Management’s Discussion and Analysis of Financial Condition and Results of Operations
Quantitative and Qualitative Disclosures About Market Risk
Financial Statements and Supplementary Data
Changes in and Disagreements With Accountants on Accounting and Financial Disclosure
Controls and Procedures
Other Information
Disclosure Regarding Foreign Jurisdictions that Prevent Inspections
PART III
Directors, Executive Officers and Corporate Governance
Executive Compensation
Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
Certain Relationships and Related Transactions, and Director Independence
Principal Accounting Fees and Services
PART IV
Exhibits, Financial Statement Schedules
Form 10-K Summary
When we use the terms "we," "us," "our," "Avaya" or the "Company," we mean Avaya Holdings Corp., a Delaware corporation, and its consolidated subsidiaries taken as a whole, unless the context otherwise indicates.
This Annual Report on Form 10-K (this "Annual Report") contains the registered and unregistered trademarks or service marks of Avaya and are the property of Avaya Holdings Corp. and/or its affiliates. This Annual Report on Form 10-K also contains additional trade names, trademarks or service marks belonging to us and to other companies. We do not intend our use or display of other parties' trademarks, trade names or service marks to imply, and such use or display should not be construed to imply, a relationship with, or endorsement or sponsorship of us by, these other parties.
Explanatory Note
As previously disclosed in the Company’s NT 10-K (the “12b-25”) filed with the U.S. Securities & Exchange Commission (the “SEC”) on November 30, 2022, the Company was not able to timely file its annual report on Form 10-K because the audit committee (the “Audit Committee”) of the Company’s board of directors was conducting internal investigations to review, among other things, the circumstances surrounding the Company’s financial results for the quarter ended June 30, 2022 and items related to a whistleblower claim. The Audit Committee has completed its planned procedures with respect to its investigations and continues to cooperate with the SEC's ongoing investigation, which could require additional procedures to be
performed. The results of the investigations are disclosed in Note 1, "Background and Basis of Presentation," to the Company's Consolidated Financial Statements. Additionally, the Company has completed its impairment assessment of its long lived assets, including its intangible assets. The Company has also determined that its internal control over financial reporting is not effective as of September 30, 2022 as a result of material weaknesses disclosed in Item 9A.
Additionally, on February 14, 2023 (the “Petition Date”), Avaya Holdings Corp. (“Avaya Holdings”) and certain of its direct and indirect subsidiaries (the “Debtors”) commenced voluntary cases (the “Chapter 11 Cases”) under Chapter 11 of Title 11 of the United States Code (the “Bankruptcy Code”) in the United States Bankruptcy Court for the Southern District of Texas (the “Bankruptcy Court”). On the Petition Date, the Company entered into a Restructuring Support Agreement (the “RSA”) with certain of its creditors that contemplated a prepackaged joint plan of reorganization (the “Plan”). The implementation of the Plan pursuant to the RSA did not provide for any recovery for holders of the Company’s existing common stock, par value $0.01 per share (the “Common Stock”) or Series A Convertible Preferred Stock, par value $0.01 per share (the "Series A Preferred Stock").
After the Petition Date, following the effectiveness of a Form 25-NSE and the filing of post-effective amendments to outstanding registration statements to remove unsold securities, the Company filed a Form 15 with the United States Securities and Exchange Commission (the "SEC") to deregister its Common Stock under the Securities Exchange Act of 1934 (the “Exchange Act”) and to suspend its reporting obligations pursuant to Section 15(d)(1) of the Exchange Act, because the Company had less than 300 holders of record of each class of securities to which Securities Act registration statements related at the beginning of its 2023 fiscal year. The Company is filing this report to comply with its obligations to file all reports required to be filed with the SEC not filed prior to the filing of the Form 15.
The Bankruptcy Court confirmed the Plan on March 22, 2023, and the Debtors satisfied all conditions required for Plan effectiveness and emerged from the Chapter 11 Cases as a non-reporting private company on May 1, 2023 (the "Emergence Date").
Cautionary Note Regarding Forward-looking Statements
Certain statements in this Annual Report on Form 10-K, including statements containing words such as "anticipate," "believe," "estimate," "expect," "intend," "plan," "project," "target," "model," "can," "could," "may," "should," "will," "would" or similar words or the negative thereof, constitute "forward-looking statements." These forward-looking statements, which are based on our current plans, expectations, estimates and projections about future events, should not be unduly relied upon. These statements involve known and unknown risks, uncertainties and other factors that may cause our actual results, performance and achievements to materially differ from any future results, performance and achievements expressed or implied by such forward-looking statements. We caution you therefore against relying on any of these forward-looking statements.
The forward-looking statements included herein are based upon our assumptions, estimates and beliefs and involve judgments with respect to, among other things, future economic, competitive and market conditions, the anticipated impact of our previously announced cost-cutting initiatives and future business decisions, all of which are difficult or impossible to predict accurately and many of which are beyond our control. Although we believe that the expectations reflected in such forward-looking statements are based on reasonable assumptions, our actual results and performance could differ materially from those set forth in the forward-looking statements and may be affected by a variety of risks, uncertainties and other factors, which may cause our actual results, performance or achievements to differ materially from any future results, performance or achievements expressed or implied by these forward-looking statements. Risks, uncertainties and other factors that may cause these forward-looking statements to be inaccurate include, among others: the effect of Emergence (as defined below) on our business; the sufficiency of the Exit Term Loan Facility and the Exit ABL Facility for our future liquidity needs; our ability to continue implementing operating efficiencies and technical developments; our ability to capitalize on the reorganization and emerge as a stronger and more competitive enterprise; potential adverse effects of the Emergence on the Company's operations, third-party relationships and employee attrition; the impact and timing of any cost-savings measures and related local law requirements in various jurisdictions; the effectiveness of our internal control over financial reporting and disclosure controls and procedures, and the potential for additional material weaknesses in our internal controls over financial reporting or other potential weaknesses of which we are not currently aware or which have not been detected; the impact of litigation and regulatory proceedings; the findings of the Audit Committee’s investigations; the impact of litigation and regulatory proceedings; the impact and timing of any cost-savings measures; and the risks and other factors discussed in Part I, Item 1A, "Risk Factors," and Part II, Item 7, "Management's Discussion and Analysis of Financial Condition and Results of Operations," to this Annual Report on Form 10-K.
All forward-looking statements are made as of the date of this Annual Report on Form 10-K and the risk that actual results will differ materially from the expectations expressed in this Annual Report will increase with the passage of time. Except as otherwise required by the federal securities laws, we undertake no obligation to publicly update or revise any forward-looking statements after the date of this Annual Report, whether as a result of new information, future events, changed circumstances or any other reason. In light of the significant uncertainties inherent in the forward-looking statements included in this Annual
Report, the inclusion of such forward-looking statements should not be regarded as a representation by us or any other person that the objectives and plans set forth in this Annual Report will be achieved.
Marketing, Ranking and Other Industry Data
This Annual Report on Form 10-K includes industry and trade association data, forecasts and information that we have prepared based, in part, upon data, forecasts and information obtained from independent trade associations, industry publications and surveys and other information available to us. Some data is also based on our good faith estimates, which are derived from management’s knowledge of the industry and independent sources. Industry publications and surveys and forecasts generally state that the information contained therein has been obtained from sources believed to be reliable. We have not independently verified any of the data from third-party sources, nor have we ascertained the underlying economic assumptions relied upon therein. Statements as to our market position are based on market data currently available to us. Our estimates involve risks and uncertainties and are subject to change based on various factors, including those discussed under the heading Item 1A, "Risk Factors" in this Annual Report on Form 10-K.
PART I
Item 1.
Business
Our Company
Avaya is a global leader in communications products, solutions and services for businesses of all sizes, delivering technology predominantly through software and services. We enable organizations worldwide to succeed by creating intelligent communications experiences for their employees and their customers. Avaya is building innovative open, converged contact center ("CC") and unified communications and collaboration ("UCC") software solutions to enhance and simplify communications and collaboration in the cloud, on-premises or as a hybrid of both. We offer hardware and gateway solutions, including devices that enhance collaboration and productivity, and position organizations to incorporate future technological advancements.
Our experienced team of professionals delivers award-winning services from initial planning and design, to seamless implementation and integration, to ongoing managed operations, optimization and support. We also help clients customize and personalize our software solutions to address their specific needs.
Businesses are built by the experiences they provide, and Avaya solutions deliver millions of those experiences globally every day. With an install base including many of the largest enterprise customers with the most complex needs, Avaya is shaping the future of businesses and workplaces, with innovation and partnerships that power tangible business results. Our communications solutions power tailored, effortless customer and employee experiences that enable our clients to effectively engage and interact with each other and with their customers.
In serving both our existing and new customers across verticals, Avaya is uniquely positioned to meet customers where they are in their digital transformation and journeys to cloud communications, so they can innovate without disruption to gain the benefit of high-value cloud capabilities. We offer a full range of software sales and licensing models that can be deployed on-premises or via a public/multi-tenant cloud, private/dedicated instance cloud or as a hybrid cloud solution. With our open, extensible development platform, customers and third parties can create custom applications and automated workflows for their unique needs and integrate Avaya’s capabilities into the customer's existing infrastructure and business applications. Our solutions enable a seamless communications experience that adapts to how employees work, instead of changing how they work.
Operating Segments
The Company has two operating segments: Products & Solutions and Services .
Products & Solutions
Products & Solutions encompasses our CC and UCC software platforms, applications and devices. During fiscal 2022, we expanded our portfolio to include new cloud-based solutions, and we continued to integrate Artificial Intelligence ("AI") to create enhanced user experiences and improve performance.
• Contact Center: Avaya’s industry-leading contact center solutions enable clients to build a customized portfolio of applications to drive stronger customer engagement and higher customer lifetime value. Our reliable, secure and scalable communications solutions include voice, email, chat, social media, video, workforce engagement and third-party integration that can improve customer service and help companies compete more effectively. Avaya delivers CCaaS solutions for cloud deployment, and we continue to support enterprises with world-class premises-based solutions and add new value by complementing this highly dependable infrastructure with new capabilities from the cloud. The Avaya Experience Platform™ is our cloud contact center solution that helps organizations deliver immersive, memorable, and personalized customer experiences across all connected touchpoints. It brings together advanced capabilities -- including AI speech analytics and noise removal, attribute-based routing, and automation and self-service -- and brings together teams, resources, and insights to maximize contact center performance and experiences. We continue to integrate AI and automation capabilities into our portfolio, providing our clients a deeper understanding of their customers’ needs with a robust and secure platform.
• Unified Communications: Avaya communications and collaboration solutions support hybrid working environments, empowering teams with fast, always-on continuous collaboration from anywhere. Employees can communicate in context with better access to communication tools and better quality of communications to help deliver greater business impacts.
Avaya multi-tenant cloud-based UCaaS solutions integrate chat, file sharing and task management with real-time collaboration including calling, meetings and content sharing for distributed team productivity. Avaya offers Avaya Cloud Office by RingCentral ("Avaya Cloud Office" or "ACO") in partnership with RingCentral, Inc. ("RingCentral"), giving customers looking to replace outdated or disparate legacy telephony systems with a simple, all-in-one cloud
communications solution. Our on-premises UC solutions, IP Office for midmarket and Avaya Aura for enterprise, continue to deliver high reliability and functionality that is preferred in a variety of situations.
Services
Complementing our product and solutions portfolio is an award-winning global services portfolio, delivered by Avaya and our extensive partner ecosystem. Within our services portfolio, we utilize a variety of formal survey and customer feedback mechanisms to drive continuous improvement and streamlined process automation, with a focus on constantly increasing our value to customers. Our innovative offerings provide solutions for new clients who want to directly utilize our cloud solutions, support for clients who have the need for hybrid cloud solutions that maximize the value their on-premises systems can deliver, and flexible migration paths for our premises-based customers. This is delivered and supported by:
• Professional Services enable our customers to take full advantage of their IT and communications solution investments to drive measurable business results. Avaya has repositioned its professional services organization to focus on go-forward customer needs. The new Avaya Customer Experience Service ("ACES") brings our depth of experience as our experts partner with customers and guide them along each step of the solution lifecycle to deliver services that add value and drive business transformation — including journey to cloud consulting services. The role of professional services organizations changes in a cloud world, moving from implementations to cloud migration. ACES takes a client-led approach to bring the expertise and practice areas that help clients define the choices and pace for their journey, based on their priorities for experiences and outcomes. Importantly, organizations can bring forward the customizations they have built over the years and add new value with AI and cloud capabilities. Most of our professional services revenue is non-recurring in nature.
• Enterprise Cloud and Managed Services enable customers to take advantage of our technology via the cloud, on-premises solutions or a hybrid of both, depending on the system and the needs of the customer. Avaya focuses on customer performance and growth, encompassing software releases, operating customer cloud, premise or hybrid-based communication systems and helping customers migrate to next-generation business communications environments. Most of our enterprise cloud and managed services revenue in fiscal 2022 was recurring in nature and based on multi-year services contracts.
• Global Support Services help businesses protect their technology investments and address the risk of business-impacting outages. Understanding that agility and high availability are critical to maintain or gain competitive advantage, we facilitate those capabilities through proactive problem prevention, rapid resolution, continual solution optimization, and we increasingly leverage automation to onboard and manage a customer’s communications infrastructure, for faster, more effective deployments from proof of concept to production, and ever-increasing automation. Our subscription offering sets a foundation for continually evolving the customer experience by providing access to future capabilities and solution enhancements. Most of our global support services revenue is recurring in nature.
Through our comprehensive services, we support our customers' ability to fully leverage our technology and maximize their business results. Our solutions drive employee productivity improvements and a differentiated customer experience.
Our services teams help our customers maximize their ability to benefit from Avaya's next-generation communications solutions. Customers can choose the level of support best suited for their needs, aligned with deployment, monitoring, solution management, optimization and more. Our enhanced performance monitoring, coupled with a continuous focus on automation, allows us to quickly identify and remediate issues to avoid business impact.
Deployment Options and Capabilities
Avaya is transforming to become a leader in communications software and platforms delivered as a service, offering a base set of capabilities on which our clients can build custom and personalized integrations. Cloud and Software-as-a-Service (“SaaS”) models generally refer to the products and services that allow organizations to move from owning, managing and running
solutions to paying only for the capabilities they need. Avaya provides an option for customers to access Avaya software and solutions across CC and UCC, and customize as they see fit.
Avaya offers the full spectrum of deployment options, including via private cloud/dedicated instance, multi-tenant public cloud, hybrid cloud, as well as on-premises. This enables organizations to deploy our solutions in the way that best serves their business requirements and complements their existing investments, while moving with the speed and agility they require.
Avaya Solutions, delivered as a Private, Public, Hybrid or On-Premises Solution
• Private cloud/dedicated instance: Communication services are delivered to customers via its own dedicated instance of the software, which are deployed and operated in hyperscaler environments like Microsoft Azure and Google Cloud for greater scalability and cost-effectiveness.
• Public cloud/multi-tenant: Communications services are delivered to the business via a shared instance of the software on a shared platform.
• Hybrid cloud: Communications capabilities can be added to existing premises-based communications investments, or be consumed from either our dedicated instance or multi-tenant cloud offers. Hybrid solutions can be challenging. Avaya is uniquely positioned to deliver cloud services on top of premises-based solutions, given our deep expertise and successful history of supporting the most complex large enterprise, multinational and government needs globally, allowing our customers to innovate without disruption as they migrate to the cloud on the pace and path that fits their needs.
• On-Premises: While a growing portion of our business is transitioning to our private, public and hybrid cloud deployment models, many customers have business models and/or requirements that mandate a premises-based infrastructure. We will therefore continue to support these solutions via perpetual software licensing and subscription-based models.
Avaya solutions are addressing the convergence of private and public cloud deployments observed across the industry. Used in conjunction with our private/dedicated instance cloud solutions, a customer can take advantage of public cloud capabilities to cost-effectively add value at the edge of their network. Sales of technology through Avaya public cloud solutions are primarily included within the Company's Products segment and sales of technology through the Company's private cloud solutions are primarily recorded within Enterprise Cloud and Managed services in the Company's Services segment.
Avaya’s investments in data-driven automation mean that if an organization needs to deploy an advanced, integrated, value-focused solution via a private cloud but needs it deployed quickly, Avaya can deliver on the requested timeline. The benefit to the organization is “always available” access to the latest capabilities and innovation, quickly and at scale.
Avaya Subscription Licensing
A subscription licensing model can help customers begin their journey to the cloud by changing from an ownership model for existing on-premises solutions to a usage model with monthly or annual subscription payments. This approach not only provides access to the latest software, it simplifies ordering and payment, as the customer only pays for the software and solutions that they need as opposed to buying an off-the-shelf solution that cannot be easily tailored to their needs. Revenue from the Avaya Subscription offering is primarily included within the Company's Services segment.
Avaya Cloud Migration
We believe our migration methodology differentiates us from many other cloud vendors in the market because our range of solutions and services positions us to meet customers where they are in their digital transformation journey, and innovate without disruption as they migrate to the cloud on the pace and path that fits their needs. Our approach also provides flexible options based on standardized methodologies, enterprise software expertise and a range of services and tools to help organizations along every step of their journey to the cloud, reducing transition complexities and risks.
The comprehensive Avaya portfolio and our development roadmap helps customers take advantage of public, private and hybrid cloud solutions and capabilities that meet their needs at any stage in their transformation journey.
Application Development and Integration
Along with off-the-shelf integration with frequently used business applications across an organization, Avaya’s converged communications platform simplifies the embedding of Avaya Cloud communications and collaboration capabilities into business applications, including customer relationship management and enterprise resources planning. Our open platform and Avaya Communications Application Programming Interfaces ("APIs") enable customers and third parties to work with Avaya to create customized engagement applications and to meet the unique operating requirements of a customer with unified communications and contact center capabilities including voice, video, messaging, meetings and more. Avaya also offers a cloud-based execution and test environment for developing proof-of-concept applications.
The Avaya Client Software Development Kit ("SDK") provides a developer-friendly set of tools that enables the building of innovative user experiences for vertical or business specific applications. Any functionality Avaya uses in its own clients and applications is available to developers through the SDK. Developers can mix and match functionality from both our CC and UCC solutions. All of this is supported by an extensive global partner ecosystem. These partners work with Avaya and our customers to test and certify their solutions to inter-work with Avaya to expand the value our solutions deliver.
Our Business
Our solutions address the needs of a diverse range of businesses, including large multinational enterprises, small and medium-sized businesses and government organizations. Our customers operate in a broad range of industries, including financial services, healthcare, hospitality, education, government, manufacturing, retail, transportation, energy, media and communications. We employ a flexible go-to-market strategy with direct or indirect presence in approximately 180 countries. As of September 30, 2022, we had more than 3,600 active channel partners and for fiscal 2022 our product revenue from indirect sales through our channel partners represented 65% of our total Products & Solutions segment revenue.
For fiscal 2022, 2021 and 2020, we generated revenue of $2,490 million, $2,973 million and $2,873 million, of which 31%, 33% and 37% was generated by Products & Solutions and 69%, 67% and 63% by Services, respectively. Revenue by business area is presented in the following table for the periods indicated:
Fiscal years ended September 30,
(In millions)
Products & Solutions:
Contact Center
Unified Communications and Collaboration
Services:
Professional Services
Enterprise Cloud and Managed Services
Global Support Services
Our software revenue as a percentage of total consolidated revenue represented 64% for both fiscal 2022 and 2021 and 61% of total consolidated revenue for fiscal 2020. Our software revenue aggregates revenue across our two reporting segments. Software revenue includes subscription, public and private cloud, perpetual licenses and related software maintenance revenue. On-premises license revenue is included in Product & Solutions, while subscription and related software maintenance revenues are primarily included in Services.
One of our key focuses is increasing our software and recurring revenue — these include revenues from products and services that are delivered via the cloud, or as either recurring subscription-based software revenue, managed services, global support services, non-recurring perpetual-based software sales or delivered pursuant to multi-period contracts. Other revenues, which are generally non-recurring, consist of professional services and hardware devices, which is a smaller percent of our business, and non-recurring perpetual-based software and one-time professional services. Hardware predominantly consists of endpoints, which include phones, video conferencing equipment and headsets. Professional services include cloud migration and installation services, as well as project-based deployment, design and optimization services.
Avaya ARR (Annualized Recurring Revenue) provides a leading indicator into the software solutions driving our results. This metric is similar to what our industry peers report and reflects certain recurring components of Avaya's portfolio. Revenues reported as part of Avaya ARR include revenues from:
• Avaya Subscription
• Avaya Private Cloud
• Avaya CCaaS
• Avaya CPaaS
• Avaya DaaS (Device as a Service)
• Avaya Spaces
• Recurring revenues generated from Avaya Cloud Office
Avaya ARR does not include recurring revenues from Maintenance, Managed Services or Avaya Cloud Office one-time revenues.
In fiscal 2022, ARR was $896 million, compared to $530 million and $191 million reported for fiscal 2021 and 2020, respectively. The growth in ARR is primarily attributable to our customer’s continued migration from on-premise solutions to subscription and cloud based solutions. We believe the ARR, combined with our remaining performance obligations, provides a view into our long-term revenue growth potential and trajectory.
Trends Shaping Our Industry
We believe several key trends are shaping our industry, creating a substantial opportunity for Avaya and other market participants:
Cloud Growth and Migration:
• Growth in cloud-based technologies continues as businesses focus on digital transformation projects. This expansion of cloud delivery of software applications and management of varied devices in turn leads to an increasing demand for reliability and security.
• Even with the growing contact center market conversion to cloud, on-premises solutions remain a meaningful share of the market, estimated at ~48% in 2026.
• While companies seek innovation, they also want to avoid disruption. The ability to add modular innovation over the top of existing systems can drive significant value, enabling them to transform in a phased approach. This preference for a hybrid approach that mitigates risk favors vendors that have a large install base of customers with dependable technology in place.
• With the increasing overlap between CC and UCC, driven by customer workflows and the need to bring the back office into the frontline of the company, platforms that deliver integrated CCaaS and UCaaS are the foundation of next-generation business communications solutions. A converged, integrated offering for next-generation communications capabilities delivered across a host of mobile devices, and multiple communication and customer service channels bridges what has typically been siloed CC and UCC applications into one powerful tool.
