9 million of paid-in-kind interest expensed in prior periods. Cash flows from financing activities for the nine months ended June 30, 2013 includes proceeds of $589 million from the issuance of term B-5 loans and proceeds of $290 million from the issuance of 9% Senior Secures Notes. The proceeds from the issuance of the term B-5 loans were used to repay $584 million principal amount of our 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. Additionally, during fiscal 2013, the Company completed a non-cash exchange in which $642 million of the 9.75% senior unsecured cash-pay notes and $742 million of the 10.125%/10.875% senior unsecured PIK toggle notes were exchanged for $1,384 million of 10.50% senior secured notes due 2021. Cash used for financing activities for the nine months ended June 30, 2014 and 2013 also includes cash paid for debt issuance and debt modification costs of $10 million and $49 million, respectively. 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 acquisition of the enterprise solutions business of Nortel Networks Corporation in December 2009. 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 were scheduled to mature on 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 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 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. On February 5, 2014, the Company, Citibank, N.A., as Administrative Agent, and the lenders party thereto entered into Amendment No. 8 to Credit Agreement, pursuant to which the senior secured credit facility was amended. Pursuant to Amendment No. 8 to Credit Agreement, the Company refinanced in full all term B-5 loans outstanding under the senior secured credit facility with the cash proceeds from the Company's borrowing of approximately $1,138 million aggregate principal amount of term B-6 loans under the senior secured credit facility. In addition, the Company paid $15 million in cash for certain fees and expenses incurred in connection with the refinancing. The new term B-6 loans mature on March 31, 2018, which was the same date on which the term B-5 loans were scheduled to mature. The new tranche of term B-6 loans bears interest at a rate per annum equal to either a base rate (subject to a floor of 2.00%) or a LIBOR rate (subject to a floor of 1.00%), in each case plus an applicable margin. Subject to the floor described in the 50-------------------------------------------------------------------------------- Table of Contents immediately preceding sentence, the base rate is determined by reference to the higher of (1) the prime rate of Citibank, N.A. and (2) the federal funds effective rate plus one half of 1%. The applicable margin for borrowings of term B-6 loans is 4.50% per annum with respect to base rate borrowings and 5.50% per annum with respect to LIBOR borrowings, in each case, subject to increase pursuant to the senior secured credit facility in connection with the making of certain refinancing, extended or replacement term loans under the senior secured credit facility with an Effective Yield (as defined in the senior secured credit facility) greater than the applicable Effective Yield payable in respect of the term B-6 loans at such time plus 50 basis points. Any voluntary prepayment, and certain mandatory prepayments, of principal of the term B-6 loans, or any amendment to the terms of the term B-6 loans, the primary purpose of which is to effect a Term B-6 Repricing Transaction (as defined in the senior secured credit facility), in each case, after February 5, 2014 and on or prior to August 5, 2014, will be subject to payment of a 1.0% premium on the aggregate principal amount of the term B-6 loans so prepaid or amended. On May 15, 2014, the Company redeemed 100% of the aggregate principal amount of its 10.125%/10.875% senior unsecured PIK toggle notes due 2015 and 9.75% senior unsecured cash-pay notes due 2015 at a redemption price of 100% of the principal amount thereof, plus accrued and unpaid interest, or $92 million and $58 million, respectively. The redemption price of $150 million was funded through cash on-hand of $10 million, borrowings of $100 million under the multi-currency revolver available under the senior secured credit facility, and $40 million under the senior secured asset-based credit facility. Borrowings under the senior secured multi-currency revolver bear interest at a rate per annum equal to a LIBOR rate plus an applicable margin. Borrowings under the senior secured asset-based asset based credit facility bear interest at a rate per annum equal to, at the Company's option, either (a) a LIBOR rate plus a margin of 1.75% or (b) a base rate plus a margin of 0.75%. The interest rate election made on the May 15, 2014 borrowing was the LIBOR rate. See Note 8, "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 2014 to be as follows: • Benefit obligations-We estimate we will make payments under our pension and postretirement obligations totaling $83 million during the remainder of fiscal 2014. These payments include: $63 million to satisfy the minimum statutory funding requirements of our U.S. qualified plans, $1 million of payments under our U.S. benefit plans which are not pre-funded, $6 million under our non-U.S. benefit plans which are predominately not pre-funded, $2 million under our U.S. retiree medical benefit plan which is not pre-funded and $11 million under the agreements for represented retirees to post-retirement health trusts. See discussion in Note 12, "Benefit Obligations" to our unaudited interim Consolidated Financial Statements for further details of our benefit obligations. • Debt service-We expect to make payments of $130 million during the remainder of fiscal 2014 for principal and interest associated with our long-term debt, as refinanced. • Capital expenditures-We expect to spend approximately $35 million to $40 million for capital expenditures and capitalized software development costs during the remainder of fiscal 2014. • Restructuring payments-We expect to make payments of approximately $30 million to $35 million during the remainder of fiscal 2014 for employee separation costs and lease termination obligations associated with restructuring actions we have taken and expected to be taken. On March 27, 2014, in connection with an antitrust litigation matter, a jury found against the Company on two of eight counts and awarded damages to Telecom Labs, Inc., TeamTLI.com Corp. and Continuant Technologies, Inc. ("TLI/Continuant") in the amount of $20 million. Under the federal antitrust laws, the jury's award is subject to automatic trebling, or $60 million. The Company continues to believe that TLI/Continuant's claims are without merit and unsupported by the facts and law, and the Company intends to defend this matter, including by filing an appeal to the United States Court of Appeals for the Third Circuit. Once required, and in order to stay the enforcement of the judgment pending appeal or otherwise, the Company will post a bond in the amount of the final judgment, plus interest. The Company expects to secure posting of the bond through existing resources and may use any or a combination of the issuance of one or more letters of credit under its existing credit facilities and cash on hand. See Note 15 - "Commitments and Contingencies - Antitrust Litigation" to our unaudited interim Consolidated Financial Statements for additional details regarding this litigation matter. 