Hybrid/Distributed Workforce:
• A clear priority is the business need to support individuals' expectations for flexible, multi-channel communications and remote and hybrid work styles that have arisen out of the COVID-19 pandemic. The global pandemic altered the way employees and end customers interact and engage, resulting in broad impacts to the ways businesses approach their internal and customer-facing communications planning and platforms.
• Evolving hybrid work environments highlight the need for organizations to ensure consistent collaboration experiences in unpredictable situations, regardless of workers' locations or time zones. Avaya solutions are well positioned to enable this work-from-anywhere approach while maintaining security, reliability and scalability requirements.
• Businesses plan to modify their use of office space to accommodate hybrid and remote work. Modifications will include space reduction, implementing hot-desking and hoteling solutions and equipping shared spaces and meeting rooms for video conferencing with remote participants. Video conferencing and collaboration solutions are an integral part of the changing office environment.
The Rise of Artificial Intelligence:
• Automation through AI solutions is driving improved customer and employee experiences. Conversational AI infused in contact center solutions will improve operational efficiencies and customer experiences, leading to accelerated contact center platform replacements. AI enhancements also improve the meeting and collaboration experience between in-person and remote meeting participants. Video applications are increasingly being infused with virtual assistants, smart transcription and translation and facial recognition.
• Extreme automation is fueling simplicity. Although the enabling technologies in our sector are becoming more complex, their use in contact center applications is driving increased simplicity for organizations and their employees. Simplicity in operations, engagement, customer intelligence and customer experience form the root of the innovation happening in our space.
Growth of the Experience Economy:
• The Experience Economy continues to grow. The Experience Economy is based on the concept that experience is a key source of value — it is a differentiator that creates a competitive advantage for products and services. As
consumers embrace new technologies and devices in creative ways and at an accelerating pace, Avaya is continuing to invest in AI-powered solutions delivered through cloud and subscription models to create "experiences that matter" for customers, employees and agents. This increased adoption and deployment of AI is providing significant new opportunities for enhanced CC and UCC solutions that improve the customer experience and transform the digital workplace communications and workflows.
Our Market Opportunity
We believe that these trends create significant market opportunities for Avaya next-generation CCaaS, UCaaS and Workstream Collaboration solutions. Avaya offers customers a choice of deployment models including private cloud/dedicated instances, multi-tenant public cloud and premises-based solutions with a broad set of flexible licensing models. Other cloud vendors typically offer only one deployment model - multi-tenant public cloud. Avaya can meet its customers where they are in their cloud journey with a recurring subscription model and/or capabilities added over the top of existing systems. At the same time, we offer new capabilities that bring new value and guide them on a cloud migration path that fits their requirements.
We are pursuing a platform approach that we believe will result in enhanced market opportunity for Avaya, especially when coupled with our strategy to enable our customers to innovate without disruption. We see a significant segment of Avaya customers, particularly in large enterprise and government, that would experience tremendous disruption and risk in leaving behind their customized on-premises platform to fully move to cloud today—whether with Avaya or another vendor. Instead, we believe they prefer to expand their capabilities, rather than by starting anew. We are building solutions that "protect" those key elements of their existing solutions while providing additional functionality delivered via the cloud in a combined, hybrid solution. Most of our competitors cannot match that advantage. We see our ability to improve the user experience and add new value for existing customers while preserving the benefits of their existing systems as a significant driver of retention and growth.
Avaya intends to add further value by exposing APIs for our customers and partners. This enables them to customize and personalize their Avaya platforms, and complete purpose-built integrations with other third-party providers or enterprise systems, to enhance their productivity or improve their employee-to-employee or customer-to-agent interactions. With this, the technology partners in our ecosystem become another major differentiating strength, as they integrate to Avaya communications platforms and add value to our solutions for customers. We believe that the total available market for our solutions includes spending on one-time and recurring communications applications, upgrades and professional and support services to implement, maintain and manage these solutions, along with business devices that improve the application experience.
We are expanding our business in several of these areas, with CCaaS as our North Star. Through our software and subscription offers, we are also growing in the customer segments that we serve, particularly in large enterprises with more than 1,000 employees, as well as in midmarket enterprises with between 50 and 250 agents in the contact center market and between 100 and 1,000 employees using our communications and collaboration solutions. The growth opportunity in these markets comes from the need for enterprises to increase productivity and upgrade their contact center and unified communications and collaboration strategy to a more integrated approach to account for changing customer expectations and the accelerated hybrid work / "work from anywhere" trends, increased mobility, and the demand for seamless experiences across multiple communications channels. In response to these needs, we expect that aggregate total spending on CC, UCC, services and support and enterprise cloud and managed services to grow, with the majority of growth coming from cloud services.
Although the decision makers for our solutions and services have traditionally been senior IT leadership, our research finds that buying decisions are being influenced by business units and the broader C-suite, including Chief Executive Officers ("CEOs"), Chief Marketing Officers ("CMOs") and Chief Digital Officers ("CDOs"). These executive officers have become more involved as digital transformation has expanded beyond the data center and IT infrastructure to encompass lines of business operations and customer experiences. CEOs, CMOs and CDOs are recognizing growing customer and employee demand for better interactions across multiple channels of their choosing, and they see an opportunity to differentiate their companies and lines of business by delivering a superior customer experience.
We believe that due to the increasing importance of technology as both an internal and external-facing presence of the enterprise, as well as the high stakes of data breaches and similar cyber-security events, CEOs are increasingly engaged in the decision-making process. CMOs and CDOs are gaining additional budget authority as they are tasked with improving customer experience. We believe that because of the shifts in decision-making roles, the focus of customer experience solutions should be to provide businesses with better ways to engage with end users securely across multiple platforms and channels, creating better customer experiences, and ultimately, higher revenues for the business.
In our experience, decision makers have three critical priorities:
• Leverage existing technology infrastructure while positioning for the future: The speed at which new technology enters the market is challenging for companies to rapidly adopt and deploy. We believe this pressure creates strong
demand for scalable systems that do not require enterprise-wide overhauls of existing technology to implement newer solutions and technologies. Instead, it favors incremental, flexible, extensible technologies that are easy to adopt and compatible with existing infrastructures.
• Shift to cloud-based solutions: Companies today seek technology that helps them lower Total Cost of Ownership and increase deployment speed and application agility, including a variety of public, private and hybrid cloud solutions. They are also shifting away from a complex, proprietary capital-intensive consumption model to one that is more flexible and efficient in gaining access to the latest technology.
• Manage the reliable and secure integration of an increasing number and variety of devices and endpoints: Today, business users leverage laptops, smartphones and tablets just as often as – if not more often than – desk-based devices. The ability to communicate seamlessly and securely across devices, applications and endpoints must be managed as part of an integrated communications infrastructure.
Customers are also looking for faster proof points, whether that is in the context of limited trials or pilots, and they want to innovate quickly to learn fast from what went well and what did not, and incorporate those learnings.
Our Strategy
We believe we have positioned Avaya as a leader in cloud-based communications solutions by:
• Defining innovation in our core market segments by partnering and delivering powerful AI-enabled cloud communications solutions, with CCaaS clearly established as our North Star.
• Winning with global services capabilities that support customer cloud adoption and drive expansion.
• Activating, converting and transforming our installed base, enabling them to innovate without disruption. We will help our enterprise customers add new value by deploying cloud capabilities over the top of their existing premises-based solutions, on a pace and path that meets their unique needs.
In addition, Avaya intends to:
• Expand Sales within Existing Customers and Pursue New Customers: We have a significant opportunity to increase sales to our existing customers with our platform approach and strategy to enable them to add new cloud capabilities and migrate without disruption. Our market leadership, global scale and extensive customer interaction, including at the C-suite level, supports our Avaya portfolio, creating a strong software platform from which to drive and shape the evolution of enterprise communications. We have strong credibility with our customers, which provides us with a competitive edge as our customers make the transition to the cloud. Additionally, our CCaaS solutions and Avaya Cloud Office increase the potential for acquiring new customers.
Our solutions are both HIPAA and PCI DSS (Payment Card Industry Data Security Standard) compliant as we believe the ability to service the healthcare and pharmaceuticals industries, as well as merchants that accept credit cards, significantly expands our potential customer base and total addressable market. These certifications allow for market penetration into what are otherwise restrictive and difficult markets.
• Re-align and simplify Avaya go-to-market, and support structures: We will streamline our operating structure internally to align with the products and services that will deliver the greatest value to our customers — and therefore to our partner ecosystem and to Avaya.
• Increase our Midmarket Capabilities and Market Share: We believe our market opportunity for the portion of the midmarket segment that Avaya serves is growing. We define the midmarket as firms with between 50 and 250 agents for CC and between 100 and 1,000 employees for UCC. Not only do we believe this segment is growing, but we also believe midmarket businesses are underserved and willing to invest in IT enhancements. We intend to continue to invest in our midmarket offerings and go-to-market resources to increase market share and meet the growing demands of this segment.
• Adjust Sales and Distribution Capabilities to Customer Needs: Our flexible go-to-market strategy consists of both a direct sales force and an indirect sales force through our alliances and channel partners, which enables us to reach customers across industries and around the globe. We believe our channel partner network is a valuable competitive differentiator based on our brand and long history of fostering a robust channel sales go-to-market motion. We intend to continue to align our channel partners and sales forces to optimize their market focus and better serve vertical segments. We provide our channel partners, including Technology Service Distributors (TSDs) and sales agents, with training, marketing programs and technical support that helps to further differentiate our offerings from those of our competitors. These agents are our primary distribution channel for small to midmarket customers. Under our Technology Service Distributor program, small to midmarket sales agents connect prospective customers with our
direct sales force. The Avaya team then handles the transaction from contracting and partnering with the customer to determine what services are appropriate to ultimately managing and billing the customer for the Avaya services provided. The Technology Service Distributor program provides an option that rounds out the available choices for customers, channel partners and sales agents to access Avaya’s industry-leading communications solutions.
We also leverage our sales and distribution channels to accelerate customer adoption of our cloud-based solutions and generate an increasing percentage of our revenue from our high-value software solutions, video collaboration, mid-market offerings and user experience applications.
Our Competitive Strengths
We believe the following competitive strengths position us to capitalize on the opportunities created by the market trends affecting our industry as Avaya continues to transform as a software and services company.
A Leading Position and Install Base across our Primary Markets
With a full suite of CC and UCC solutions offered and our expansive go-to-market capability, we are a global leader in business communications. We maintain a leading market share in worldwide contact center agents and are recognized by industry analysts as being among the leaders in unified communications and collaboration seats. Additionally, we believe we are a leading provider of private/dedicated instance cloud and managed services and that our market leadership and incumbent position within our customer base provides us with a superior opportunity to cross-sell to existing customers and position ourselves to win over new customers. With our platform approach and strategy to migrate our customers without disruption, we create drivers for customer retention and growth within this industry-leading installed base. The ability to add capabilities over the top of existing infrastructure for our existing customers puts us in a position where we have virtually no meaningful competition in migrating these customers.
Our Open Standards Technology Supports Multi-vendor, Multi-platform Environments
At Avaya, our open architecture and standards-based technology enable us to accommodate existing and new customers with multi-vendor environments seeking to leverage existing investments while achieving immediate overall costs savings and improved functionality. Providing enterprises with strong integration capabilities positions them to take advantage of new UCC and CC technology as it is introduced. Our software technology does not limit customers to a single vendor or add to the backlog of integration work. In fact, our extensive partner ecosystem, together with our open communications APIs — a set of routines, protocols and tools for building software applications and applications development environments — enable our customers to derive additional and unique value from our architecture.
Building on our Leading Service Capabilities for a Significant Recurring Revenue Stream
Avaya's services relationships have long been significant contributors to our recurring revenue base and provide substantial visibility into our customers' future collaboration needs. Our enterprise cloud and managed services and support services use a standardized approach with a global methodology and business process management for delivery and support. Typically, we provide this to our customers through recurring contracts ranging from one to five years.
In addition to insights into their ongoing operational needs, our professional services team provides customers with a path to the cloud from premise-based solutions by engaging in migration planning, security services, custom application integration and other consulting activities that position us to understand our customers’ business needs today and in the future.
Research and Development ("R&D")
Avaya makes substantial investments in R&D to develop new systems, solutions and software in support of business communications, including, but not limited to, converged communications systems, communications applications, multimedia contact center innovations, collaboration tools, video, speech-enabled applications, cloud offerings, web services, artificial intelligence and services for our customers. We are investing in converged cloud technology platforms that are API-first and elastic — scaling down to profitably support small and medium business segments and scaling up to support large-scale requirements of our largest enterprise customers. This platform approach means a consolidated code base that will speed innovation and our delivery of feature enhancements exponentially.
Over the past three fiscal years, we have invested approximately $660 million in R&D, including technology acquisitions, reflecting a consistent investment in R&D as a percentage of product revenue and evidencing our commitment to innovation. Our investments in fiscal 2022 focused on driving innovative cloud solutions across our portfolio and new releases of our CC and UCC solutions.
Patents, Trademarks and Other Intellectual Property
We own a significant number of patents important to our business and we expect to continue to file patent applications to protect our R&D investments in new products and services across all areas of our business. As of September 30, 2022, we had
more than 4,300 patents and pending patent applications, including foreign counterpart patents and foreign applications. These patents and pending patent applications cover a wide range of products and services involving a variety of technologies. For the United States, patent terms may be 20 years from the date of the patent's filing, depending upon term adjustments made by the patent office. In addition, we hold numerous trademarks in the United States and in other countries. We also have licenses to intellectual property for the manufacture, use and sale of our products.
We obtain patent and other intellectual property rights used in connection with our business when practicable and appropriate. Historically, we have done so both organically, through commercial relationships, and in connection with acquisitions.
We manage our patent portfolio to maximize return on investment by selectively selling patents at market prices and cross-licensing with other parties when such sales or licensing are in best our interests. These monetization programs are conducted in a manner that helps to preserve Avaya’s freedom to operate and to help ensure that Avaya retains patents needed for defensive use.
From time to time, assertions of infringement of certain patents or other intellectual property rights of others have been made against us, and certain pending claims are in various stages of litigation. Based on our experience and customary industry practice, we believe that any licenses or other rights that might be necessary for us to continue with our current business could be obtained on commercially reasonable terms. For more information concerning the risks related to patents, trademarks and other intellectual property, see Item 1A, "Risk Factors-Risks Related to Our Business-Intellectual Property and Information Security-We may be subject to litigation and infringement claims, which could cause us to incur significant expenses or prevent us from selling our products or services."
Customers
Avaya employs a flexible, go-to-market strategy to support our diverse customer base. Our customers range in size from small businesses employing a few individuals to large government agencies and multinational companies with tens or hundreds of thousands of employees. Our customers operate in a broad range of industries, including financial services, manufacturing, retail, transportation, energy, media and communications, hospitality, health care, education and government. Our customers include leading Forbes Global 2000 companies across all these industries. Customers continue to trust Avaya and lean into our approach of enabling them to innovate without disruption. For more information concerning the risks related to contracts with the U.S. federal government, see Item 1A, "Risk Factors-Risks Related to Our Business-Our Operations, Markets and Competition-Contracting with government entities can be complex, expensive and time-consuming."
Sales and Distribution
Our customer-centric, cloud-first, global go-to-market strategy serves to focus and strengthen our reach and impact on large multinational enterprises, midmarket and regional enterprises and small businesses. Our sales organizations are equipped to sell our comprehensive portfolio, complemented by services offerings including professional services, product support, integration and other services so we can engage our customers in the way they prefer to work with us, either directly with Avaya or indirectly through our sales channels.
We continue to focus on efficient deployment of Avaya sales resources, both directly and indirectly through our channel partners, for maximum market penetration and global growth. Our investment in our sales organization includes fully integrated curricula on the sales process, guided selling, sales enablement and on our solutions for all roles within our sales organization.
Our Global Partner and Alliance Ecosystem
Avaya fosters relationships with an expansive set of partners that we believe deliver business-impacting value for each company, for Avaya, and most importantly, for the customers we serve together. We have built a global network of traditional channel partners, cloud system integrators, technology solutions distributors, sales agents and other service providers to fill any customer need:
• Channel Partners: Our channel partners serve our customers worldwide through our Avaya Edge business partner program. Through certifications, the Avaya Edge program positions Value Added Reseller partners to sell, implement and maintain our communications systems, applications and services. Note, the largest Avaya distributor, ScanSource Inc., is also its largest customer and represented 8% of the Company's total consolidated revenue for fiscal 2022. See Item 1A, "Risk Factors-Risks Related to Our Business-Our Operations, Markets and Competition-We depend on our indirect sales channel" for additional information on the Company's reliance on its indirect sales channel.
• Technology Service Distributor (TSD) and Agent Channel: Another active channel that has expanded Avaya’s indirect reach: the TSD and Agent channel. TSDs operate like a traditional distributor in that they connect and represent vendors to an enormous channel of agents. TSDs provide training, assist with solution selection and function as a resource, but unlike traditional distributors, TSDs primarily focus on cloud services. The primary focus of an agent is working with customers to define a solution and connecting the customers with vendors. An agent often
operates as a consultant or expert on behalf of its customer. The TSD and Agent channel is most prevalent in the US and Canada, with an expanding presence in Western Europe and the Asia-Pacific region.
• Global Service Provider alliances: Through these partnering arrangements with leading telecommunications service providers, we pursue sell-to and sell-through opportunities for Avaya solutions and services. These alliances are integral in selling and implementing our cloud-based services and are principal routes to market for our CCaaS and UCaaS solutions.
• Global Systems Integrator alliances: These refer to arrangements with systems integrator partners, as well as key channel partners with strong professional services and personalized integration capabilities who include Avaya solutions within broader digital transformation programs and end-to-end vertical solutions.
• Ecosystem alliances: These partnering arrangements are with industry leaders and leading technology companies. They feature deeper, R&D-led integrations and/or expanded go-to-market efforts, including new routes to market through Avaya's participation in third-party marketplaces such as Salesforce App Exchange or the Microsoft Azure Marketplace. We have also developed closer partnerships with hyperscalers such as Microsoft, Google and Amazon.
During fiscal 2022, we expanded our partnership with Microsoft with an increased commitment to the development of Azure-based cloud solutions including Private Cloud CC and UC offers and delivered CCaaS capabilities from within Microsoft Dynamics 365. We further attained Microsoft IP Co-Sell Incentivized status for our existing CCaaS offer, strengthening the value of Avaya with Microsoft Sales and Sellers in joint go-to-market activities. Avaya has also been working with Salesforce to build joint go-to-market momentum with Avaya for Salesforce, a recently commercialized Salesforce Service Cloud Voice offer. Finally, Avaya and Google continue to drive more cloud adoption and scale Contact Center AI capabilities. The next-generation Avaya Media Processing Platform was also delivered as a native, cloud-first solution, containerized and orchestrated with microservices through Google Cloud Platform.
In addition, during fiscal 2022 we established a new relationship with Alcatel-Lucent Enterprise (ALE), expanding our customer reach for CCaaS through ALE sales efforts, while simultaneously broadening the Avaya portfolio to include the ALE suite of networking solutions. We also built on our strategic partnership with RingCentral for Avaya Cloud Office, our UCaaS solution, adding new capabilities and expanding into new markets.
In 2022, we expanded our go-to-market reach for Avaya solutions via cloud provider and SaaS marketplaces, including Salesforce App Exchange and the Microsoft Azure Marketplace. We also achieved Microsoft IP Co-Sell Incentivized status for our CCaaS solution. The Avaya DevConnect program is designed to promote the development, compliance-testing and co-marketing of innovative third-party products that are compatible with Avaya’s standards-based products. Member organizations have expertise in a broad range of technologies, including IP telephony, CC and UCC applications.
Manufacturing and Suppliers
We have outsourced substantially all of our manufacturing operations to several contract manufacturers. All manufacturing of our products is performed in accordance with detailed specifications and product designs, furnished or approved by Avaya, and is subject to rigorous quality control standards. We periodically review our product manufacturing operations and consider changes we believe may be necessary or appropriate. We also purchase certain hardware components and license certain software components from third-party Original Equipment Manufacturers, which we then resell separately or as part of our products under the Avaya brand.
In some cases, certain components are available only from a single source or from a limited number of suppliers. Delays or shortages associated with these components could cause significant disruption to our operations, although we have not yet had any such event have a material impact on us. For more information on risks related to products, components and logistics, see Item 1A, "Risk Factors-Risks Related to Our Business-Our Operations, Markets and Competition-We rely on third-party contract manufacturers, component suppliers and partners (some of which are sole source and limited source suppliers) and warehousing and distribution logistics providers. If these relationships are disrupted and we are unable to obtain substitute manufacturers, suppliers or partners, on favorable terms or at all, our business, operating results and financial condition may be harmed."
Competition
Although we believe we are differentiated from any single competitor, competition will continue to evolve and grow. Proper execution of our strategy will force them to change their selling tactics to compete effectively. The following represent the Company's primary competitors in various lines of our business:
• UCC premise and cloud: Alcatel-Lucent Enterprise, Atos Unify, Cisco, 8x8, GoTo, Huawei, Microsoft, Mitel, NEC, RingCentral and Zoom.
• CC premise and cloud: Amazon, Cisco, Content Guru, Dialpad, Enghouse Interactive, Five9, Genesys, LiveVox, NICE inContact, Talkdesk and Twilio.
• Video Products and Conferencing Solutions premise and cloud: Cisco, Google, Huawei, Lifesize, GoTo, Microsoft, Poly, RingCentral, Yealink and Zoom.
We also face competition in certain geographies in which we operate with companies that have a particular strength and focus in those regions.
While we believe our global, in-house end-to-end services organization as well as our indirect channel provide us with a competitive advantage, we face competition from companies offering products and services directly or indirectly through their channel partners, as well as resellers, consulting and systems integration firms and network service providers.
For more information on risks related to our competition, see Item 1A, "Risk Factors-Risks Related to Our Business-Our Operations, Markets and Competition-We face formidable competition from providers of unified communications and contact center solutions and services, including cloud-based solutions, and this competition may negatively impact our business and limit our growth."
Employee and Human Capital Management
Our Global Footprint
Our ability to attract, retain and engage diverse talent is critical to the successful execution of our strategy and delivering on our mission to create experiences that matter for our customers and employees. Our cultural principles of Simplicity, Trust, Accountability, Teamwork, Empowerment and Inclusion have been foundational to our culture and serve as the framework for each phase of the employee life cycle.
As of September 30, 2022, we employed 7,090 employees, of which 34% were located in North America (United States and Canada), 26% were located in Asia Pacific, 8% were located in the Caribbean and Latin America and 32% were located in Europe, Middle East and Africa. In addition, 22% of our global employee headcount identified as female. In the United States, 27% of the employee headcount identified as female and 26% of our employees self-identified as a minority group. On September 6, 2022, we announced a reduction in force to realize annual cost reductions, together with other unrelated incremental cost reduction actions, to better align the Company’s workforce with its operational strategy and cost structure. During the fourth quarter of fiscal 2022, we completed a reduction in force of 766 employees, approximately 10% of our global workforce, and we recognized $26 million of related restructuring expense. The Company made, and expects to make, additional reductions in workforce during fiscal 2023 as it continues to align the business with its operational strategy and cost structure.
Of our 2,077 employees located in the United States, 13% are represented by a labor union. In many countries outside of the US, our employees are represented by trade unions, work councils or collective bargaining agreements at the national level.
At Avaya, we champion an open, fair and supportive environment where our employees can thrive both professionally and personally. We work hard, give back to our communities, take care of our customers and promote high levels of employee engagement and well-being. Human capital management and environmental, social and governance ("ESG") matters are woven into the everyday fabric of Avaya's culture and actively sponsored by our executive leadership. In addition, aspects of human capital management and ESG are overseen by our Board of Directors as well as the Compensation Committee, Audit Committee and the Nominating and Corporate Governance Committee.
Fostering a Destination Place to Work
Our people strategy enables a culture that empowers our team members to leverage their strengths and experiences and also provides development and growth opportunities to sustain and expand our world-class services and cultivate innovation. This strategy is reflected in Avaya's goal to become a destination place to work, retain our top performers and attract high-caliber new talent into the organization. Underpinned by our cultural principles, our global population demonstrates the following attributes in the way we work and in everything we do:
• We espouse a customer-centric approach to focus on making our customers' lives simpler and more efficient.
• We foster a safe environment where innovative solutions are encouraged and rewarded.
• We encourage our people to speak up, take responsibility and embrace ownership.
• We lead by example and function as a transparent and dynamic team working towards a unified vision.
• We recognize one another for our achievements and strengths and value diversity of thought and the uniqueness of everyone in a collaborative environment.
• We empower our people to take risks, immerse themselves in the experience and drive customer success.
Employee Engagement
We enhance employee engagement by soliciting and addressing feedback, investing in our employees and promoting diversity, equity, inclusion and belonging.
We regularly conduct employee surveys to better understand and improve perceptions in the areas of engagement, recognition, career development, inclusion, leadership and management effectiveness and ethics and integrity. 71% of our employees participated in our most recent survey in 2022 and responses indicated employee engagement of 76%. We use the feedback to identify opportunities and take action to continually strengthen our culture and enhance engagement, as we strive to make Avaya a destination place to work. For the third consecutive year, Avaya was recognized by Forbes as one of the World's Best Employers in 2022.
At Avaya, we are acutely aware that developing our talent is both critical for continuing success in a rapidly evolving industry as well as for employee retention. We invest significant resources in professional development, career advancement and training for our global employee population. In addition to ongoing performance reviews and development discussions that occur as part of our formalized annual performance lifecycle, consistent, meaningful conversations are encouraged between employees and managers to continue the dialogue regarding aspirations, goals and career growth.
Avaya continues to invest in tools, resources, partnerships and programs to further develop our internal capabilities to develop talent and build a leadership pipeline to support our business success in 2022. In addition to hosting leadership development programs with partners such as BetterUp and ZengerFolkman, Avaya developed and launched two new leadership development programs in 2022; Stepping Into Leadership for new leaders and Accelerate! for high-potential early career employees. All employees have access to learning tools and programs such as LinkedIn Learning and Mentoring. Over 80% of employees have activated their LinkedIn Learning accounts. Avaya also hosted its first employee learning week, Spark Week, with over 1,700 employees participating in a variety of virtual sessions ranging in topics from business acumen to health and well-being.
Diversity, Equity, Inclusion and Belonging (DEI&B) at Avaya
At Avaya, we drive and promote a clear strategy to build a workplace that mirrors the society in which we do business — a workplace where individuality is celebrated and harnessed to create a culture of engagement, innovation, inclusivity and belonging.
To successfully execute on our strategy, we have established a Global DEI&B Council, chaired by our CEO, to ensure alignment between our DEI&B strategy and our overall business strategy and a Global DEI&B Committee, chaired by our Chief Human Resources Officer, to ensure global calibration and oversee the execution of various DEI&B initiatives. We continue to partner with Blue Ocean Brain to promote diversity awareness and education for our employees.
Our Employee Resource Groups ("ERGs"), employee-led groups that bring employees together to foster a sense of belonging, have increased to seven active ERGs: Avaya Blacks Leading Empowerment (ABLE), Abilities Employee Resource Group (AERG), Asociacion Latinos Mundiales Avaya (ALMA), Asian Pacific Islanders @ Avaya (API@A), PRIDE @ Avaya, Veterans @ Avaya (VET@A) and Women's Inspired Network @ Avaya (WIN@A). ERG representatives serve on the Global DEI&B Committee to discuss insights, recommendations and initiatives with leadership.
We focus on ensuring our hiring pipeline is accessible, dynamic and that we draw from a diverse pool of talent. To further these objectives, we utilize tools to support 'blind sourcing', conduct on-going training of our talent acquisition teams around topics such as unconscious bias, micro aggressions and inequities, and provide hiring managers toolkits to engage and attract diverse talent networks.
Employee Benefits
We provide comprehensive health insurance plans that include medical, dental and vision for our employees and their families in most countries. Our global employee population has access to employee assistance and wellness programs, including those covering financial wellness.
Corporate Responsibility
At Avaya, we believe it is our responsibility to help make the world a better place, and together with our employees, communities, customers, suppliers and community partners, we are working to make that a reality. Avaya embeds corporate responsibility into our day-to-day business, from our product design to supply chain management and employee giving. We pride ourselves on leveraging sustainability to drive innovation and develop new products, processes, services and technologies that contribute to the development and well-being of human needs and institutions while also respecting the world's natural resources. Remaining steadfast in our commitment to combat climate change, Avaya exceeded its 2020 target by reducing Scope 1 & Scope 2 emissions by 65% and Scope 3 emissions from business travel by 49% from 2014 levels. From fiscal 2020 to fiscal 2021, we reduced our total emissions by 1%. Building on our achievements and continuing the momentum, in fiscal 2022, we committed to set near-term company-wide emissions reduction targets in line with climate science. Additional detail
on our environmental, social and governance initiatives, including with respect to human capital, climate change and charitable giving, are included in our Corporate Responsibility Report and on our website. 1
Environmental, Health and Safety Matters
Avaya is subject to a wide range of governmental requirements relating to safety, health and environmental protection, including:
• certain provisions of environmental laws governing the cleanup of soil and groundwater contamination;
• various local, federal and international laws and regulations regarding the material content and design of our products;
• various local, federal and international laws that require us to be financially responsible for the collection, treatment, recycling and disposal of those products; and
• various employee safety and health regulations that are imposed in various countries within which we operate.
We are responsible for conducting remediation at four currently or formerly owned or leased sites. We do not believe this work will have a material impact on our business, results of operations or liquidity.
Cybersecurity
Avaya has a vigorous, risk-based cybersecurity program, dedicated to protecting our data as well as data belonging to our customers and partners. We utilize a defensive in-depth strategy, with multiple layers of security controls to protect our data and solutions. Organizationally, we have a Product Security Council, cross-functional Cyber Incident Response teams, Security Operations Centers, and strong governance to ensure compliance with our security policies and protocols. These teams are comprised of experts across our enterprise, as well as outside experts, to ensure that we are monitoring the effectiveness of our cybersecurity governance and vulnerability management programs.
For more information on risks related to data security, see Item 1A, "Risk Factors-Risks Related to Our Business-Intellectual Property and Information Security- A breach of the security of our information systems, products or services or of the information systems of our third-party providers could adversely affect our business, operating results and financial condition."
Corporate Information
Our principal executive offices are located at 350 Mt. Kemble Avenue, Morristown, New Jersey. Our corporate telephone number is (908) 953-6000. Our website address is www.avaya.com. Information contained in, and that can be accessed through our website is not incorporated into and does not form a part of this Annual Report on Form 10-K.
Avaya Holdings is a holding company with no stand-alone operations and has no material assets other than its ownership interest in Avaya LLC (formerly known as Avaya Inc.) and its subsidiaries. All of the Company’s operations are conducted through its various subsidiaries, which are organized and operated according to the laws of their jurisdiction of incorporation or formation, as applicable, and consolidated by the Company.
All of the Company's periodic reports filed with the Securities and Exchange Commission ("SEC") pursuant to Section 13(a), 14 or 15(d) of the Securities Exchange Act of 1934, as amended, are available, free of charge, on the SEC’s website (www.sec.gov).
1 The contents of our website and our Corporate Responsibility Report and CDP Climate Change Questionnaire are referenced for general information only and are not incorporated into this 10-K.
Item 1A.
Risk Factors
Summary of Risk Factors
The risk factors summarized and detailed below could materially harm our business, operating results and/or financial condition, or impair our future prospects. These are not all of the risks we face and other factors not presently known to us or that we currently believe are immaterial may also affect our business if they occur. Material risks that may affect our business, operating results and financial condition include, but are not necessarily limited to, those relating to:
Risks Related to the Company's Emergence from Chapter 11
• emergence may have a negative impact on our business relationships;
• long-term liquidity requirements and the adequacy of our capital resources are difficult to predict at this time;
• financial results after emergence may not reflect historical trends or meet our expectations;
• increased levels of employee attrition as a result of the Chapter 11 Cases including among senior management;
• there is no market for our New Common Stock;
• a significant portion of our outstanding voting stock is owned among certain stockholders, which may prevent you from influencing significant corporate decisions; and
• the transition to a significantly new Board, which may shift the future strategy and plans of the Company and could negatively impact our future financials.
Risks Related to the Investigations and Internal Control over Financial Reporting
• we may not be successful in remediating the identified material weaknesses exist in our internal control over financial reporting;
• we may continue to incur significant expenses related to the Investigation and the remediation of the material weaknesses in our internal control over financial reporting; and
• the Investigations and the findings thereof may continue to divert the attention of management and other human resources from the operation of our business.
Risks Related to Our Business
• executing our strategic operating plan, including continued expansion of our cloud-based solutions and services offerings relies in part on our strategic partnership with RingCentral, Inc.;
• market opportunities may not develop for our solutions and services in ways that we anticipate and we may not succeed in developing new innovative solutions and services to keep pace with rapidly changing technology, evolving industry standards and customer preferences;
• transitioning customers from a perpetual license to a subscription-based, recurring revenue model and if we are successful, how that may negatively impact the timing of our cash flows;
• industry consolidation and competition from providers of contact center and unified communications solutions and services, including cloud-based solutions;
• our reliance on our indirect sales channel;
• disruptions to our third-party contract manufacturers, component suppliers and partners (some of which are sole source and limited source suppliers) and warehousing and distribution logistics providers;
• compliance with laws and regulations relating to the formation, administration, performance and pricing of contracts with government entities;
• completing acquisitions and/or strategic alliances, including those needed to increase our share of the cloud communications industry and integrating such acquired businesses and alliances;
• increasing use of artificial intelligence in our offerings may expose us to social and ethical issues which may result in reputational harm and liability;
• our ability to detect and correct design defects, errors, failures or “bugs” in our products and services;
• litigation, intellectual property, infringement claims and the protection of our intellectual property;
• some of our products contain software from open source code sources;
• failure to comply with laws and contractual obligations related to data privacy and protection;
• security breaches of our information systems, products or services or of the information systems of our third-party providers;
• operational, logistical, economic and/or political challenges in a specific country or region, including compliance with United States ("U.S.") and foreign government laws and regulations, which could negatively affect our revenue, costs, expenses and financial condition or those of our channel partners and distributors;
• compliance with certain telecommunications or other rules and regulations, which could subject us to enforcement actions, fines, loss of licenses and possibly restrictions on our ability to operate or offer certain of our services;
• changes in, and responses to, U.S. trade policy, including the imposition of tariffs and sanctions and retaliatory measures by other countries;
Risks Related to Our Financial Results
• shifts in the mix of sizes or types of organizations that purchase our solutions or the mix of products, solutions and services purchased by our customers could affect our gross margins and operating results;
• we recorded a significant charge to earnings and we may be required to record additional charges if our intangible assets become impaired;
• levels of returns on pension and post-retirement benefit plan assets, changes in interest rates and other factors affecting the amounts to be contributed to fund future pension and post-retirement benefit plan liabilities could adversely affect our cash flows, operating results and financial condition in future periods; and
• our ability to generate sufficient cash flows from operations to meet our debt service and other obligations.
Risks Related to the Company's Emergence from Chapter 11
We recently emerged from bankruptcy, which could adversely affect our business and business relationships.
We emerged from bankruptcy on May 1, 2023 (the "Emergence Date"). It is possible that having recently emerged from the Chapter 11 Cases could adversely affect our business and relationships with vendors, suppliers, service providers, customers, employees and other third parties. As a result of our recent emergence, the following risks exist:
• vendors or other contract counterparties could terminate their relationship with us or require financial assurances or other enhanced performances;
• we may face challenges in renewing existing contracts and competing for new business;
• it may be more difficult to attract, motivate and/or retain key executives and employees;
• employees may be distracted from the performance of their duties or more inclined to pursue other employment opportunities; and
• competitors may take business away from us, and our ability to attract and retain customers may be negatively impacted.
We cannot accurately predict or quantify the impacts or material adverse effects of the residual risk and uncertainties associated with our Emergence, or the occurrence of one or more of these risks could have on our results of operations, financial condition, business and reputation. We cannot assure you that having recently been subject to bankruptcy protection will not adversely affect our future results of operations, financial condition and business.
Our long-term liquidity requirements and the adequacy of our capital resources are difficult to predict at this time.
During fiscal 2022, we have generated negative cash flows from operations and expect to continue to generate negative cash flows from operations in the near term. We face uncertainty regarding the adequacy of our long-term liquidity and capital resources. In addition to the cash requirements necessary to fund ongoing operations, we have incurred significant professional fees and other costs in connection with the preparation and administration of the Chapter 11 Cases. We cannot assure you that cash on hand at Emergence, cash flow from operations and the Exit ABL Facility will be sufficient to continue to fund our operations. In addition, we have agreed to provide financial support to certain of our foreign subsidiaries and if those agreements expire and/or are not renewed, those subsidiaries' ability to operate could be negatively impacted, which in turn could adversely affect our ability to execute our business plans in those jurisdictions.
Our liquidity, including our ability to meet our ongoing operational obligations, is dependent upon, among other things (i) our ability to comply with the terms and conditions of our Exit Term Loan and associated agreements, (ii) our ability to comply
with our Exit ABL Facility and associated agreements, (iii) our ability to maintain adequate cash on hand and (iv) our ability to generate cash flow from operations.
Our actual financial results after Emergence may not be comparable to our historical financial information or to our projections filed with the Bankruptcy Court.
As a result of the implementation of the Plan and the transactions contemplated thereby, including the application of fresh start accounting, our future results of operations, financial condition and business may not be comparable to the results of operations, financial condition and business reflected in our historical financial statements.
In connection with the disclosure statement we filed with the Bankruptcy Court, and the hearing to consider confirmation of the Plan, we prepared projected financial information to demonstrate the feasibility of the Plan and our ability to continue operations upon our Emergence. Those projections were prepared solely for the purpose of bankruptcy proceedings and have not been, and will not be, updated on an ongoing basis and should not be relied upon by investors. At the time they were prepared, the projections reflected numerous assumptions concerning our anticipated future performance with respect to prevailing and anticipated market and economic conditions that were and remain beyond our control and that may not materialize. Projections are inherently subject to substantial and numerous uncertainties and to a wide variety of significant business, economic and competitive risks and the assumptions underlying the projections and/or valuation estimates may prove to be wrong in material respects. Actual results may vary significantly from those contemplated by the projections. As a result, investors should not rely on these projections.
It may be difficult for us to attract and retain employees, including members of our senior management, as a result of the Chapter 11 Cases.
As a result of our Emergence, it may be difficult for us to attract and retain employees, including members of senior management. A loss of key personnel or material erosion of employee morale could adversely affect our business and results of operations. Our ability to engage, motivate and retain key employees or take other measures intended to motivate and incentivize key employees to remain with us following our Emergence may be challenging given the uncertainties currently facing the business and changes we may make to the organizational structure to adjust to changing circumstances. The loss of members of our senior management team could impair our ability to execute our strategy and implement operational initiatives, which would be likely to have a material adverse effect on our business, financial condition and results of operations.
There is no public market for our New Common Stock, and we cannot assure you that an active trading market will develop for the New Common Stock.
There is no established trading market for the New Common Stock. We have no plans to list the New Common Stock on a securities exchange or to register it with the SEC. We cannot assure you that any market for the New Common Stock will develop, or that such a market will provide liquidity for holders of the New Common Stock. The liquidity of any market for the New Common Stock will depend upon the number of holders of the New Common Stock, our results of operations and financial condition, the introduction of new products and services by us or our competitors, publicity regarding our industry and various other factors may have a significant impact on the market price of the shares of New Common Stock. Accordingly, stockholders may not be able to sell their shares of our New Common Stock at the volumes, prices or times that they desire.
Certain stockholders own a significant portion of our outstanding voting stock and hold the right to appoint five of the nine seats on our Board. Concentration of ownership among such stockholders may prevent you from influencing significant corporate decisions.
As set forth in "Part III, Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters," certain of our stockholders beneficially own a significant portion of our outstanding voting stock. These stockholders also hold the right to appoint five members to our Board. As a result, these significant stockholders could have significant influence on matters requiring stockholder approval, including the election of directors and approval of significant corporate transactions, as well as corporate actions requiring solely the approval of our Board, such as financing transactions and significant asset sales.
It is possible that the interests of these stockholders will not align with the interests of our other stockholders. These significant stockholders and other investment funds affiliated with them are in the business of making investments in companies and may acquire and hold interests in businesses that compete directly or indirectly with us. The concentration of ownership may also have the effect of delaying or preventing a change in control and may not be fully aligned with the interests of other stockholders.
Upon Emergence, our Board significantly changed and may implement changes in our business strategy that could negatively affect the scope and results of our future operations.
Our corporate business strategy is subject to continued development, evaluation and implementation by our management and Board. Pursuant to the Plan, the composition of our Board changed significantly upon Emergence. Our Board currently consists
of nine directors, only one of whom, our President and CEO, had previously served on our Board. The new directors have different backgrounds, experiences and perspectives from those who previously served on our Board and thus may have different views on the issues that will determine our future, including our strategic plan and priorities. There can be no guarantee that our new Board will pursue, or will pursue in the same manner, our previous strategy and business plans. As a result, the future strategy and plans of the Company may differ materially from those of the past.
Risks Related to the Investigation and Internal Control Over Financial Reporting.
We determined that certain material weaknesses in our internal control over financial reporting existed as of September 30, 2022. If we fail to properly remediate these or any future material weaknesses or deficiencies, our ability to produce accurate and timely financial statements may be impaired, which may adversely affect investor confidence in us.
We have identified material weaknesses in our internal control over financial reporting and have concluded that our internal control over financial reporting and our disclosure controls and procedures were not effective as of September 30, 2022. A material weakness is a deficiency, or a combination of deficiencies, in internal control over financial reporting, such that there is a reasonable possibility that a material misstatement of our annual or interim financial statements will not be prevented or detected on a timely basis.
The Company did not design and maintain an effective control environment as former senior management failed to set an appropriate tone at the top. Specifically, former senior management applied pressure to individuals to achieve financial targets which created an environment where employees were hesitant to express dissent or communicate concerns to others within the organization. The ineffective control environment contributed to the following additional material weaknesses:
The Company did not design and maintain effective controls related to the information and communication component of the COSO (Committee of Sponsoring Organizations of the Treadway Commission) framework. Specifically, the Company did not design and maintain effective controls to ensure appropriate communication between certain functions within the Company. This material weakness contributed to an additional material weakness, that the Company did not design and maintain effective controls over the ethics and compliance program.
These material weaknesses did not result in any material misstatements of the Company’s financial statements or disclosures, but did result in an immaterial interim out-of-period correction during fiscal 2022. Additionally, each of the material weaknesses described above could result in a misstatement of substantially all account balances or disclosures that would result in a material misstatement to the annual or interim consolidated financial statements that would not be prevented or detected.
Based on the results of the investigation, the Audit Committee approved a number of remedial actions, which Avaya has implemented or is in the process of implementing.
Avaya is committed to addressing the issues identified in connection with the Audit Committee's review. Although we plan to complete the remediation process as quickly as possible, we cannot at this time estimate how long it will take, and our remediation measures may not prove to be successful in remediating these material weaknesses. In addition, if we are unable to successfully remediate these material weaknesses and produce accurate and timely consolidated financial statements, our liquidity and access to the capital markets may be adversely affected. Additionally, the result of any evaluation of effectiveness of these measures in future periods remains subject to the risk that our internal controls and procedures may become inadequate because of changes in our business condition, changes in accounting rules and regulations, or to the degree our compliance with our internal policies or procedures may deteriorate.
Avaya also cannot predict whether, or to the extent, such remedial actions will impact its operations or financial results. In addition, the findings of the Audit Committee review could further subject Avaya to litigation and regulatory investigations and could cause Avaya to fail to meet its reporting obligations, any of which could diminish investor confidence in Avaya, and/or limit Avaya's ability to access capital markets.
For additional information on the material weaknesses identified and our remedial efforts, see Item 9A, "Controls and Procedures."
We have incurred and expect to continue to incur significant expenses related to the Investigations and the remediation of the material weaknesses in our internal control over financial reporting, and any resulting litigation .