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 51-------------------------------------------------------------------------------- Table of Contents 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 2014 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. As of June 30, 2014 the Company had $100 million of issued and outstanding borrowings and $100 million available under the senior secured multi-currency revolver. As of June 30, 2014 the Company had $40 million of outstanding borrowings, $85 million of issued and outstanding letters of credit and remaining revolver availability of $118 million under the multi-currency asset-based revolving credit facility. See Note 8, "Financing Arrangements" to our unaudited interim Consolidated Financial Statements. On July 31, 2014, Avaya completed the sale of assets and liabilities associated with the Technology Business Unit ("TBU") for $26 million, subject to working capital and other customary price adjustments. Upon closing, the Company received $26 million of proceeds. See Note 4, "Divestitures - Technology Business Unit," 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 or other jurisdiction in which such offer, solicitation or sale would be unlawful prior to registration or qualification under the securities laws of any such State or other jurisdiction. 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. Debt Ratings As of June 30, 2014, 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 negative 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 November 22, 2013 and determined that there were no significant changes to our critical accounting policies in the nine months ended June 30, 2014 except for recently adopted accounting guidance as discussed in Note 2, "Recent Accounting Pronouncements - New Accounting Guidance Recently Adopted" to our unaudited interim Consolidated Financial Statements. 52-------------------------------------------------------------------------------- Table of Contents New Accounting Pronouncements See discussion in Note 2, "Recent Accounting Pronouncements" to our unaudited interim Consolidated Financial Statements for further details. 53-------------------------------------------------------------------------------- Table of Contents 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 products and contact center products; • the market for our products and services, including unified communications products; • 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; • 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, and climate change risks; 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. 54-------------------------------------------------------------------------------- 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 and excludes the results of discontinued operations for all periods presented. 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 current capital structure. 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, certain fees payable to our private equity sponsors 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. 55-------------------------------------------------------------------------------- Table of Contents The unaudited reconciliation of loss from continuing operations, which is a GAAP measure, to EBITDA and Adjusted EBITDA is presented below: Three months ended June 30, Nine months ended June 30, In millions 2014 2013 2014 2013 Loss from continuing operations $ (64 ) $ (118 ) $ (244 ) $ (319 ) Interest expense 112 122 347 346 Interest income - (1 ) (1 ) (2 ) (Benefit from) provision for income taxes (8 ) (3 ) 19 (6 ) Depreciation and amortization 99 110 336 332 EBITDA 139 110 457 351 Impact of purchase accounting adjustments - 1 - 1 Restructuring charges, net 45 63 94 165 Sponsors' fees (a) 2 1 6 5 Acquisition-related costs - 1 - 1 Integration-related costs (b) 1 3 5 12 Divestiture-related costs (c) 2 - 2 - Loss on extinguishment of debt (d) 1 - 5 6 Third-party fees expensed in connection with the debt modification (e) - - 2 18 Non-cash share-based compensation 6 4 20 7 Gain on sale of investments and long-lived assets, net - (1 ) - (1 ) Change in certain tax indemnifications 8 - 5 - Impairment of long-lived assets - 1 - 1 Venezuela hyperinflationary and devaluation charges - - 2 1 Resolution of legal matters (f) 8 10 8 10 Other - - 2 - (Gain) loss on foreign currency transactions (1 ) 5 (1 ) (10 ) Pension/OPEB/nonretirement postemployment benefits and long-term disability costs (g) 12 19 38 64 Adjusted EBITDA $ 223 $ 217 $ 645 $ 631 (a) Sponsors' fees represent monitoring fees payable to affiliates of the Sponsors and their designees pursuant to a management services agreement entered into at the time of the Merger. (b) Integration-related costs primarily represent third-party consulting fees and other administrative costs and 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. (c) Divestiture-related costs include legal and other costs related to the sale of the ITPS and TBU businesses. (d) Loss on extinguishment of debt represents losses recognized in connection with certain debt refinancing transactions entered into during fiscal 2014 and 2013. 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 8, "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 certain debt refinancing transactions entered into during fiscal 2014 and 2013. See Note 8, "Financing Arrangements," to our unaudited interim Consolidated Financial Statements located elsewhere in this Form 10-Q. (f) Charges recognized in connection with the resolution of certain commercial and intellectual property legal disputes that, individually and in the aggregate, were not material to Avaya's financial position. (g) 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. 56-------------------------------------------------------------------------------- Table of Contents |