We have devoted substantial internal and external resources towards the Investigations and expect to continue to devote substantial resources towards the implementation of enhanced procedures and controls over deficiencies and the remediation of material weaknesses in our internal control over financial reporting. Because of these efforts, we have incurred and expect that we will continue to incur significant fees and expenses for legal, accounting, financial and other consulting and professional services, as well as the implementation and maintenance of systems and processes that will need to be updated, supplemented or replaced. We have taken several remediation efforts in response to the Investigations. However, there can be no assurance that these steps will be successful. To the extent these steps are unsuccessful or incomplete, or we identify additional problems requiring remediation, we may be required to devote significant additional time and expense to any additional remediation
efforts. The incurrence of significant additional expense or the requirement that management devotes substantial time that could reduce the time available to execute on our business strategies, could have a material adverse effect on our business, financial condition and results of operations.
The Investigations and the findings thereof have diverted, and may continue to divert, management and other human resources from the operation of our business.
The absence of timely and accurate financial information has hindered and may in the future hinder our ability to effectively manage our business. The Investigations and the findings thereof have diverted, and may continue to divert, management and other human resources from the operation of our business. The Company’s board of directors, members of management, and our accounting, legal, administrative and other staff and outside consultants have spent significant time on the Investigations and the findings thereof, and will likely spend significant time on remediation of the material weaknesses identified in our internal control over our financial reporting. These resources have been, and will likely continue to be, diverted from the strategic and day-to-day management of our business, and may have an adverse effect on our ability to accomplish our strategic objectives and on our results of operations and financial condition.
Risks Related to Our Business
Our Operations, Markets and Competition
If we do not successfully execute our business strategy, which depends in part on our ability to increase our share of the market for cloud-based solutions, software and services offerings, our business could be materially and adversely affected.
We sell business communications solutions and services in markets where the technology available and the utilized go-to-market models change rapidly. We are evolving from a traditional telecommunications hardware company into a software and services company, focused on expanding our cloud- and mobile-enabled contact center, unified communications and innovative next-generation workflow automation solutions.
As the markets we participate in rapidly develop and change, especially those related to cloud-based solutions, to increase our revenue we must continue to expand and develop attractive solutions and services offerings. To be successful, our cloud enabled contact center and unified communications solutions and services must offer relevant features and provide consistent high-quality services at competitive prices.
As is typical of any new solution introduced in a rapidly evolving market, the level of demand for, and market acceptance of, these new solutions is uncertain. If we successfully expand and develop our cloud-based solutions and services, our business will still remain dependent on customer decisions to migrate their legacy communications infrastructures to cloud solutions based on newer technology. While these investment decisions are often driven by macroeconomic factors, customers may also delay the purchase of newer technology due to a range of other factors, including prioritization of other IT projects, delays or failures to meet customers' certification requirements, the weighing of the costs and benefits of deploying new infrastructures and devices and the need to deploy capital to respond to unforeseen circumstances. In addition, customers' focus on the architecture, management and integration of such new technologies, and possible cyber breaches and other security considerations, could also affect market acceptance of new solutions.
The functionality, relevance, customer acceptance and continued use of our cloud-based solutions and services will depend, in part, on our ability and our partners' ability to integrate our offerings with third-party applications and platforms, including enterprise collaboration, enterprise resource planning, customer relationship management, human capital management and other proprietary application suites. Moreover, our business will remain dependent on customer decisions to migrate their legacy communications infrastructures to cloud solutions based on newer technology. In addition, the relevance of our offerings and quality of our services is imperative to maintain our roster of cloud-based customers once this migration is complete, which is at the crux of our strategy to shift our clients to subscription-based pricing and service models as opposed to perpetual license models.
If we are unable to successfully develop and expand our cloud-based solutions and services offerings, or if our customers and potential customers perceive our offerings and ability to service our customers as less attractive or capable than our competitors, our cloud-based solutions and services could fail to achieve market acceptance, which in turn could impact our growth strategy and materially and adversely affect our business, operating results and financial condition.
Our business communications solutions and services may not match market opportunities and the new solutions and services we develop may not keep pace with rapidly changing technology, evolving industry standards and customer preferences.
The demand for our solutions and services can change quickly and in ways that we may not anticipate because the market in which we operate is characterized by rapid, and sometimes disruptive, technological developments, evolving industry standards, frequent new product introductions and enhancements, changes in customer requirements and a limited ability to accurately
forecast future customer orders. Our solutions and services may not satisfy customer needs and we may not be able to successfully identify new market opportunities for our solutions and services.
In addition, we may not be able to successfully develop and bring new solutions to market in a timely manner. Our solutions need to keep pace with changes in technology, industry standards and customer needs. Our operating results may be adversely affected if the market opportunity for our solutions and services does not develop in the ways that we anticipate, if we are not able to successfully identify new market opportunities for our solutions and services, if we are not able develop and bring new solutions to market in a timely manner or if we are not able to achieve market acceptance of our solutions and services.
We may not be successful in transitioning customers from a perpetual license to a subscription-based, recurring revenue model.
We intend to increase our recurring revenue by shifting more of our business to a subscription-based model instead of a perpetual license model. While we will continue to support premises-based infrastructure solutions via perpetual software licensing and subscription-based models, one of our key focuses is increasing our recurring revenue. To do this, we need to offer relevant, cloud-enabled contact center and unified communications solutions and services at competitive prices, which will allow us to both "upsell" existing customers and attract new customers. To successfully execute this strategy, we seek to enter into contracts with customers to provide our products and services over long periods of time.
Our ability to enter into long-term agreements with customers could be impacted by macroeconomic factors, such as customers' outlook for the economy or its business, and specific considerations related to our company, including considerations about our ability to evolve our offerings to keep pace with technological advances and our ability to continue to provide our award-winning services, as well as perceptions related to our financial strength. If customers are reluctant to enter into long-term subscription arrangements with us it would affect our ability to execute our strategic plan and, in turn, our financial performance and conditions.
The timing of our cash flows may be negatively impacted as we shift more of our business to a subscription-based, recurring revenue model.
Our shift in business strategy from a perpetual license to a subscription-based model has and will continue to affect timing of cash flows. Under a subscription-based revenue model, customer payments are spread over a predetermined time period (e.g. monthly or annually) rather than being received upfront as is the case with most perpetual-based licensing models. As a result, until our subscription-based revenue increases to desired levels, the timing of our cash flows may be negatively impacted as we shift more of our business to a subscription-based model.
We may not be successful in executing elements of our strategic operating plan, which may have a material adverse impact on our business, financial results and results of operations.
Each year, we develop our strategic operating plan that serves as a roadmap for implementing our business strategy and the basis for the allocation of resources, capital, investment decisions, product life cycles, process improvements and strategic alliances and acquisitions. In developing our strategic operating plan, we make certain assumptions including, but not limited to, those related to the market environment, customer demand, evolving technologies, competition, market consolidation, the global economy and our overall strategic priorities for the upcoming fiscal year. Actual economic, market and other conditions may be different from our assumptions which could require us to adjust our strategic operating plan. In addition, we cannot provide any assurances that we will be able to successfully execute our strategic plan, that our strategic plan will not result in additional unanticipated costs, that the growth we anticipate through execution of our strategic plan will occur, that our channel partners will provide timely and adequate support for our products or that our strategic plan will result in improvements in future financial performance. If we do not successfully execute our strategic operating plan, or if actual results vary significantly from our expectations, our business, operating results, financial condition and market capitalization could be materially and adversely impacted.
Our strategic operating plan relies in part upon the successful execution of our strategic partnership with RingCentral, as well as our ability to meet our obligations pursuant to the Amended and Restated RingCentral Agreements, which may not be successful.
Our strategic operating plan relies on market acceptance of our cloud-based solutions and our investment in being at the forefront of offering these solutions. Our ability to implement this strategy relies, at least in part, on our strategic partnership with RingCentral. A strategic partnership between two independent businesses is a complex, costly and time-consuming process that requires significant management attention and resources. Realizing the benefits of our strategic partnership with RingCentral depends in part on our ability to work with RingCentral to develop, market and sell Avaya Cloud Office by RingCentral (“Avaya Cloud Office” or “ACO”). As with any strategic partnership, unforeseen challenges may arise, which could impact the ultimate benefits achieved from the alliance. In addition, RingCentral is also a competitor of Avaya and execution risk exists, with the potential for sales and channel conflict, which could negatively affect our working relationship.
The failure to meet the challenges involved in having two businesses work together could harm our ability to realize the anticipated benefits of this partnership and cause an interruption of, or a loss of momentum in, our business activities. We may also incur significant costs associated with this partnership and our revenues may not increase as anticipated, which may materially and adversely affect our business, operating results and financial condition.
In addition, the Company agreed to purchase seats of ACO in the event certain volumes of ACO sales are not met over a five year term, which is described further in Note 22, "Commitments and Contingencies." In the event that the cumulative number of ACO seats sold as of the end of each calendar quarter is lower than the agreed upon threshold for such quarter, the Company will be required to purchase a number of ACO seats equal to such shortfall from RingCentral, which we were required to do during the first quarter under the Amended and Restated RingCentral Agreements. Any such ACO seats purchased are subject to certain limitations and must be purchased for a two-year paid term with payments made monthly and pricing that is variable based on sales volumes by jurisdiction, contract size and product tier. The Company may resell such ACO seats to end customers or maintain them for internal use. However, to the extent we are required to buy more seats than we are able to use or sell, the surplus seats could have an adverse impact on the Company’s financial position, results of operations and operating cash flows. The Company is not able to estimate the ultimate future cash outflow impact, if any, of these volume commitments.
We face formidable competition from providers of unified communications and contact center solutions and services, including cloud-based solutions, and this competition may negatively impact our business and limit our growth.
The markets for our solutions and services are characterized by rapid changes in customer demands, ongoing technological changes, evolving industry standards, new product introductions and evolving methods of building and operating networks.
Both traditional and new competitors are investing heavily in this market and competing for customers. As these markets evolve, we expect competition to intensify and to expand to include companies that do not currently compete against us. In addition, our alliance partners (including RingCentral), distributors and resellers are permitted to work with our competitors and most of them do so.
Because we offer solutions for contact centers and unified communications which are cloud-based, on-premise or hybrid, we face a wide range of competitors. Some of our competitors include:
• UCC premise and cloud: Alcatel-Lucent Enterprise, Atos Unify, Cisco, 8x8, GoTo, Huawei, Microsoft, Mitel, NEC, RingCentral and Zoom.
• CC premise and cloud: Amazon, Cisco, Content Guru, Dialpad, Enghouse Interactive, Five9, Genesys, LiveVox, NICE inContact, Talkdesk and Twilio.
• Video Products and Conferencing Solutions premise and cloud: Cisco, Google, Huawei, Lifesize, GoTo, Microsoft, Poly, RingCentral, Yealink and Zoom.
We also face competition in certain geographies in which we operate with companies that have a particular strength and focus in those regions.
Several of our existing competitors have, and many of our future competitors may have, greater financial, technical and research and development ("R&D") resources, more well-established brands or reputations and broader customer bases than we do and, as a result, these competitors may be able to respond more quickly to potential acquisitions and other market opportunities, new or emerging technologies and changes in customer requirements. Competitors with greater resources may also be able to offer lower prices, additional products or services or other incentives that we cannot match or do not offer. Competitors might also be perceived as having greater financial strength, which is also a significant criterion for customers looking for cloud-based solution providers. On the other hand, smaller competitors may be able to respond to technological evolution and changes in customer demand with more speed and agility than we can. Some of our competitors may have customer bases that are more geographically balanced than ours and, therefore, may be less affected by an economic downturn in a particular region. Some competitors may also have deeper expertise in a particular stand-alone technology that could develop more quickly than we anticipate, that might allow them to meet changes in customer requirements quicker than we can.
Our competitors also have relationships with channel partners, distributors, resellers, consulting and systems integration firms and/or network service providers which pose a competitive threat to us. Very few, if any, of our partners, distributors, resellers or other service providers work exclusively with Avaya.
We may face increased competition from current leaders in IT infrastructure, consumer products, personal and business applications and the software that connects the network infrastructure to those applications. In addition, because the business communications market continues to evolve and technology continues to develop rapidly, we may face competition in the future from companies that do not currently compete against us, but whose current business activities may bring them into competition with us in the future. In particular, this may be the case as business, information technology and communications applications deployed on converged networks become more integrated to support business communications. With respect to services, we may also face competition from companies that seek to sell remotely hosted services or software as a service
directly to end customers. Competition from potential market entrants may take many forms, including offering products and solutions similar to those that we offer. In addition, certain of these technologies continue to move from a proprietary environment to an open standards-based environment, which may make such technologies more attractive to users.
We cannot predict which competitors may enter our markets, what forms such competition may take or whether we will be able to respond effectively to new competitors or to the rapid evolution in technology and product development that has characterized our business. In addition, in order to effectively compete with any new technology or a new market entrant, we may need to make additional investments in our business, use more capital resources than our business currently requires or reduce prices. Any of these competitive factors could materially and adversely affect our business.
Industry consolidation and new adjacent player business models may lead to stronger competition and may harm our business, operating results and financial condition.
There has been a trend toward industry consolidation in the markets in which we compete as companies that provide unified communications purchase contact center providers. We expect this trend to continue as companies attempt to strengthen or hold their positions in an evolving market and as companies acquire or sell businesses because they are unable to continue all or a portion of their operations. We also believe that customers are increasingly seeking a single provider for their unified communications and contact center products and service needs. Industry consolidation may result in stronger competitors that are better able to compete as single-source vendors for such customers.
We also face risks related to consolidation of our channel partners. For instance, companies that are currently our strategic alliance partners may acquire or form alliances with our competitors, and reduce their business with us. We also face risks related to the rapid consolidation in the value-added reseller ("VAR") and service provider markets, as consolidation in these areas leads to fewer customers for the industry as a whole which both exacerbates competitive dynamics and increases pricing pressure. The loss of one or more major customers as a result of consolidation, whether an enterprise customer, VAR partner or service provider, could have a material adverse effect on our business, operating results and financial condition.
In addition, new adjacent player business models may also create additional competition which could negatively impact our business. For instance, we host offers in Microsoft Azure however Microsoft has also announced a competitive cloud contact center offer which may create additional competition which could negatively impact our business.
We depend on our indirect sales channel.
An important element of our go-to-market strategy is the use of our global network of alliance partners, distributors, dealers, value-added resellers, agents, telecommunications service providers and system integrators, who we collectively refer to as our "channel partners," to sell and implement our products and services. Use of channel partners provides us with opportunities to expand sales coverage, penetrate new markets and increase market absorption of new solutions that we would not have on our own without making significant changes in the way we operate our business, including investments in local sales and support coverage models, rewards and incentives, training and certification, self-service and automation systems and tools, and expanded post-sales customer success coverage. Some of our channel partners are our biggest customers, with our top partners in North America and in our international markets representing approximately 70% of our North American channel revenues and approximately 30% of our international channel revenues, respectively. In the event a large channel partner ceases to do business with us it is unlikely that we would be able to replicate the channel partner's sales to the relevant end users, whether directly or with other channel partners. As a result, our financial results could be adversely affected if our relationships with these channel partners were to deteriorate, if our support models, or other product/platform or other services strategies conflict with those of our channel partners, if any of our competitors were to enter into strategic relationships with or acquire any of our channel partners, if some or all of our channel partners are not enabled to sell new solutions and services or if the financial condition of some or all of our channel partners were to weaken.
In addition, at times our partners sell offerings that are competitive to our products and services and they also resell our solutions to their customer base. If channel partners that have previously favored Avaya products and services over those of our competitors do not do so in the future, whether as a result of internal decision making, perception about our products in the market or perception about our financial strength, it could significantly impact our results. These risks are exacerbated by the fact that our channel partners have direct contact with our customers, which may foster independent relationships amongst themselves, thereby allowing our channel partners to sell non-Avaya solutions to our customers.
We expend significant amounts of time, money and other resources on developing and maintaining channel relationships. However, there can be no assurance that we will be successful in maintaining, expanding or further developing relationships with channel partners. If we are not successful, we may lose sales opportunities, customers or market share, in addition to the time, effort and resources expended to form the relationship. Although the terms of individual channel partner agreements may deviate from our standard program terms, our standard program agreements for resellers generally provide for a term of one year with automatic renewals for successive one-year terms and generally may be terminated by either party for convenience upon 30 days' notice. Our standard program agreements for distributors generally may be terminated by either party for
convenience upon 90 days' prior written notice. There are certain of our contractual agreements with our largest distributors and resellers that permit termination of the relationship by either party for convenience upon prior notice of 180 days. See Part I, Item 1, "Business-Sales and Distribution," to this Annual Report on Form 10-K for more information on our global channel partner program.
We rely on third-party contract manufacturers, component suppliers and partners (some of which are sole source and limited source suppliers) and warehousing and distribution logistics providers. If these relationships are disrupted and we are unable to obtain substitute manufacturers, suppliers or partners, on favorable terms or at all, our business, operating results and financial condition may be harmed.
We have outsourced substantially all of our manufacturing operations to several contract manufacturers. Our contract manufacturers produce the vast majority of our products in facilities located in southern China, with other products manufactured in facilities located in Mexico, Taiwan, Germany, Ireland and the U.S. All manufacturing of our products is performed in accordance with detailed specifications and product designs furnished or approved by us and is subject to rigorous quality control standards. We periodically review our product manufacturing operations and consider changes we believe may be necessary or appropriate. Although we closely manage the transition process when manufacturing changes are required, we could experience disruption to our operations during any such transition. Any such disruption could negatively affect our reputation and our operating results. We also purchase certain hardware components and license certain software components and resell them separately or as part of our products under the Avaya brand. In some cases, certain components are available only from a single source or from a limited source of suppliers. These sole source and limited source suppliers may stop selling their components at commercially reasonable prices, or at all, or it may be difficult to receive their components in a timely manner due to supply chain disruptions. Interruptions, delays or shortages associated with these components could cause significant disruption to our operations and we may not be able to make scheduled product deliveries to our customers in a timely fashion. In the event that we need to use alternative suppliers, we could incur significant costs to redesign our products or to qualify alternative suppliers, which would reduce our realized margins. We have also outsourced substantially all of our warehousing and distribution logistics operations to several providers of such services on a global basis, and any delays or material changes in such services could cause significant disruption to our operations. If any of our providers of outsourced services were to experience financial difficulty or seek protection under bankruptcy laws it could also affect their ability to perform services for us.
In addition, we rely on third parties to provide certain services to us or to our customers, including hosting partners and providers of other cloud-based services. If these third-party providers do not perform as expected, our customers may be adversely affected, resulting in potential liability and negative exposure for us. If it is necessary to migrate these services to other providers due to poor performance, cyber breaches or other security considerations, or other financial or operational factors, it could result in service disruptions to our customers and significant time and expense to us, any of which could adversely affect our business, operating results and financial condition. Please refer to the risk factor below "Business and/or supply chain interruptions, whether due to catastrophic disasters or other events, could adversely affect our operations" for additional information on risks related to supply chain disruptions.
Contracting with government entities can be complex, expensive and time-consuming.
The Company earns revenue from contracts with U.S. federal government entities. The procurement process for government entities is in many ways more challenging than contracting in the private sector. We must comply with laws and regulations relating to the formation, administration, performance and pricing of contracts with government entities, including U.S. federal, state and local governmental bodies. These laws and regulations may impose added costs on our business or prolong or complicate our sales efforts, and failure to comply with these laws and regulations or other applicable requirements could lead to claims for damages from our customers, penalties, termination of contracts and other adverse consequences. Any such damages, penalties, disruptions or limitations in our ability to do business with government entities could have a material adverse effect on our business, operating results and financial condition.
Government entities often require highly specialized contract terms that may differ from our standard arrangements. Government entities often impose compliance requirements that are complicated, require preferential pricing or "most favored nation" terms and conditions, or are otherwise time-consuming and expensive to satisfy. Compliance with these special standards or satisfaction of such requirements could complicate our efforts to obtain business or increase the cost of doing so. Even if we do meet these special standards or requirements, the increased costs associated with providing our solutions to government customers could harm our margins.
If we are unable to successfully complete acquisitions and/or strategic alliances and effectively integrate acquired businesses, our business, operating results and financial condition may be adversely affected.
Our strategic operating plan, specifically our plan for accelerating the development, sales and delivery of our cloud-based solutions and services, requires continued investments in acquisitions and strategic alliances with other companies in various areas, such as our acquisition of CTIntegrations, LLC, a digital channel platform, in August 2021. Identifying and evaluating
potential strategic alternatives and/or partners may be time consuming and divert the attention and focus of management and other key personnel. Any potential transaction would be dependent upon a number of factors that may be beyond our control, including among other things, economic conditions, market consolidation, industry trends and competing bidders. There is no assurance that we will be able to complete any acquisition or strategic alliance even if we expend significant sums and efforts in connection with a potential transaction. Without such transactions it may be challenging for us to execute on our strategic operating plan in our desired time frame and our business, operating results and financial condition could be harmed.
Once we complete an acquisition or other material investment, we may not be able to successfully integrate acquired businesses, resulting in the failure to realize the intended benefits. Acquisitions could result in difficulties integrating acquired operations and, if deemed desirable, transitioning overlapping products into a single product line, thereby resulting in the diversion of capital and the attention of management and other key personnel away from other business issues and opportunities. We may also fail to retain employees acquired through acquisitions, which may negatively impact our integration efforts. Our due diligence efforts may not reveal all potential liabilities associated with the acquired entity. We may incur substantial expenses as part of these corporate development and integration processes and if we fail to successfully identify, execute and integrate acquisitions or product portfolios, or if they fail to perform as we anticipate, our existing businesses and our revenue and operating results could be adversely affected.
Social and ethical issues relating to the use of AI in our offerings may result in reputational harm or liability.
Social and ethical issues relating to the use of new and evolving technologies, such as artificial intelligence ("AI") in our offerings, may result in reputational harm and liability and may cause us to incur additional R&D costs to resolve such issues. We are increasingly building AI into many of our offerings and we anticipate it will be a growing aspect of our solutions as our offerings evolve. AI presents emerging ethical issues regarding, among other things, privacy, bias and discrimination and the elimination of human jobs. If we enable or offer solutions that draw controversy due to their perceived or actual impact on society, we may experience brand or reputational harm, competitive harm or legal liability. Potential government regulation in the space of AI ethics may also increase the burden and cost of R&D in this area, subjecting us to the need to implement additional compliance programs and potential legal liability. Failure to address AI ethics issues by us or others in our industry could undermine public confidence in AI and slow adoption of AI in our products and services.
Business communications solutions are complex, and design defects, errors, failures or “bugs” may be difficult to detect and correct and could harm our reputation, result in significant costs to us and cause us to lose customers.
Business communications products, integrating hardware, software and many elements of a customer's existing network and communications infrastructure are complex. Despite testing conducted prior to the release of solutions to the market and quality assurance programs, hardware may malfunction and software may contain "bugs" that are difficult to detect and fix. Any such issues could interfere with the expected operation of a solution, which might negatively impact customer satisfaction, reduce sales opportunities or affect gross margins.
Depending upon the size and scope of any such issue, remediation may have a material impact on our business. Our inability to cure an application or product defect, should one occur, could result in the failure of an application or product line, the temporary or permanent withdrawal of an application, product or market, damage to our reputation, an increase in inventory costs, an increase in warranty claims, lawsuits by customers or customers' or channel partners' end users, or application or product reengineering expenses. Our insurance may not cover or may be insufficient to cover claims that are successfully asserted against us.
Intellectual Property and Information Security
We are dependent on our intellectual property. If we are not able to protect our proprietary rights or if those rights are invalidated or circumvented, our business may be adversely affected.
Our business is primarily dependent on our technology and our ability to innovate in business communications and, as a result, we are reliant on our intellectual property. We generally protect our intellectual property through patents, trademarks, trade secrets, copyrights, confidentiality and nondisclosure agreements and other measures to the extent our budget permits. There can be no assurance that patents will be issued from pending applications that we have filed or that our patents will be sufficient to protect our key technology from misappropriation or falling into the public domain, nor can assurances be made that any of our patents, patent applications, trademarks or our other intellectual property or proprietary rights will not be challenged, invalidated or circumvented.
Preventing unauthorized use or infringement of our intellectual property rights is inherently difficult. Moreover, it may be difficult or practically impossible to detect theft, unauthorized use of our intellectual property or the production and sale of counterfeit versions of our products and solutions. For example, we actively combat software piracy as we enforce our intellectual property rights and we actively pursue counterfeiters and their distributors, but we nonetheless may lose revenue due to illegal or unauthorized use of our software. Such counterfeit sales, to the extent they replace otherwise legitimate sales, could adversely affect our operating results. If piracy activities continue at historical levels or increase, they may further harm
our business. Enforcement of our intellectual property rights also depends on our legal actions being successful against these infringes, but these actions may not be successful, even when our rights have been infringed.
In addition, our business is global and the level of protection of our proprietary technology varies by country and may be particularly uncertain in countries that do not have well developed judicial systems or laws that adequately protect intellectual property rights. The level of protection afforded to our intellectual property may also be particularly uncertain in countries that require the transfer of technology as a condition to market access. Our partnerships with foreign entities sometimes require us to transfer technology and/or certain intellectual property rights in countries that afford less protection of intellectual property rights than other countries. While we believe such technology and intellectual property transfer requirements have not adversely affected our business, such requirements may change over time and become detrimental to our ability to protect our technology or intellectual property in certain foreign countries. Patent litigation and other challenges to our patents and other proprietary rights are costly and unpredictable and may prevent us from marketing and selling a product in a particular geographic area. Financial considerations also preclude us from seeking patent protection in every country where infringement litigation could arise. Our inability to predict our intellectual property requirements in all geographies and affordability constraints also impact our intellectual property protection investment decisions. If we are unable to protect our proprietary rights, we may be at a disadvantage to others who do not incur the substantial time and expense we incur to create our products.
We may be subject to litigation and infringement claims, which could cause us to incur significant expenses or prevent us from selling our products or services.
From time to time, we receive notices and claims from third parties asserting that our proprietary or licensed products, systems and software infringe their intellectual property rights. For instance, in January 2020, Solaborate Inc. and Solaborate LLC filed a suit against us in California Superior Court in San Bernardino County which alleged breach of contract, trade secret misappropriation and unfair business practices among other causes of action. On February 3, 2023, the Company reached an agreement to settle the lawsuit with Solaborate. See Note 22, "Commitments and Contingencies," to our Consolidated Financial Statements for additional information on the Solaborate settlement. There can be no assurance that the number of these notices and claims will not increase in the future or that we do not in fact infringe those intellectual property rights. Irrespective of the merits of these claims, any resulting litigation could be costly and time consuming and could divert the attention of management and key personnel from other business issues. The complexity of the technology involved and the uncertainty of intellectual property litigation increase these risks. These matters may result in any number of outcomes for us, including entering into licensing agreements, redesigning our products to avoid infringement, being enjoined from selling products or solutions that are found to infringe intellectual property rights of others, paying damages if products are found to infringe and indemnifying customers from infringement claims as part of our contractual obligations. Royalty or license agreements may be very costly and we may be unable to obtain royalty or license agreements on terms acceptable to us, or at all, which may cause operating margins to decline.
In addition, some of our employees previously have been employed at other companies that provide similar products and services. We may be subject to claims that these employees or we have, inadvertently or otherwise, used or disclosed trade secrets or other proprietary information of their former employers. These claims and other claims of patent or other intellectual property infringement against us could materially adversely affect our business, operating results and financial condition.
We have made and will likely continue to make investments to license and/or acquire the use of third-party intellectual property rights and technology as part of our strategy to manage this risk, but there can be no assurance that we will be successful or that any costs relating to such activity will not be material. We may also be subject to additional notice, attribution and other compliance requirements to the extent we incorporate open source software into our applications. In addition, third parties have claimed, and may in the future claim, that a customer's use of our products, systems or software infringes on the third-party's intellectual property rights. Under certain circumstances, we may be required to indemnify our customers for some of the costs and damages related to such an infringement claim. Any indemnification requirement could have a material adverse effect on our business, operating results and financial condition. Additionally, any insurance that we have may not be sufficient to cover all amounts related to such indemnification.
From time to time, we may be subject to litigation, including potential class action and stockholder derivative actions for any of a variety of claims, which could adversely affect our business, results of operations and financial condition. These include labor and employment, commercial, data privacy, antitrust, alleged securities law violations or other investors claims and other matters. For instance, recently three class action lawsuits relating to alleged securities law violations were brought against us and our current and former officers and directors, all of which have since been dismissed against the Company. See Note 22, “Commitment and Contingencies” to our Consolidated Financial Statements for additional information.
Certain software we use is from open source code sources, which, under certain circumstances, may lead to unintended consequences and, therefore, could materially adversely affect our business, operating results and financial condition.
Some of our products contain software from open source code sources. The use of such open source code may subject us to certain conditions, including the obligation to offer our products that use open source code to third parties for no cost. We
monitor our use of such open source code to avoid subjecting our products to conditions we do not intend. However, the use of such open source code may ultimately subject some of our products to unintended conditions. For example, if a developer were to embed open source components into one of our products without our knowledge or authorization, our ownership and licensing of that product could be in jeopardy. Depending on terms of the applicable open source license, the use of an open source component could mean that all products delivered with that open source component become part of the open source community. In that case, our ownership rights and ability to charge license fees for those delivered products could be diminished or rendered worthless. Such unauthorized use of open source components could require us to take remedial action that may divert resources away from our development efforts and, therefore, could materially adversely affect our business, operating results and financial condition.
Failure to comply with laws and contractual obligations related to data privacy and protection could have a material adverse effect on our business, operating results and financial condition.
We are subject to the data privacy and protection laws and regulations adopted by federal, state and foreign governmental agencies, including but not limited to, the European Union's ("EU") General Data Protection Regulation ("EU GDPR") and the United Kingdom's ("UK") General Data Protection Regulation ("UK GDPR," and together with the EU GDPR, "GDPR") and California's Privacy Rights Act ("CPRA"). Data privacy and protection is highly regulated and the GDPR imposes obligations on companies, including us, who process personal data of data subjects who are in the EU or UK, regardless of whether or not that processing takes place in the EU or UK. These requirements substantially increase potential liability for all such companies for failure to comply with data protection rules. Contracts with our customers, channel partners and other third parties also subject us to privacy and data protection-related obligations.
Privacy laws and contractual requirements restrict our storage, use, processing, disclosure, transfer and protection of personal information, including credit card data, as well as data we collect from our customers and employees. We strive to comply with all applicable laws, regulations, policies, legal and contractual obligations relating to privacy and data protection. Our privacy compliance program is based on our binding corporate rules which have been approved by EU regulatory authorities. As the UK is no longer part of the EU, we have applied for UK binding corporate rules. We endeavor to apply uniform data handling practices, based on GDPR standards, on a global basis throughout all Avaya entities which process personal data, and have signed on to our binding corporate rules. We have dedicated significant time, capital and other resources to craft binding corporate rules that meet the requirements of the GDPR and other laws such as CPRA. Privacy laws and legal requirements relating to the transfer of personal data continue to evolve. We rely on our EU approved binding corporate rules for certain data transfers. For other data transfers, we rely on Standard Contractual Clauses ("SCCs"), however the SCCs and the international data transfers which they govern have been and are subject to regulatory and judicial scrutiny following the decision of the Court of Justice of the European Union in July 2020 regarding data transfers. We expect that as privacy laws continue to change and become more prevalent throughout the world, we will be required to dedicate additional resources to ensure continued compliance.
From time to time we have notified authorities in the EU and UK of potential personal data breaches and privacy issues, and we keep them appropriately updated. No such disclosure has led to fines in the past and we do not anticipate any disclosure that we previously made, and remains under consideration, will lead to fines or other adverse outcomes, although no assurance can be given that this will be the case. If the authorities determine that any of our previous or future actions have not complied with applicable laws and regulations, we may be subject to fines, penalties and lawsuits, and our reputation may suffer. Fines imposed on other companies by various data privacy regulatory authorities from the EU or UK for violations of the GDPR have been significant in amount. Furthermore, if we were found to have violated these laws or regulations, we may be subject to increased scrutiny going forward and we may also be required to make modifications to our data practices that could have an adverse impact on our business, financial results and financial position.
These data privacy risks are particularly relevant and applicable to us as a technology company because we process vast amounts of personal and non-personal data on behalf of our customers, and we also host significant and increasing amounts of data in our cloud solutions and in the cloud solutions of other companies that we offer as part of our products. We believe that regulations pertaining to the solicitation, collection, exporting, processing and/or use of personal, financial and consumer information will continue to expand globally and become increasingly broad and complex, requiring more and more attention and resources to comply.
In addition, the interpretation and application of existing consumer and data protection laws and industry standards in the U.S., Europe and elsewhere is often uncertain and in flux. The application of existing laws to cloud-based solutions is particularly uncertain. Cloud-based solutions may be subject to further regulation in the future, the impact of which cannot be fully understood at this time. Moreover, it is possible that these laws may be interpreted and applied in a manner that is inconsistent with our understanding of the rules and therefore likely inconsistent with our data and privacy practices. Complying with such laws and regulations may cause us to incur substantial costs or require us to change our business practices in a manner adverse to our business.
Any failure, or perceived failure, by us to comply with federal, state, or international laws, including laws and regulations regulating privacy, data or consumer protection, or to comply with our contractual obligations related to privacy, could result in proceedings or actions against us by governmental entities, contractual parties or others, which could result in significant liability to us as well as harm to our reputation. Additionally, we rely on contracts we enter into with third parties to protect and safeguard our customers' data. Should such parties violate these agreements or suffer a security breach, we could be subject to proceedings or actions against us by governmental entities, contractual parties or others, which could result in significant liability to us as well as harm to our reputation.
A breach of the security of our information systems, products or services or of the information systems of our third-party providers could adversely affect our business, operating results and financial condition.
We rely on the security of our information systems and, in certain circumstances, those of our third-party providers, such as channel partners, vendors, consultants and contract manufacturers, to protect our proprietary information and the information of our customers. In addition, as a UC solutions provider, the growth of bring your own device programs has increased the need for enhanced security measures at our company and with respect to the products and solutions we offer our customers. IT security system failures, including a breach of our or our third-party providers' data security systems, could disrupt our ability to function in the normal course of business by potentially causing, among other things, delays in the fulfillment or cancellation of customer orders, disruptions in the manufacture or shipment of products or delivery of services or an unintentional disclosure of customer, employee or our information. Additionally, despite our security procedures or those of our third-party providers, information systems and our products and services may be vulnerable to threats such as computer hacking, cyber-terrorism or other unauthorized attempts by third parties to access, modify or delete our or our customers' proprietary information. If any of our customers experiences a security breach which stems from our products and solutions, we could be exposed to liability.
We devote significant resources and tools to cybersecurity and the protection of our information technology and other systems, products and data and the data of our customers from intrusions and to ensure compliance with our contractual and regulatory obligations. However, these security efforts are costly to implement and may not be successful. Cyberattacks and similar threats are constantly evolving, increasing the difficulty of detecting and successfully defending against them. In some cases the attacks have been sponsored by state actors with significant financial and technological means and the risk of state-sponsored cyberattacks have increased due to political events and tensions around the world. Computer malware, viruses, scraping and general hacking have become more prevalent in our industry, have occurred on our systems in the past, and may occur on our systems in the future. There can be no assurance that we will be able to prevent, detect and adequately insure against and address or mitigate cyberattacks or security breaches or incidents. We investigate potential data breach issues identified through our security procedures and terminate, mitigate and remediate such issues as appropriate. Past incidents have involved outside actors and issues stemming from certain internal configuration, vulnerabilities in third-party software which may impact our systems, applications, products and offerings and migration issues of our applications to other platforms. A breach of our systems, as well as breaches experienced by our customers which stem from our products and solutions, could have a material adverse effect on our reputation as a provider of business communications products and services and could cause irreparable damage to us or our systems regardless of whether we, our customers or our third-party providers are able to adequately recover critical systems following a systems failure, any of which could, in turn, expose us to liability and have a material adverse effect on our operating results and financial conditions. While we do maintain insurance coverage which is intended to address certain expenses associated with cyberattacks, depending on the facts and circumstances, these policies may not cover all costs, losses or types of claims that may arise from an incident or breach.
In addition, regulatory or legislative action related to cybersecurity, privacy and data protection worldwide, such as the EU GDPR, which went into effect in May 2018, and the UK GDPR, which went into effect in January 2021, may increase the costs to develop, implement or secure our products and services. We expect cybersecurity regulations to continue to evolve and be costly to implement. Furthermore, we may need to increase or change our cybersecurity systems and expenditures to support expansion of sales into new industry segments or new geographic markets. If we violate or fail to comply with such regulatory or legislative requirements, we could be fined or otherwise sanctioned. Any such fines or penalties could be substantial and could have a material adverse effect on our business and operations.
Global Operations and Regulations
Since we operate internationally, operational, logistical, economic and/or political challenges in a specific country or region could negatively affect our revenue, costs, expenses and financial condition or those of our channel partners and distributors.
International growth is a significant aspect of our business strategy. We currently do business in approximately 180 countries with a significant amount of our sales and customer support operations and significant amounts of our R&D activities conducted in countries outside of the U.S. We also depend on non-U.S. operations of our contract manufacturers and our channel partners. For fiscal 2022, we derived 45% of our revenue from sales outside of the U.S., with the most significant
portions generated from Germany, the United Kingdom and Canada. In addition, the vast majority of our contract manufacturing takes place outside the U.S., primarily in southern China.
Accordingly, our results could be materially and adversely affected by a variety of uncontrollable factors relating to international business operations, including:
• economic conditions and geopolitical developments, such as the Russia/Ukraine conflict and the related sanctions and export controls imposed by the U.S., UK and the EU on certain industries and Russian parties, as well as any responses by the Russian government;
• tariffs, changes to significant trading relationships, the negotiation of new or revised international trade agreements and retaliatory efforts as a result of trade restrictions, constraints and prohibitions, such as the U.S. China trade dispute and the EU's position on humanitarian rights towards countries or territories in the Middle East, Africa and Asia;
• political or social unrest, economic instability or corruption or sovereign debt risks in a specific country or region;
• laws and regulations, both international and local, related to trade compliance, anti-corruption and anti-bribery (such as the Foreign Corrupt Practices Act of 1977), information security, data privacy and protection, labor, environmental protection (including new laws and regulations related to climate change) and other legal and regulatory requirements, some of which may affect our ability to import products to, export products from, or sell our products in various countries or affect our ability to procure components;
• protectionist and local security legislation;
• difficulty in enforcing intellectual property rights, such as protecting against the counterfeiting of our products;
• less established legal and judicial systems necessary to enforce our rights, especially related to our intellectual property;
• relationships with employees and works councils, as well as difficulties in finding qualified employees, including skilled design and technical employees, as companies expand their operations offshore;
• high levels of inflation and currency fluctuations;
• unfavorable tax and currency regulations;
• military conflict, terrorist activities and health pandemics or similar issues;
• deterioration of relations between China and Taiwan could disrupt our manufacturing operations;
• future government shutdowns or uncertainties which could affect the portion of our revenues which comes from the U.S. federal government sector;
• natural disasters, such as earthquakes, hurricanes, floods or other events or effects of global climate change, anywhere we and/or our channel partners and distributors have business operations; and
• other matters in any of the countries or regions in which we and our contract manufacturers and business partners currently operate or intend to operate, including in the U.S.
In addition, we have agreed to provide financial support to certain of our foreign subsidiaries and if those agreements expire and/or are not renewed, those subsidiaries' ability to operate could be negatively impacted, which in turn could adversely affect our ability to execute our business plans in those jurisdictions.
Any or all of these factors could materially adversely affect our business, operating results or financial condition.
Our business has been affected by the military operation launched by Russia against Ukraine.
The military operation launched by Russia against Ukraine created economic and security concerns that have had and will likely continue to have an impact on regional and global economies and, in turn, our business. Sanctions and other retaliatory measures have been taken, and could be taken in the future, by the U.S., EU and other jurisdictions which severely limit our ability to conduct commercial activities with Russian companies, organizations and individuals on the U.S.'s List of Specially Designated Nationals, some of which are Avaya customers. Under current restrictions we cannot provide certain services to customers in Russia, and as a result, as we comply with all applicable sanctions, we are unable to fulfill certain of our existing contractual obligations to customers in Russia, nor can we pursue or commence new maintenance and support arrangements in Russia.
Although the Company's financial results were not materially impacted by the conflict and related retaliatory measures during fiscal 2022, revenue from Russia was $38 million in fiscal 2022, compared to $63 million in fiscal 2021. Prolonged hostilities could exacerbate the overall effects of the conflict on our Company, both in the region and in other markets where we do
business. The conflict has led to increased global economic uncertainty as a result of its effects on oil and gas prices, supply chain delays and freight costs and the impact sanctions have had on the region and eastern Europe. While it is impossible to predict how long the ongoing conflict will impact regional and global economies, these conditions and restrictions could materially and adversely affect our operations, supply chain and financial results.
We rely on third parties to provide certain data hosting services to us or to our customers, and interruptions or delays in those services could harm our business.
Our cloud-based solutions rely on uninterrupted connection to the Internet through data centers and networks. To provide such service for our customers, we utilize data center hosting facilities located in the U.S. and the EU, as well as in our Asia Pacific region and our Central America and Latin America regions. We are also increasingly using facilities provided by Google, Amazon, Microsoft and Equinix as we continue to migrate our portfolio of products and services to cloud solutions. We do not control the operation of these facilities, and they are vulnerable to service interruptions or damage from floods, earthquakes, fires, power loss, telecommunications failures and similar events.
These facilities, whether owned and operated by us or a third-party, are subject to acts of vandalism or terrorism, sabotage, similar misconduct and/or human error. If any of these data centers and networks cease operations, we would need to migrate our solutions and our customers to other providers. However, we cannot be sure we will be able to find a new provider in a timely manner and even if we do find a new provider we cannot be sure the terms offered will be acceptable to us. The occurrence of these or other unanticipated problems at these facilities could result in lengthy interruptions in the ability to use our solutions efficiently or at all, which could harm our business, operating results and financial condition.
If we do not comply with certain telecommunications or other rules and regulations, we could be subject to enforcement actions, fines, loss of licenses and possibly restrictions on our ability to operate or offer certain of our services.
Certain of our cloud-based communications and collaboration solutions are regulated in the U.S. by the Federal Communications Commission and various state and local agencies, and across the globe by governments of various foreign countries. For instance, we are subject to existing or potential regulations relating to security, privacy, consumer protection, protection of customer information, disability access, porting of numbers, Universal Service and Telecommunications Relay Service Fund contributions, emergency access, robocalling mitigation, law enforcement intercept and other requirements. We are required to pay state and local 911 fees and contribute to state universal funds in states that assess interconnected Voice over Internet Protocol ("VoIP") services. The expansion of telecommunications regulations in the U.S. to our non-interconnected VoIP services could result in additional federal and state regulatory obligations and taxes.
In addition, we are subject to similar laws and regulations in the countries where we offer services and expect that as our business continues to grow internationally we will become subject to additional requirements. As many of these laws and regulations are new, such as the European Electronics Communications Code which regulates electronic communications networks and services in the EU, their applicability to Avaya's solutions, their interpretation and related enforcement practices are not certain. Such new laws and regulations may conflict with other rules and/or be subject to differing interpretations; therefore, these laws and regulations may negatively impact our ability to offer services and our cost to deliver services in these countries, and it is possible that we or our products or solutions may not be compliant with each applicable law or regulation.
We may also be impacted by new laws and regulations related to environmental sustainability (including climate change), human rights and product certification, which may require increased disclosures and/or actions by us or our customers, partners, vendors and/or suppliers. If we do not comply with applicable federal, state, local and foreign rules and regulations, we could be subject to enforcement actions, fines, loss of licenses and possible restrictions on our ability to operate or offer certain of our solutions or we could be subject to requirements to modify certain solutions, which could have a material adverse effect on our operating results and financial condition. Moreover, changes in telecommunications requirements, regulatory requirements in other industries in which we operate now or in the future, and/or new legal and regulatory requirements, could have a material adverse effect on our business, operating results and financial condition even though such regulations may not directly apply to our business.
Changes in U.S. trade policy, including the imposition of tariffs and the resulting consequences, may have a material adverse impact on our business, operating results and financial condition.
There have been significant changes in U.S. trade policies, tariffs, sanctions and treaties affecting imports and exports and additional policy changes are possible in the future. For example, in 2022, the U.S. mandated restrictions that limit our ability to support individuals and companies in Russia, thereby significantly reducing our operations within the territory. Changes in U.S. trade policy may continue to result in one or more foreign governments adopting responsive trade policies that make it more difficult, costly and/or significantly constrain our ability to transact within those countries.
We cannot predict the extent to which the U.S. or other countries will impose new or additional quotas, sanctions, duties, tariffs, taxes or other similar restrictions upon the import or export of our products in the future. Such actions or other governmental action related to trade agreements or policies has the potential to adversely impact demand for our products, our costs, our
customers, our suppliers and the U.S. economy, which in turn could have a material adverse effect on our business, operating results and financial condition.
Risks Related to Our Financial Results
We recorded a significant charge to earnings as a result of our goodwill and intangible assets becoming impaired. If our intangible assets become further impaired, we may be required to record a significant charge to earnings.
The Company's intangible assets are principally composed of technology and patents, customer relationships and trademarks and trade names. Goodwill and intangible assets with indefinite lives are tested for impairment on an annual basis and also when events or changes in circumstances indicate that impairment may have occurred. Intangible assets with determinable lives are tested for impairment only when events or changes in circumstances indicate that an impairment may have occurred. Determining whether an impairment exists can be difficult and requires management to make significant estimates and judgments. During fiscal 2022, the Company recorded a goodwill impairment charge of $1,471 million, which represented the full carrying amount of the Company's goodwill, and an indefinite-lived intangible asset impairment charge of $146 million, primarily due to (i) a reduction in the Company's outlook to reflect the observed earnings shortfall in the third quarter of fiscal 2022 which was caused primarily by a slowdown in the pace and trajectory of customer migration to the Company's subscription hybrid offering, (ii) a reduction in the Company's revenue outlook which reflects streamlining of the Company's portfolio offerings as the Company continues to right-size its internal and external cost structure in the fourth quarter of fiscal 2022 and (iii) an increase in the discount rate to reflect increased risk from higher market uncertainty. As of September 30, 2022, the Company has $1,776 million of intangible assets on its Consolidated Balance Sheet. The Company incurred an incremental indefinite-lived intangible asset impairment charge of $9 million during the three months ended December 31, 2022.
To the extent that business and/or economic conditions deteriorate further, or if changes in key assumptions and estimates differ significantly from management's expectations, it may be necessary to record impairment charges in the future. A future impairment charge could have a material adverse effect on our business, financial condition and results of operations. See Note 7, "Goodwill," and Note 8, "Intangible Assets, net," to our Consolidated Financial Statements included in Part II, Item 8 of our Annual Report on Form 10-K for additional information.
Shifts in the mix of sizes or types of organizations that purchase our solutions or changes in the components of our solutions purchased by our customers could affect our gross margins and operating results.
Our gross margins and our operating results can vary depending on numerous factors related to the implementation and use of our solutions, including the sizes and types of organizations that purchase our solutions, the mix of software and hardware they purchase and the level of professional services and support they require. We provide our solutions to a broad range of companies, from small businesses to large multinational enterprises and government organizations. Sales to larger enterprises generally result in greater revenue but may take longer to negotiate and finalize than sales to small businesses. Conversely, sales to small businesses may be faster to execute than sales to larger enterprises, but they may involve greater credit risk and fewer opportunities to sell additional services. Moreover, we have evolved from a traditional telecommunications hardware company into a software and services company, focused on expanding our cloud- and mobile-enabled contact center, unified communications and innovative next-generation workflow automation solutions. While we have seen an improvement in our gross margins and operating results as the proportion of our revenue derived from software solutions increases, that might not always be the case. If we do not build our roster of customers for software solutions and increase the scale of our cloud-enabled software sales, we might not recognize the higher margins anticipated in our business plan. Overall, if the mix of companies that purchase our solutions, the mix of the manner of purchase of our solutions (i.e., subscription v. perpetual license) or the mix of solution components purchased by our customers changes unfavorably, our revenues and gross margins could decrease and our operating results could be harmed.
Levels of returns on pension and post-retirement benefit plan assets, changes in interest rates and other factors affecting the amounts to be contributed to fund future pension and post-retirement benefit plan liabilities could adversely affect our cash flows, operating results and financial condition in future periods.
We sponsor a number of defined benefit plans for employees in the U.S., Canada, and various foreign locations. As of September 30, 2022, we had $552 million of liabilities associated with these plans on our balance sheet, $545 million of which was unfunded. Pension and other post-retirement plan costs and required contributions are based upon a number of actuarial assumptions, including an expected long-term rate of return on pension plan assets, level of employer contributions, the expected life span of pension plan beneficiaries and the discount rate used to determine the present value of future pension obligations. Any of these assumptions could prove to be wrong, resulting in a shortfall of our pension and post-retirement benefit plan assets as compared to our obligations under our pension and post-retirement benefit plans. Future pension funding requirements, and the timing of funding payments, may also be subject to changes in legislation.
In addition, our major defined benefit pension plans in the U.S. are funded with trust assets invested in a globally diversified portfolio of securities and other investments. These assets are subject to market fluctuations, will yield uncertain returns and cause volatility in the net periodic benefit cost and future funding requirements of the plans. A decline in the market value of the pension and post-retirement benefit plan assets below our projected return rates will increase the funding requirements under our pension and post-retirement benefit plans if the actual asset returns do not recover these declines in value in the foreseeable future. We are responsible for funding any shortfall of our pension and post-retirement benefit plans' assets compared to obligations under the pension and post-retirement benefit plans, and a significant increase in our pension liabilities could have a material adverse effect on our cash flows, operating results and financial condition.
We are exposed to risks inherent in our defined benefit pension plans in Germany.
We operate several defined benefit plans in Germany (collectively, the "German Plans") and as of September 30, 2022, the total projected benefit obligation for the German Plans of $294 million exceeded plan assets of $3 million, resulting in an aggregate pension liability for the German Plans of $291 million. Under the German Plans, which were closed to new members in 2006, retirees generally benefit from the receipt of a perpetual annuity at retirement, based on their years of service and ending salary. The total projected benefit obligation is based on actuarial valuations, which themselves are based on assumptions and estimates about the long-term operation of the plans, including mortality rates of members, the performance of financial markets and interest rates. Our funding requirements for future years may increase from current levels depending on the net liability position of these plans. In addition, if the actual experience of the plans differs from our assumptions, the net liability could increase and additional contributions may be required. Changes to pension legislation in Germany may also adversely affect our funding requirements. Increases in the net pension liability or increases in future cash contributions could have a material adverse effect on our cash flows, operating results and financial condition.
We have substantial debt and may be unable to generate sufficient cash flows from operations to meet our debt service and other obligations.
As part of the Plan, we restructured our balance sheet which included the incurrence of substantial debt. On the Emergence Date, the DIP Term Loan converted on a dollar-for-dollar basis into a term loan under a senior secured exit term loan facility and the Company incurred an additional $310 million under the facility (including amounts incurred pursuant to a rights offering) for an aggregate principal amount of $810 million (the "Exit Term Loan", such facility, the "Exit Term Loan Facility") and the DIP ABL Facility converted on a dollar-for-dollar basis into a senior secured exit asset-based revolving loan facility (the "Exit ABL Loan", such facility, the "Exit ABL Loan Facility").
Our ability to generate sufficient cash flows from operations to make payments for scheduled debt service and other obligations depends on a range of economic, competitive and business factors, many of which are outside of our control. Weakness in global economic conditions could exacerbate these risks. Our business may generate insufficient cash flows from operations to meet our debt service and other obligations. To the extent our cash flow from operations is insufficient to fund our debt service and other obligations, we may be forced to reduce or delay investments and capital expenditures or seek additional capital or restructure or refinance our indebtedness. For instance, we were previously forced to take actions to restructure and refinance our indebtedness and other obligations and there can be no assurance that we will be able to meet our scheduled debt service and other obligations in the future.
Our inability to generate sufficient cash flows to satisfy our outstanding debt and other obligations, or to refinance our obligations on commercially reasonable terms, would have a material adverse effect on our results of operations, financial condition and business.
General Risk Factors
Our ability to retain and attract executives and other key personnel is critical to the success of our business and execution of our growth strategy.
The success of our business depends on the skill, experience and dedication of our employee base. If we are unable to recruit sufficiently experienced and capable executives and employees, including those who can help us increase revenues generated from our cloud-based solutions and services, our business and financial results may suffer. Experienced and capable employees in the technology industry remain in high demand, and there is continual competition for their talents. Challenges in the labor market, such as labor shortages particularly in the U.S. and changes to U.S. immigration policies that restrain the flow of professional and technical talent, may harm our ability to attract key personnel, including R&D staff. Our recent financial performance, including our Emergence, and perceptions about our business in the market may also make it more difficult for us to compete for appropriate talent, putting us at a competitive disadvantage as we seek talent.
While we strive to maintain our competitiveness in the marketplace, there can be no assurance that we will be able to successfully retain and attract the employees that we need to achieve our business objectives.
Our future performance and business success also relies on the continued service and contributions of our senior management and other key personnel. If managers or other key personnel resign, retire or are terminated, or their service is otherwise interrupted, our business, financial condition or results of operations could be harmed. We may also have difficulty replacing them in a timely manner and we could experience significant declines in productivity and/or errors due to insufficient staffing or managerial oversight. Moreover, turnover of senior management and other key personnel might adversely impact, among other things, our operating results, our customer relationships and could lead us to incur significant expenses related to executive transition costs that may impact our operating results.
Business and/or supply chain interruptions, whether due to catastrophic disasters or other events, could adversely affect our operations.
Our operations and those of our contract manufacturers and outsourced service providers are vulnerable to interruption by fire, earthquake, hurricane, flood or other natural disasters, power loss, computer viruses, computer systems failure, telecommunications failure, pandemics, quarantines, national catastrophe, terrorist activities, war and other events beyond our control. Some of these interruptions are natural disasters which may occur more frequently or with greater intensity due to global climate change. Our disaster recovery plans may not be sufficient to address these interruptions. If any disaster were to occur, our ability and the ability of our contract manufacturers and outsourced service providers to operate could be seriously impaired and we could experience material harm to our business, operating results and financial condition. Because our ability to attract and retain customers depends on our ability to provide customers with highly reliable service, even minor interruptions in our operations could harm our reputation as a reliable solutions provider. In addition, the coverage or limits of our business interruption insurance may not be sufficient to compensate for any losses or damages that may occur.
In addition, these catastrophic disasters or other events, such as the global shortage of semiconductor chips and the military conflict between Russia and Ukraine, related export controls and possible counter responses to such sanctions, could lead to supply chain disruptions, restrictions on our ability to distribute our products and restrictions on our ability to provide services in the regions affected. Any prolonged and significant supply chain disruption that impacts us or our customers, partners, vendors and/or suppliers, or an inability to provide products or services, would likely impact our sales in the affected region, increase our costs and negatively affect our operating results.
If we are unable to achieve our cost-reduction goals or we experience another earnings shortfall, we may have to perform additional cost-reduction measures such as a further reduction in force.
In September 2022, in connection with our efforts to reduce costs, we authorized a reduction in force. We believe this action was necessary to streamline our organization and align our workforce with our operational strategy and cost structure. However, these expense reduction measures have and may continue to yield unintended consequences and costs, such as the loss of institutional knowledge and expertise, attrition beyond our intended reduction-in-force, a reduction in morale among our remaining employees and the risk that we may not achieve the anticipated benefits, all of which may have an adverse effect on our results of operations or financial condition.
In addition, although positions have been eliminated, the duties performed in these positions remain, particularly with respect to our legal, financial and accounting functions, and we may be unsuccessful in distributing the duties and obligations of departed employees among our remaining employees or to external service providers. We may also discover that the reductions in workforce and cost cutting measures will make it difficult for us to pursue new opportunities and initiatives and require us to hire qualified replacement personnel, which may require us to incur additional and unanticipated costs and expenses. Our failure to successfully accomplish any of the above activities and goals may have a material adverse impact on our business, financial condition and results of operations.
If we are required to perform a further reduction in headcount, this could adversely impact employee retention and morale, including through a loss of continuity, and a loss of accumulated knowledge and/or inefficiency during transitional periods. Laid-off employees could also make claims against us for additional compensation, causing us to incur additional expense. A reduction could also adversely impact our reputation as an employer and could make it difficult for us to hire new employees in the future.
We are exposed to the credit risk of some of our clients and customers, which may harm our operating results and financial condition.
Most of our sales in the U.S. have standard payment terms of 30 days and, because of local customs or conditions, longer in some markets outside the U.S. We believe customer financing is a competitive factor in obtaining business, particularly in serving customers involved in significant infrastructure projects. Our financing arrangements may include not only financing the acquisition of our solutions and services but also providing additional funds for other costs associated with installation and integration of our solutions and services.
We have a thorough credit process for extending credit limits to our customers, which considers the financial profile of our end user customers in addition to that of the direct customer, distributor or channel partner. We evaluate numerous factors in
extending credit, which may include credit ratings, financial performance and discussions with customers. Despite our robust processes, our exposure to the credit risks relating to these activities may increase if our customers are adversely affected by periods of economic uncertainty or a global economic downturn. For instance, inflationary pressures and the interest rate increases by central banks around the world to temper inflation could affect our clients’ businesses and borrowing costs, which in turn would impact their ability to make payments to us. Future losses related to the Russia/Ukraine conflict or current global economic conditions, if incurred, could harm our business and have a material adverse effect on our operating results and financial condition.
The Company could be subject to changes in its tax rates, the adoption of new U.S. or international tax legislation or exposure to additional tax liabilities, which could have a material and adverse impact on the Company's operating results, cash flows and financial condition.
The Company conducts its business in the U.S. and numerous foreign jurisdictions which have complex and varying tax laws. Due to economic and political conditions, tax rates and tax laws in various jurisdictions including the U.S. may be subject to change. The Company's future effective tax rates could be affected by changes in the mix of earnings in countries with differing statutory tax rates, changes in the valuation of deferred tax assets and liabilities and changes in tax laws or their interpretation. In addition, if revenue or taxing authorities disagree with our determination of the Company's taxes owed, we could be required to pay additional taxes, interest and penalties, which may negatively impact our results of operations, cash flow and profitability of the Company.
If the Company's effective tax rates were to increase, or if the ultimate determination of the Company's taxes owed were for an amount in excess of amounts previously accrued, the Company's operating results, cash flows and financial condition could be materially and adversely affected. Any new U.S. or international tax legislation could modify existing rules, limit certain deductions and/or impose new taxes, any of which may have a material and adverse impact on our operating results, cash flows and financial condition.
Tax examinations and audits could have a material and adverse impact on the Company's cash flows and financial condition.
The Company is subject to the examination of its tax returns and other tax matters by the U.S. Internal Revenue Service and other U.S. or foreign tax authorities and governmental bodies. The Company regularly assesses the likelihood of an adverse outcome resulting from such examinations to determine the adequacy of its provision for taxes. There can be no assurance as to the outcome of any such examinations.
Fluctuations in foreign currency exchange rates and interest rates could negatively impact our operating results, financial condition and cash flows .
We are a global company with significant international operations and we transact business in many currencies. The majority of our revenues and expenses are denominated in U.S. dollars. However, we are exposed to foreign currency exchange rate fluctuations related to certain revenues and expenses denominated in foreign currencies. Our primary currency exposures relate to net operating expenses denominated in the Euro, Indian Rupee and Mexican Peso. These exposures may change over time as business practices evolve and the geographic mix of our business changes.
In addition, a portion of our borrowings bear interest at variable rates exposing us to interest rate fluctuation risks. Therefore, we are subject to risk from changes in interest rates on the variable component of those rates. As a result of the significant global inflationary environment, central banks across the globe have continued to increase interest rates in the past year, which can lead to an increase in interest expense under variable rate borrowings. We had $1,893 million of variable rate loans outstanding as of September 30, 2022. From time to time we use derivative instruments to hedge foreign currency risks associated with certain monetary assets and liabilities, primarily accounts receivable, accounts payable and certain intercompany obligations, as well as to hedge risks associated with changes in interest rates. The measures we have taken to help mitigate these risks are discussed in Part II, Item 7A, "Quantitative and Qualitative Disclosures about Market Risk," of our Annual Report on Form 10-K. However, any attempts to hedge against foreign currency exchange rate and/or interest rate fluctuation risk may be unsuccessful and result in an adverse impact to our operating results, financial condition and cash flows.
Our reputation and/or business could be negatively impacted by ESG matters and/or our reporting of such matters.
Regulators, investor advocacy groups, investment funds and other stakeholders are increasingly focused on environmental, social and governance ("ESG") matters and have placed increasing importance on the non-financial impacts of their investments. Standards for tracking and reporting ESG matters continue to evolve, and our business may be impacted by new laws, regulations or investor criteria in the U.S., Europe and around the world related to ESG.
Certain of our institutional investors use third-party benchmarks or scores to measure a company's ESG practices in an increasingly broad set of matters including but not limited to, environmental sustainability (including climate change), human capital, labor, product certification and risk oversight. Such scoring and examination may expand the nature, scope and
complexity of matters that we are required to control, assess and report. In addition to potential impacts on our operations, the cost of complying with such scrutiny by institutional investors as well as any new laws and regulations, including building appropriate compliance and reporting functions within our company, could be significant. If our ESG practices do not meet the standards set by these stakeholders, they may choose not to invest in our common stock, or if our peer companies outperform us in their ESG initiatives, potential or current investors may elect to invest with our competitors instead of with us.
Avaya, like other companies, is subject to potential climate-related risks and costs such as those resulting from severe weather events, prolonged changes in temperature, carbon taxes, emissions caps and increased environmental disclosures requested or required by clients, regulators and others. As our required and voluntary disclosures about ESG matters grow, we may be criticized for the accuracy, adequacy or completeness of such disclosures. Our ESG-related events and regulatory requirements, and uncertainty about them, could materially affect the sales of our products and services.
In addition, we intend to set certain ESG-related initiatives, goals and/or commitments regarding environmental matters, diversity and other matters. Our intention to set certain ESG-related initiatives and goals reflect our current plans and aspirations and are not guarantees that we will be able to achieve them. These initiatives, goals, or commitments could result in unexpected expenses, changes in our relationships with strategic partners, distributors and third-party service providers, loss of revenue or business disruption. We could fail to achieve, or may be perceived to fail to achieve, ESG-related initiatives, goals or commitments and we may be criticized for the timing, scope or nature of these initiatives, goals or commitments, or for any revisions to them. Our actual or perceived failure to achieve our ESG-related initiatives, goals or commitments could negatively impact our reputation or otherwise materially harm our business.
Item 1B.
Unresolved Staff Comments
None.
Item 2.
Properties
As of September 30, 2022, we had 111 leased facilities located in 58 countries. These included 7 primary research and development facilities located in Canada, Czech Republic, India, Ireland, Italy and the U.S. Our real property portfolio consists of aggregate floor space of 1.3 million square feet, substantially all of which is leased. Of the 1.3 million square feet of leased space, 135,000 square feet relates to facilities exited or partially exited as the Company continues to evaluate its real estate footprint. Our remaining lease terms range from monthly leases to 7 years. We believe that all of our leased facilities are in good condition and are well maintained. Our facilities are used for the current operations of both of our operating segments. For additional information regarding obligations under operating leases, see Note 5, "Leases," to our Consolidated Financial Statements included in Part II, Item 8 of this Annual Report on Form 10-K.
Item 3.
Legal Proceedings
The information set forth under Note 22, "Commitments and Contingencies," to our Consolidated Financial Statements included in Part II, Item 8 of this Annual Report on Form 10-K, is incorporated herein by reference.
Item 4.
Mine Safety Disclosures
Not applicable.
PART II
Item 5.
Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
Market Information
The common stock of Avaya Holdings Corp. was delisted from the New York Stock Exchange ("NYSE") on February 15, 2023. Prior to its delisting, Avaya Holdings Corp. had begun trading on the NYSE on January 17, 2018, under the symbol "AVYA."
Number of Holders of Common Stock
The number of record holders of the Company's Common Stock as of April 30, 2023 was 60. That number does not include the beneficial owners of shares held in "street" name or held through participants in depositories, such as The Depository Trust Company. Upon implementation of the Plan, all shares of the Company's Common Stock and Series A Preferred Stock were canceled.
Dividends
No dividends were paid by Avaya Holdings Corp. on its common stock over the past three fiscal years, and the Company does not anticipate paying cash dividends on its common stock in the foreseeable future.
Purchases of Equity Securities by the Issuer
The following table provides information with respect to purchases by the Company of shares of common stock during the three months ended September 30, 2022:
Period
Total Number of Shares (or Units) Purchased (1)
Average Price Paid per Share (or Unit)
Total Number of Shares (or Units) Purchased as Part of Publicly Announced Plans or Programs
Maximum Number (or Approximate Dollar Value) of Shares (or Units) That May Yet Be Purchased Under Plans or Programs (2)(3)
July 1 - 31, 2022
August 1 - 31, 2022
September 1 - 30, 2022
Total
(1) During the fourth quarter of fiscal 2022, the Company suspended distribution of shares of its common stock which vested pursuant to awards issued under the 2019 Equity Incentive Plan.. As such, no shares of common stock were withheld for taxes on restricted stock units that vested during the three months ended September 30, 2022. Refer to Note 16, "Share-based Compensation," for further details.
(2) The Company maintained a warrant repurchase program which authorized it to repurchase the Company's outstanding warrants to purchase shares of the Company's common stock for an aggregate expenditure of up to $ 15 million. The Company's 2017 Emergence Date Warrants expired on December 15, 2022, and none of the 2017 Emergence Date Warrants were repurchased.
(3) The Company maintained a share repurchase program which authorized it to repurchase the Company's common stock for an aggregate expenditure of up to $500 million. The repurchases were to be made from time to time in the open market, through block trades or in privately negotiated transactions. Upon implementation of the Plan, the common stock was canceled.
Recent Sales of Unregistered Securities
None.
Stock Performance Graph
The following graph compares the cumulative total return on our common stock for the period from December 19, 2017, the date the common stock began trading, through September 30, 2022, with the total return over the same period on the Russell 2000 Index and the NASDAQ Computer Index. The graph assumes that $100 was invested on December 19, 2017 in the Company's common stock and in each of the indices and assumes reinvestment of dividends, if any. The graph is based on historical data and is not necessarily indicative of future price performance.
Avaya Holdings Corp.
Russell 2000 Index
NASDAQ Computer Index
Avaya Holdings Corp.
Russell 2000 Index
NASDAQ Computer Index
Avaya Holdings Corp.
Russell 2000 Index
NASDAQ Computer Index
This performance graph shall not be, or deemed to be, incorporated by reference into any filing under the Securities Act of 1933 or the Securities Exchange Act of 1934, except to the extent that the Company specifically incorporates it by reference. In addition, the Performance Graph will not be deemed to be "soliciting material" or to be "filed" with the SEC or subject to Regulation 14A or 14C, other than as provided in Regulation S-K, or to the liabilities of section 18 of the Securities Exchange Act of 1934, except to the extent that the Company specifically requests that such information be treated as soliciting material or specifically incorporates it by reference into a filing under the Securities Act or the Exchange Act.
The common stock of Avaya Holdings Corp. was delisted from the NYSE on February 15, 2023.
Item 6.
[Reserved]
Item 7.
Management’s Discussion and Analysis of Financial Condition and Results of Operations
This "Management’s Discussion and Analysis of Financial Condition and Results of Operations" should be read in conjunction with the Consolidated Financial Statements and related notes thereto included in Item 8 of this Annual Report on Form 10-K. The matters discussed in this "Management’s Discussion and Analysis of Financial Condition and Results of Operations" contain certain forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Forward-looking statements involve significant risks and uncertainties. See the "Cautionary Note Regarding Forward-looking Statements" above and Part 1, Item 1A, "Risk Factors" in this Annual Report on Form 10-K for additional information regarding forward-looking statements and the factors that could cause actual results to differ materially from those anticipated in the forward-looking statements.
Overview
Avaya is a global leader in communications products, solutions and services for businesses of all sizes, delivering technology predominantly through software and services. We enable organizations worldwide to succeed by creating intelligent communications experiences for our clients, their employees and their customers. Avaya is building innovative open, converged contact center ("CC") and unified communications and collaboration ("UCC") software solutions to enhance and simplify communications and collaboration in the cloud, on-premises or as a hybrid of both. We offer hardware and gateway solutions, including devices that enhance collaboration and productivity, and position organizations to incorporate future technological advancements.
Our global, experienced team of professionals delivers award-winning services from initial planning and design, to seamless implementation and integration, to ongoing managed operations, optimization and support. We also help clients customize and personalize our software solutions to address their specific needs.
Businesses are built by the experiences they provide, and Avaya solutions deliver millions of those experiences globally every day. With a global install base including many of the largest enterprise customers with the most complex needs, Avaya is shaping the future of businesses and workplaces, with innovation and partnerships that power tangible business results. Our communications solutions power tailored, effortless customer and employee experiences that enable our clients to effectively engage and interact with each other and with their customers.
In serving both our existing and new customers across verticals, Avaya is uniquely positioned to meet customers where they are in their digital transformation and journeys to cloud communications, so they can innovate without disruption to gain the benefit of high-value cloud capabilities. We offer a full range of software sales and licensing models that can be deployed on-premises or via a public/multi-tenant cloud, private/dedicated instance cloud or as a hybrid cloud solution. With our open, extensible development platform, customers and third parties can create custom applications and automated workflows for their unique needs and integrate Avaya’s capabilities into the customer's existing infrastructure and business applications. Our solutions enable a seamless communications experience that adapts to how employees work, instead of changing how they work.
Operating Segments
The Company has two operating segments: Products & Solutions and Services .
Products & Solutions
Products & Solutions encompasses our CC and UCC software platforms, applications and devices. During fiscal 2022, we expanded our portfolio to include new cloud-based solutions, and we continued to integrate Artificial Intelligence ("AI") to create enhanced user experiences and improve performance.
• Contact Center: Avaya’s industry-leading contact center solutions enable clients to build a customized portfolio of applications to drive stronger customer engagement and higher customer lifetime value. Our reliable, secure and scalable communications solutions include voice, email, chat, social media, video, workforce engagement and third-party integration that can improve customer service and help companies compete more effectively. Avaya delivers Contact Center as a Service ("CCaaS") solutions for cloud deployment, and we continue to support enterprises with world-class premises-based solutions and add new value by complementing this highly dependable infrastructure with new capabilities from the cloud. We continue to integrate AI and automation capabilities into our portfolio, providing our clients a deeper understanding of their customers’ needs with a robust and secure platform.
• Unified Communications: Avaya communications and collaboration solutions support hybrid working environments, empowering teams with fast, always-on continuous collaboration from anywhere. Employees can communicate in context with better access to communication tools and better quality of communications to help deliver greater business impacts.
Avaya multi-tenant cloud-based UCaaS solutions integrate chat, file sharing and task management with real-time collaboration including calling, meetings and content sharing for distributed team productivity. Avaya offers Avaya Cloud Office in partnership with RingCentral, giving customers looking to replace outdated or disparate legacy telephony systems with a simple, comprehensive communications solution. Our on-premises Unified Communications ("UC") solutions, IP Office for midmarket clients and Avaya Aura for enterprise clients continue to deliver high reliability and functionality that is preferred in a variety of situations, including specific verticals, or where connectivity may be an issue.
Services
Complementing our product and solutions portfolio is an award-winning global services portfolio, delivered by Avaya and our extensive partner ecosystem. Within our services portfolio, we utilize a variety of formal survey and customer feedback mechanisms to drive continuous improvement and streamlined process automation, with a focus on constantly increasing our value to customers. Our innovative offerings provide solutions for new clients who want to directly utilize our cloud solutions, support for clients who have the need for hybrid cloud solutions that maximize the value their on-premises systems can deliver, and flexible migration paths for our premises-based customers. This is delivered and supported by:
• Professional Services enable our customers to take full advantage of their IT and communications solution investments to drive measurable business results. Avaya has repositioned its professional services organization to focus on go-forward customer needs. The new Avaya Customer Experience Service ("ACES") brings our depth of experience as our experts partner with customers and guide them along each step of the solution lifecycle to deliver services that add value and drive business transformation — including journey to cloud consulting services. The role of professional services organizations changes in a cloud world, moving from implementations to cloud migration. ACES takes a client-led approach to bring the expertise and practice areas that help clients define the choices and pace for their journey, based on their priorities for experiences and outcomes. Importantly, organizations can bring forward the customizations they have built over the years and add new value with AI and cloud capabilities. Most of our professional services revenue is non-recurring in nature.
• Enterprise Cloud and Managed Services enable customers to take advantage of our technology via the cloud, on-premises solutions or a hybrid of both, depending on the system and the needs of the customer. Avaya focuses on customer performance and growth, encompassing software releases, operating customer cloud, premise or hybrid-based communication systems and helping customers migrate to next-generation business communications environments. Most of our enterprise cloud and managed services revenue in fiscal 2022 was recurring in nature and based on multi-year services contracts.
• Global Support Services help businesses protect their technology investments and address the risk of business-impacting outages. Understanding that agility and high availability are critical to maintain or gain competitive advantage, we facilitate those capabilities through proactive problem prevention, rapid resolution, continual solution optimization, and we increasingly leverage automation to onboard and manage a customer’s communications infrastructure, for faster, more effective deployments from proof of concept to production, and ever-increasing automation. Our subscription offering sets a foundation for continually evolving the customer experience by providing access to future capabilities and solution enhancements. Most of our global support services revenue is recurring in nature.
Through our comprehensive services, we support our customers’ ability to fully leverage our technology and maximize their business results. Our solutions drive employee productivity improvements and a differentiated customer experience.
Our services teams help our customers maximize their ability to benefit from Avaya’s next-generation communications solutions. Customers can choose the level of support best suited for their needs, aligned with deployment, monitoring, solution management, optimization and more. Our enhanced performance monitoring coupled with a continuous focus on automation allows us to quickly identify and remediate issues to avoid business impact.
Recent Developments
As previously disclosed, on February 14, 2023 (the “Petition Date”), Avaya Holdings and certain of its direct and indirect subsidiaries (the “Debtors”) entered into a Restructuring Support Agreement (the “RSA”) with certain of its creditors and RingCentral which contemplated the Plan.
On the Petition Date, the Debtors commenced the Chapter 11 Cases in the United States Bankruptcy Court for the Southern District of Texas (the “Bankruptcy Court”). The Chapter 11 Cases were jointly administered under the caption In re Avaya Inc., et al ., case number 23-90088.
The Bankruptcy Court confirmed the Plan on March 22, 2023 and the Debtors satisfied all conditions required for Plan effectiveness and emerged from the Chapter 11 Cases on May 1, 2023.
Upon Emergence, the Debtors reduced their total debt by more than 75% and increased their liquidity position to over $650 million.
See Note 1, “Background and Basis of Presentation,” Note 11, "Financing Arrangements," and Note 24, "Subsequent Events," to our Consolidated Financial Statements for additional information on the Chapter 11 Cases as well as:
▪ the Board and Audit Committee Investigations;
▪ the Chapter 11 Filing;
▪ the Restructuring Support Agreement;
▪ the Automatic Stay;
▪ the Plan;
▪ the Debtor in Possession Financing and Exit Financing;
▪ the NYSE Delisting; and
▪ the Emergence from Voluntary Reorganization under Chapter 11 of the Bankruptcy Code.
Cost-Cutting Initiative
Since July 2022, the Company has initiated a number of cost-cutting measures that are expected to primarily impact the Company’s overall selling, general and administrative expenses, as well as discretionary spending, including but not limited to reductions in force with respect to employees globally aimed at aligning the size of the Company’s workforce with the Company’s operational strategy and cost structure. As a result of these cost-cutting actions, the Company expects to generate more than $500 million in annual cost reductions. The Company has commenced these actions which began to yield quantifiable savings in the first quarter of fiscal 2023 and are expected to be completed in fiscal 2024.
OneCloud Business Updates
During the first quarter of fiscal 2022, the Company executed a OneCloud arrangement for a large global financial institution with an estimated total contract value at that time in excess of $400 million over a term of up to 7 years. The contract was subsequently canceled during the fourth quarter of fiscal 2022. As a result, in the fourth quarter of fiscal 2022 the Company recognized revenue of $14 million and expenses of $22 million, which includes impairment of fixed assets, acceleration of previously deferred costs and other third party costs, associated with this arrangement.
Factors and Trends Affecting Our Results of Operations
There are several trends and uncertainties affecting our business. Most importantly, we are dependent on general economic conditions, the willingness of our customers to invest in technology and the manner in which our customers procure such technology and services.
Industry Trends
Cloud Growth and Migration:
• Growth in cloud-based technologies continues as businesses focus on digital transformation projects. This expansion of cloud delivery of software applications and management of varied devices in turn leads to an increasing demand for reliability and security.
• Even with the growing contact center market conversion to cloud, on-premises solutions remain a meaningful share of the market, estimated at ~48% in 2026.
• While companies seek innovation, they also want to avoid disruption. The ability to add modular innovation over the top of existing systems can drive significant value, enabling them to transform in a phased approach. This preference for a hybrid approach that mitigates risk favors vendors that have a large install base of customers with dependable technology in place.
• With the increasing overlap between CC and UCC, driven by customer workflows and the need to bring the back office into the frontline of the company, platforms that deliver integrated CCaaS and UCaaS are the foundation of next-generation business communications solutions. A converged, integrated offering for next-generation communications capabilities delivered across a host of mobile devices, and multiple communication and customer service channels bridges what has typically been siloed CC and UCC applications into one powerful tool.
Hybrid/Distributed Workforce:
• A clear priority is the business need to support individuals' expectations for flexible, multi-channel communications and remote and hybrid work styles that have arisen out of the COVID-19 pandemic. The global pandemic altered the way employees and end customers interact and engage, resulting in broad impacts to the ways businesses approach their internal and customer-facing communications planning and platforms.
• Evolving hybrid work environments highlight the need for organizations to ensure consistent collaboration experiences in unpredictable situations, regardless of workers' locations or time zones. Avaya solutions are well positioned to enable this work from anywhere approach while maintaining security, reliability and scalability requirements.
• Businesses plan to modify their use of office space to accommodate hybrid and remote work. Modifications will include space reduction, implementing hot-desking and hoteling solutions and equipping shared spaces and meeting rooms for video conferencing with remote participants. Video conferencing and collaboration solutions are an integral part of the changing office environment.
The Rise of Artificial Intelligence:
• Automation through AI solutions is driving improved customer and employee experiences. Conversational AI infused in contact center solutions will improve operational efficiencies and customer experiences leading to accelerated contact center platform replacements. AI enhancements also improve the meeting and collaboration experience between in-person and remote meeting participants. Video applications are increasingly being infused with virtual assistants, smart transcription and translation, and facial recognition.
• Extreme automation is fueling simplicity. Although the enabling technologies in our sector are becoming more complex, their use in contact center applications is driving increased simplicity for organizations and their employees. Simplicity in operations, engagement, customer intelligence and customer experience form the root of the innovation happening in our space.
Growth of the Experience Economy:
• The experience economy continues to grow. The experience economy is based on the concept that experience is a key source of value — it is a differentiator that creates a competitive advantage for products and services. As consumers embrace new technologies and devices in creative ways and at an accelerating pace, Avaya is continuing to invest in AI-powered solutions delivered through cloud and subscription models to create "experiences that matter" for customers, employees and agents. This increased adoption and deployment of AI is providing significant new opportunities for enhanced CC and UCC solutions that improve the customer experience and transform the digital workplace communications and workflows.
Russia/Ukraine Conflict
The military operation launched by Russia against Ukraine created economic and security concerns that have had and will likely continue to have an impact on regional and global economies and, in turn, our business. Sanctions and other retaliatory measures against Russia have been taken, and could be taken in the future, by the U.S., EU and other jurisdictions which severely limit our ability to conduct commercial activities with Russian companies, organizations and individuals on the U.S.'s List of Specially Designated Nationals, some of which are Avaya customers. Under current restrictions we cannot provide certain services to customers in Russia, and as a result, as we comply with all applicable sanctions, we are unable to fulfill certain of our existing contractual obligations to customers in Russia, nor can we commence new maintenance and support arrangements in Russia. The conflict and related retaliatory measures have had, and will continue to have, a negative effect on revenue in Russia for the foreseeable future. Revenue from Russia during fiscal 2022 was $38 million, compared to revenue of $63 million during fiscal 2021. Prolonged hostilities could exacerbate the overall effects of the conflict on our Company, both in Russia and in other markets where we do business.
Effects of Inflation
The Company’s operations expose it to the effects of inflation. Inflation has become a significant factor in the world economy post-pandemic and has led to an increased interest rate environment as well as inflationary pressures on the Company’s operations, including but not limited to increased labor and finance costs.
Financial Results Summary
Fiscal year ended September 30, 2022 compared with the Fiscal year ended September 30, 2021
The section below provides a comparative discussion of our consolidated results of operations between fiscal 2022 and 2021. See Item 7, "Management's Discussion and Analysis of Financial Condition and Results of Operations" in our Annual Report on Form 10-K for the fiscal year ended September 30, 2021 filed on November 22, 2021 for comparative discussion of our consolidated results of operations between fiscal 2021 and 2020.
The following table displays our consolidated net loss for the periods indicated:
Fiscal years ended September 30,
(In millions)
REVENUE
Products
Services
COSTS
Products:
Costs
Amortization of technology intangible assets
Services
GROSS PROFIT
OPERATING EXPENSES
Selling, general and administrative
Research and development
Amortization of intangible assets
Impairment charges
Restructuring charges, net
OPERATING (LOSS) INCOME
Interest expense
Other income, net
(LOSS) INCOME BEFORE INCOME TAXES
Provision for income taxes
NET LOSS
Revenue
Revenue for fiscal 2022 was $2,490 million compared to $2,973 million for fiscal 2021. The decrease was primarily driven by the cumulative effect of the continuing shift away from on-premise product solutions, and the associated maintenance support, professional services and managed services, to subscription and cloud-based solutions, and the unfavorable impact of foreign exchange rates. The decrease was partially offset by higher revenue from the Company's subscription and cloud offerings; a cancellation penalty related to a significant contract; and perpetual license sale with a government agency in the current period. Although revenue from those offerings continued to grow year-over-year, the increase in subscription and cloud revenue was not sufficient to offset declines in revenue from on-premise product solutions and the associated maintenance, software support services and professional services. This was caused by a deceleration in the growth of the Company's subscription revenue beginning in the third quarter of fiscal 2022 due to weakening customer purchasing trends, including shorter contract durations and slower pace of customer migrations to the subscription and cloud offerings.
The following table displays revenue and the percentage of revenue to total sales by operating segment for the periods indicated:
Percentage of Total Revenue
Yr. to Yr. Percentage Change
Yr. to Yr. Percentage Change, net of Foreign Currency Impact
Fiscal years ended September 30,
Fiscal years ended September 30,
(In millions)
Products & Solutions
Services
Unallocated amounts
Total Revenue
(1) Not meaningful.
Products & Solutions revenue for fiscal 2022 was $777 million compared to $992 million for fiscal 2021. The decrease was primarily attributable to the continuing shift away from on-premise product solutions to subscription and cloud-based solutions, lower hardware revenue, and the unfavorable impact of foreign exchanges rates, partially offset by a significant perpetual license sale with a government agency in the current period and a cancellation penalty related to a significant contract.
Services revenue for fiscal 2022 was $1,713 million compared to $1,982 million for fiscal 2021. The decrease was primarily driven by anticipated declines in maintenance and support services, professional services and managed services which continue to face headwinds driven by the cumulative effect of the continuing shift away from on-premise product solutions to subscription and cloud-based solutions, and the unfavorable impact of foreign exchanges rates, partially offset by an increase in revenue from the Company's subscription and cloud portfolio. The increase was not sufficient to offset declines in revenue from maintenance, software support services and professional services due to a deceleration in the growth of the Company’s subscription revenue beginning in the third quarter of fiscal 2022. The deceleration was the result of weakening customer purchasing trends, including shorter contract durations and slower pace of customer migrations to the subscription and cloud offerings.
Unallocated amounts for fiscal 2021 represent the fair value adjustment to deferred revenue recognized upon emergence from bankruptcy in December 2017 which is excluded from segment revenue.
The following table displays revenue and the percentage of revenue to total sales by location for the periods indicated:
Percentage of Total Revenue
Yr. to Yr. Percentage Change
Yr. to Yr. Percentage Change, net of Foreign Currency Impact
Fiscal years ended September 30,
Fiscal years ended September 30,
(In millions)
International:
Europe, Middle East and Africa
Asia Pacific
Americas International - Canada and Latin America
Total International
Total Revenue
Revenue in the U.S. for fiscal 2022 was $1,380 million compared to $1,704 million for fiscal 2021. The decrease in U.S. revenue was mainly driven by continuing shift away from on-premise product solutions to subscription and cloud-based solutions, and the associated maintenance support, professional services and managed services, partially offset by higher revenue from the Company's subscription and cloud offering, the fulfillment of certain obligations related to a government contract, including a significant perpetual license sale in the current period, a cancellation penalty related to a significant contract, and higher revenue from hardware products.
Revenue in Europe, Middle East and Africa ("EMEA") for fiscal 2022 was $624 million compared to $732 million for fiscal 2021. The decrease in EMEA was mainly driven by the continuing shift away from on-premise product solutions to subscription and cloud-based solutions, and the associated hardware maintenance and software support services, professional services and managed services, the unfavorable impact of foreign currency exchange rates, and the negative impact from various sanctions and other retaliatory measures against Russia resulting from the Russia/Ukraine conflict, partially offset by higher revenue from the Company's subscription offering.
Revenue in Asia Pacific ("APAC") for fiscal 2022 was $272 million compared to $297 million for fiscal 2021. The decrease in APAC revenue was mainly driven by the continuing shift away from on-premise product solutions to subscription and cloud-based solutions, and the associated hardware maintenance and software support services, professional services and managed services, the unfavorable impact of foreign currency exchange rates, partially offset by higher revenue from the Company's subscription and cloud offering.
Revenue in Americas International for fiscal 2022 was $214 million compared to $240 million for fiscal 2021. The decrease in Americas International revenue was primarily driven by the continuing shift away from on-premise product solutions to subscription and cloud-based solutions, and the associated hardware maintenance and software support services, professional services and managed services, the unfavorable impact of foreign currency exchange rates, partially offset by higher revenue from the Company's subscription and cloud offering.
Gross Profit
The following table sets forth gross profit and gross margin by operating segment for the periods indicated:
Gross Margin
Change
Fiscal years ended September 30,
Fiscal years ended September 30,
Amount
Percent
(In millions)
Products & Solutions
Services
Unallocated amounts
Total
(1) Not meaningful.
Products & Solutions gross profit for fiscal 2022 was $355 million compared to $594 million for fiscal 2021. The decrease was mainly attributable to the decline in revenue described above. Products & Solutions gross margin decreased from 59.9% in fiscal 2021 to 45.7% in fiscal 2022. The decrease in margin was mainly driven by a less favorable product mix including a higher proportion of hardware sales and third party software sales as the consumption of higher margin software continues to shift to a subscription model, which is reflected within our Services segment, cost incurred associated with the cancellation of a
significant contract, higher third party expenses including costs associated with the perpetual license sale to a government agency, and a write-off of excess inventory in the current period.
Services gross profit for fiscal 2022 was $962 million compared to $1,230 million for fiscal 2021. The decrease was mainly driven by the decline in revenue described above. Services gross margin decreased from 62.1% in fiscal 2021 to 56.2% in fiscal 2022. The decrease in margin was mainly driven by the anticipated decline in higher margin software support services, and an increase in costs associated with a higher mix of cloud and partner offerings, partially offset by an increase in revenue from the Company's subscription and cloud offerings. The increase was not sufficient to offset declines in revenue from maintenance, software support services and professional services due to a deceleration in the growth of the Company’s subscription revenue beginning in the third quarter of fiscal 2022. The deceleration was the result of weakening customer purchasing trends, including shorter contract durations and slower pace of customer migrations to the subscription and cloud offerings, which negatively impacted the gross margin.
Unallocated amounts for fiscal 2022 and 2021 include the amortization of technology intangible assets and fair value adjustments recognized upon emergence from bankruptcy which are excluded from segment gross profit.
Operating Expenses
The following table sets forth operating expenses and the percentage of operating expenses to total revenue for the periods indicated:
Percentage of Total Revenue
Change
Fiscal years ended September 30,
Fiscal years ended September 30,
Amount
Percent
(In millions)
Selling, general and administrative
Research and development
Amortization of intangible assets
Impairment charges
Restructuring charges, net
Total operating expenses
Selling, general and administrative expenses for fiscal 2022 were $964 million compared to $1,053 million for fiscal 2021. The decrease was primarily attributable to lower channel compensation, lower accrued incentive compensation, lower employee compensation expenses, the favorable impact of foreign currency exchange rates, and lower facility related costs, partially offset by higher advisory fees in the current period to assist in the assessment of strategic and financial alternatives to improve the Company's capital structure, higher travel and marketing related expenses, higher credit loss expenses, higher severance expenses related to the reduction in force completed in the fourth quarter of fiscal 2022, higher costs associated with legal matters, and other expenses.
Research and development expenses for fiscal 2022 were $222 million compared to $228 million for fiscal 2021. The decrease was primarily attributable to lower accrued incentive compensation and the favorable impact of foreign currency exchange rates, partially offset by higher employee compensation expenses.
Amortization of intangible assets was $159 million for both fiscal 2022 and 2021.
Impairment charges for fiscal 2022 were $1,640 million. During fiscal 2022, the Company recorded a goodwill impairment charge of $1,471 million, which represented the full carrying amount of the Company's goodwill, and an indefinite-lived intangible asset impairment charge of $146 million, primarily due (i) to a reduction in the Company's outlook to reflect the observed earnings shortfall in the third quarter of fiscal 2022 which was caused primarily by a slowdown in the pace and trajectory of customer migration to the Company's subscription hybrid offering, (ii) a reduction in the Company's revenue outlook which reflects streamlining of the Company's portfolio offerings as the Company continues to right-size its internal and external cost structure in the fourth quarter of fiscal 2022 and (iii) an increase in the discount rate to reflect increased risk from higher market uncertainty. In addition, the Company recorded $23 million of fixed assets impairment charges mainly associated with projects that were discontinued.
Restructuring charges, net were $65 million for fiscal 2022 compared to $30 million for fiscal 2021. Restructuring charges during fiscal 2022 consisted of $48 million for employee separation actions primarily in the U.S. and EMEA, and $17 million for facility exit costs as the Company optimizes its real-estate footprint. Restructuring charges during fiscal 2021 consisted of $19 million for employee separation actions and $11 million for facility exit costs primarily in the U.S. and EMEA. The Company anticipates additional restructuring charges in fiscal 2023 in connection with the cost-cutting actions described above.
Operating (Loss) Income
Operating loss for fiscal 2022 was $1,880 million compared to operating income of $180 million for fiscal 2021. Our operating results for fiscal 2022 as compared to fiscal 2021 reflect, among other things, the following items which are described in more detail above:
• lower revenue and gross profit for fiscal 2022; and
• impairment charges of $1,640 million mainly related to the Company's goodwill and indefinite-lived intangible asset, the Avaya Trade Name, during fiscal 2022 with no comparable charges in the prior period, partially offset by
• lower selling, general and administrative expenses and research and development costs in fiscal 2022.
Interest Expense
Interest expense for fiscal 2022 was $224 million compared to $222 million for fiscal 2021. The higher interest expense due to the issuance of the Tranche B-3 Term Loans, Exchangeable Notes and the associated embedded derivatives during the fourth quarter of the fiscal 2022 was offset by gains from the Company's interest rate swap agreements which were de-designated from hedge accounting treatment as of June 30, 2022.
We expect a significant decrease in our interest expense as a result of our capital structure post-Emergence. See Note 24, "Subsequent Events," to our Consolidated Financial Statements.
Other Income, Net
Other income, net for fiscal 2022 was $55 million as compared to $44 million for fiscal 2021. The increase was mainly driven by the change in fair value of the 2017 Emergence Date Warrants and the net impact of foreign currency gains (losses), partially offset by a non-cash settlement gain recorded during fiscal 2021 related to the Company's other post-retirement plan.
Provision for Income Taxes
The provision for income taxes was $47 million for fiscal 2022 compared to a provision for income taxes of $15 million for fiscal 2021.
The Company's effective income tax rate for fiscal 2022 differed from the U.S. federal tax rate by 23% or $477 million principally related to the nondeductible goodwill impairment charge recorded in the third quarter of fiscal 2022 and deferred taxes (including losses) generated for which no benefit was recorded because it is more likely than not that the tax benefits would not be realized.
The Company's effective income tax rate for fiscal 2021 differed from the U.S. federal tax rate by 729% or $15 million principally related to deferred taxes (including losses) generated for which no benefit was recorded because it is more likely than not that the tax benefits would not be realized, and certain nondeductible expenses.
Net Loss
Net loss was $2,096 million for fiscal 2022 compared to $13 million for fiscal 2021 as a result of the items discussed above.
Liquidity and Capital Resources
The accompanying Consolidated Financial Statements of the Company have been prepared assuming the Company will continue as a going concern and in accordance with GAAP. The going concern basis of presentation assumes that the Company will continue in operation one year after the date these Consolidated Financial Statements are issued and will be able to realize its assets and discharge its liabilities and commitments in the normal course of business.
During the fiscal year ended September 30, 2022, the Company experienced a significant slowdown in its operations and had operating cash outflows of $312 million. Additionally, prior to the Chapter 11 Cases, the Company had been involved in discussions with its lenders relating to the financing transactions it completed in July 2022 (as described further in Note 11, "Financing Arrangements") and the scheduled June 2023 maturity of the Convertible Notes. In its Form 12b-25 in respect of the Quarterly Report on Form 10-Q for the period ended June 30, 2022 filed with the SEC on August 9, 2022, the Company indicated that in light of the Convertible Notes being characterized as a current liability and the related engagement with advisors to address the Convertible Notes, coupled with the decline in revenues during the third quarter, which represented substantially lower revenues than previous Company expectations, and the negative impact of significant operating losses on the Company’s cash balance, the Company determined that there was substantial doubt about the Company’s ability to continue as a going concern.
The Company has completed certain restructuring actions and is working to complete its remaining restructuring plan as its operating cash flows are expected to remain negative through at least fiscal 2023. The Company may take additional actions, as needed. The Company’s plans are designed to reduce its operating expenses and improve cash flows in line with its forecasted
revenues. On the Emergence Date, the Company had approximately $585 million of cash and cash equivalents, and its post-Emergence debt profile was significantly improved (an aggregate principal amount of $810 million compared to $3,364 million at September 30, 2022), reducing its annual interest expense and extending the earliest maturity of its non-revolving long-term debt to 2028. This post-Emergence capital structure, coupled with restructuring actions that the Company executed to reduce its on-going operating expenses, have provided the Company with sufficient working capital to meet its operating cash flow requirements for at least one year from the issuance of these financial statements. Accordingly, as a result of the successful Emergence, the Company has alleviated the substantial doubt that had previously existed regarding the Company's ability to continue as a going concern. The Company's longer term liquidity profile will depend on successfully implementing its strategic plan which includes enhancing its product offerings, successfully partnering with alliance companies and executing on remaining cost reductions.
Cash Flow Activity
The following table provides a summary of the statements of cash flows for the periods indicated:
Fiscal years ended September 30,
(In millions)
Net cash (used for) provided by:
Operating activities
Investing activities
Financing activities
Effect of exchange rate changes on cash, cash equivalents, and restricted cash
Net decrease in cash, cash equivalents, and restricted cash
Cash, cash equivalents, and restricted cash at beginning of period
Cash, cash equivalents, and restricted cash at end of period (1)
(1) Includes $225 million and $4 million of restricted cash for fiscal 2022 and 2021, respectively.
Operating Activities
Cash used for operating activities for fiscal 2022 was $312 million compared to cash provided by operating activities of $30 million for fiscal 2021. The change was primarily due to lower cash earnings, higher advisory fees incurred to assist in the assessment of strategic and financial alternatives to improve the Company's capital structure and higher employee severance payments under the Company's restructuring programs, partially offset by the timing of customer cash payments as the Company continues its transition to a cloud and subscription model and $52 million of net proceeds received from the restructuring of the Company's Forward Swap Agreements described in Note 12, "Derivative Instruments and Hedging Activities," to our Consolidated Financial Statements.
Investing Activities
Cash used for investing activities for fiscal 2022 was $108 million compared to $117 million for fiscal 2021. The change was primarily driven by cash used for an asset acquisition in the prior year period.
Financing Activities
Cash provided by financing activities for fiscal 2022 was $406 million compared to cash used for financing activities of $142 million for 2021. The change was primarily due to the proceeds received from the issuance of the Tranche B-3 Term Loans and the issuance of the Company's 8.00% Exchangeable Notes in fiscal 2022 described in Note 11, "Financing Arrangements," to our Consolidated Financial Statements, as well as repurchases of shares of common stock under the Company's share repurchase program and a principal repayment under the Term Loan Credit Agreement in fiscal 2021 with no comparable transactions in the current period. This was partially offset by the repurchase of a portion of the Company's 2.25% Convertible Notes described in Note 11, "Financing Arrangements," to our Consolidated Financial Statements, lower proceeds from the exercise of stock options and higher debt issuance costs in the current period.
Financing Arrangements
See Note 1, "Background and Basis of Presentation," Note 11, "Financing Arrangements," and Note 24, "Subsequent Events," to our Consolidated Financial Statements for additional information regarding the Company's Pre-Petition Debt Instruments, including the Term Loan Credit Agreement, the ABL Credit Agreement the Senior Notes, the Convertible Notes and the Exchangeable Notes, as well as the DIP Term Loan Facility, the DIP ABL Facility and the effects of the Chapter 11 Cases on the Pre-Petition Debt Instruments.
Future Cash Requirements
Our primary future cash requirements will be to fund operations, debt service, capital expenditures, benefit obligations, restructuring payments and bankruptcy filing stays payments. We may also use cash in the future to make strategic acquisitions or investments.
In connection with the Company’s Emergence, our pre-petition debt was extinguished and we are currently operating under the Exit Term Loan and Exit ABL Loan and our interest expense will adjust in accordance with such facilities. We have no debt maturing in the near term.
In addition, the Company agreed to purchase seats of Avaya Cloud Office ("ACO") in the event certain volumes of ACO sales are not met over the term of its agreement with RingCentral, Inc. ("RingCentral"), which is described further in Note 22, "Commitments and Contingencies." In the event that the cumulative number of ACO seats sold as of the end of each calendar quarter is lower than the agreed upon threshold for such quarter, the Company will be required to purchase a number of ACO seats equal to such shortfall from RingCentral. Any such ACO seats purchased are subject to certain limitations and must be purchased for a two-year paid term with payments made monthly and pricing that is variable based on sales volumes by jurisdiction, contract size and product tier. The Company may resell such ACO seats to end customers or maintain them for internal use. In the event of any such requirement to purchase ACO seats, the required cash payments to RingCentral could have a significant adverse impact on the Company's financial position, results of operations and operating cash flows. Based on the variable nature of the commitment, the Company is not able to estimate the ultimate future cash flow impact, if any, of these increasing volume commitments.
In the ordinary course of business, the Company is involved in litigation, claims, government inquiries, investigations and proceedings relating to intellectual property, commercial, employment, environmental and regulatory matters, including but not limited to a suit filed by Solaborate Inc. and Solaborate LLC described in Note 22, "Commitments and Contingencies," to our Consolidated Financial Statements. On February 3, 2023, the Company reached an agreement to settle the lawsuit with Solaborate which will not have a material adverse effect on the Company's future cash requirements or cash flow.
Future Sources of Liquidity
Our existing cash balance and proceeds from the Exit Term Loan and Exit ABL Loan are our primary sources of future liquidity. As a result of the extinguishment of a significant amount of our debt in the Chapter 11 Cases, our annual interest expense was significantly reduced upon Emergence when compared to our pre-petition capital structure.
Both the Exit Term Loan and the Exit ABL Loan include conditions precedent, representations and warranties, affirmative and negative covenants, and events of default customary for financings of this type and size. See Note 11, "Financing Arrangements," for additional information on the Exit Term Loan and the Exit ABL Loan.
As of September 30, 2022 and 2021, our cash and cash equivalent balances were $253 million and $498 million, respectively. As of December 31, 2022, our cash and cash equivalent balances were $225 million, which includes unrestricted net proceeds from the July 12, 2022 financings, as well as borrowings under our ABL Credit Agreement. During the first quarter of fiscal 2023, the Company borrowed $90 million and repaid $34 million under the ABL Credit Agreement. During the second quarter of fiscal 2023, the Company repaid the remainder of the ABL Credit Agreement.
As of September 30, 2022 and 2021, our cash and cash equivalent balances held outside the U.S. were $117 million and $195 million, respectively. As of September 30, 2022, the Company's cash and cash equivalents held outside the U.S. may need to be repatriated to fund the Company's operations in the U.S. based on our expected future sources of liquidity.
At September 30, 2022, the Company had issued and outstanding letters of credit and guarantees of $31 million under the ABL Credit Agreement and had no borrowings outstanding under its ABL Credit Agreement.
Off-Balance Sheet Arrangements
See discussion in Note 22, "Commitments and Contingencies," to our Consolidated Financial Statements for further details.
EBITDA and Adjusted EBITDA
We present below the Company's EBITDA and Adjusted EBITDA, each of which is a non-GAAP measure.
EBITDA is defined as net income (loss) before income taxes, interest expense, interest income and depreciation and amortization and excludes the results of discontinued operations. EBITDA provides us with a measure of operating performance that excludes certain non-operating and/or non-cash expenses, which can differ significantly from company to company depending on capital structure, the tax jurisdictions in which companies operate and capital investments.
Adjusted EBITDA is EBITDA as further adjusted by the items noted in the reconciliation table below. We believe Adjusted EBITDA provides a measure of our financial performance based on operational factors that management can impact in the short-term, such as our pricing strategies, volume, costs and expenses of the organization, and therefore presents our financial performance in a way that can be more easily compared to prior quarters or fiscal years. In addition, Adjusted EBITDA serves
as a basis for determining certain management and employee compensation. We also present EBITDA and Adjusted EBITDA because we believe analysts and investors utilize these measures in analyzing our results. Under the Company's debt agreements, the ability to engage in activities such as incurring additional indebtedness, making investments and paying dividends is tied in part to ratios based on a measure of Adjusted EBITDA.
EBITDA and Adjusted EBITDA have limitations as analytical tools. EBITDA measures do not represent net income (loss) or cash flow from operations as those terms are defined by GAAP and do not necessarily indicate whether cash flows will be sufficient to fund cash needs. While EBITDA measures are frequently used as measures of operations and the ability to meet debt service requirements, these terms are not necessarily comparable to other similarly titled captions of other companies due to the potential inconsistencies in the method of calculation. Further, Adjusted EBITDA excludes the impact of earnings or charges resulting from matters that we consider not to be indicative of our ongoing operations that still affect our net income (loss). In particular, our formulation of Adjusted EBITDA adjusts for certain amounts that are included in calculating net income (loss) as set forth in the following table including, but not limited to, restructuring charges, impairment charges, resolution of certain legal matters and a portion of our pension costs and post-retirement benefits costs, which represents the amortization of prior service costs (credits) and actuarial (gains) losses associated with these benefits. However, these are expenses that may recur, may vary and/or may be difficult to predict.
The reconciliation of net loss, which is a GAAP measure, to EBITDA and Adjusted EBITDA, which are non-GAAP measures, is presented below for the periods indicated:
Fiscal years ended September 30,
(In millions)
Net loss
Interest expense
Interest income
Provision for income taxes
Depreciation and amortization
EBITDA
Impact of fresh start accounting adjustments (a)
Restructuring charges (b)
Advisory fees (c)
Acquisition-related costs
Share-based compensation
Impairment charges (d)
Pension and post-retirement benefit costs
Gain on post-retirement plan settlement
Change in fair value of the 2017 Emergence Date Warrants
Legal matters (e)
Gain on foreign currency transactions
Adjusted EBITDA
(a) The impact of fresh start accounting adjustments in connection with the Company's emergence from bankruptcy in 2017.
(b) Restructuring charges represent employee separation costs and facility exit costs (excluding the impact of accelerated depreciation expense) related to the Company's restructuring programs, net of sublease income.
(c) Advisory fees represent costs incurred to assist in the assessment of strategic and financial alternatives to improve the Company's capital structure.
(d) Impairment charges include an indefinite-lived intangible asset impairment charge of $146 million, a goodwill impairment charge of $1,471 million and fixed assets impairment charges of $23 million mainly associated with specific customer and internal projects that were discontinued. See Note 7, "Goodwill," and Note 8, "Intangible Assets, net," for additional information.
(e) Resolution of legal matters includes third party fees and settlements related to certain non-recurring legal matters.
Critical Accounting Policies and Estimates
The preparation of financial statements and related disclosures in conformity with accounting principles generally accepted in the United States of America ("GAAP") requires the Company's management to make judgments, assumptions and estimates that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities at the date of the financial statements, and revenue and expenses during the periods reported. Management bases its estimates on historical experience and on various other assumptions it believes to be reasonable under the circumstances. Actual results may differ from these estimates and such differences may be material. Note 2, "Summary of Significant Accounting Policies," to our Consolidated Financial Statements included in Item 8 of this Annual Report on Form 10-K describes the significant accounting policies and methods used in the preparation of the Company's Consolidated Financial Statements. The accounting policies and estimates below have been identified by the Company's management as those that are most critical to our financial statements as they require management to make significant judgments and estimates about inherently uncertain matters.
Revenue Recognition
The Company derives revenue primarily from the sale of products and services for communications systems and applications. The Company sells directly through its worldwide sales force and indirectly through its global network of channel partners, including distributors, service providers, dealers, value-added resellers, systems integrators and business partners that provide sales and services support. The Company’s critical revenue recognition estimate is the variable consideration included in the total transaction price for a customer contract.
The total transaction price for each customer contract is determined based on the total consideration specified in the contract, including variable consideration such as sales incentives and other discounts. Judgment is required in estimating variable consideration, which typically reduces the total transaction price due to the nature of the elements to which variable consideration relates. The Company’s variable consideration estimates mainly consist of reserves for contractual stock rotation rights to channel partners to support the management of inventory; future credits and sales incentives to distributors and other channel partners based on our contractual arrangements; and reserves for estimated sales returns based on a customer’s right of return. Estimates of variable consideration reflect the Company’s historical experience, current contractual requirements, specific known market events and trends, industry data and forecasted customer buying patterns. When estimating returns, the Company considers customary inventory levels held by third-party distributors. The Company’s variable consideration estimates are recorded as a reduction of revenue at the time of sale and depending on the facts and circumstances, a change in variable consideration estimate will either be accounted for at the contract level or using the portfolio method.
Goodwill and Indefinite-lived Intangible Assets
Goodwill and indefinite-lived intangible assets are not amortized but are subject to impairment testing annually, on July 1st, or more frequently if events occur or circumstances change that would more likely than not reduce the fair value of goodwill or an indefinite-lived intangible asset below its carrying amount.
Goodwill is tested for impairment at the reporting unit level. Depending on the facts and circumstances, the impairment test for goodwill can be performed using either a qualitative or quantitative approach. The qualitative approach consists of a weighting of several qualitative factors, including, but not limited to, macroeconomic conditions (including changes in interest rates and discount rates), industry and market considerations, the recent and projected financial performance of the reporting unit, changes in the Company's enterprise market value and other relevant factors to determine whether it is more likely than not that the fair value of the reporting unit is less than its carrying amount, including goodwill. This assessment can require significant judgments, including the estimation of future cash flows and an assessment of market and industry dependent risks. If the assessment of all relevant qualitative factors indicates that it is more likely than not that the fair value of a reporting unit is greater than its carrying amount, a quantitative goodwill impairment test is not necessary. If the assessment of all relevant qualitative factors indicates that it is more likely than not that the fair value of a reporting unit is less than its carrying amount, the Company will perform a quantitative goodwill impairment test. The Company has the unconditional option to bypass the qualitative assessment for any reporting unit in any period and proceed directly to performing a quantitative goodwill impairment assessment.
The quantitative goodwill impairment assessment is conducted by estimating and comparing the fair value of the reporting unit to its carrying value. If the carrying amount of the reporting unit exceeds its fair value, the Company recognizes an impairment loss equal to the amount of the excess, limited to the amount of goodwill assigned to that reporting unit. Application of the impairment test requires judgment, including the identification of reporting units, assignment of assets and liabilities to reporting units and the determination of the fair value of the reporting unit. The Company estimates the fair value of the reporting unit using a weighting of fair values derived from an income approach and a market approach.
Under the income approach, the fair value of a reporting unit is estimated using a discounted cash flows model. Future cash flows are based on forward-looking information regarding revenue and costs of the reporting unit and are discounted using an appropriate discount rate. The discounted cash flows model relies on assumptions regarding revenue growth rates, projected
earnings (excluding interest and taxes), working capital needs, technology expenses, business restructuring costs and associated savings, capital expenditures, income tax rate, discount rate and terminal growth rate. The discount rate the Company used represents the estimated weighted average cost of capital, which reflects the overall level of inherent risk involved in the reporting unit's operations and the rate of return an outside investor would expect to earn. To estimate cash flows beyond the final year of its model, the Company used a terminal value approach. Under this approach, the Company applied a perpetuity growth assumption to determine the terminal value. The Company incorporated the present value of the resulting terminal value into its estimate of fair value. Forecasted cash flows consider current economic conditions and trends, estimated future operating results, the Company’s view of growth rates and anticipated future economic conditions. Revenue growth rates inherent in this forecast are based on input from internal and external market intelligence research sources that compare factors such as growth in global economies, regional industry trends and product evolutions. Macroeconomic factors such as changes in local and/or global economic conditions, changes in interest rates, product evolutions, industry consolidations and other changes beyond the Company’s control could have a positive or negative impact on achieving its targets.
The market approach estimates the fair value of the reporting unit by applying multiples of operating performance measures to the reporting unit's operating performance (the "Guideline Public Company Method"). These multiples are derived from comparable publicly-traded companies with similar investment characteristics to the reporting unit. The key estimates and assumptions that are used to determine the fair value under this market approach include current and forward 12-month operating performance results, as applicable, and a selection of the relevant multiples.
Changes in these estimates and assumptions could materially affect the determination of fair value and the goodwill impairment test result.
The Company's goodwill balance is assigned to its Services reporting unit. During the third quarter of fiscal 2022, the Company concluded that a triggering event occurred due to (i) a sustained decrease in the market value of the Company's debt and common stock and (ii) a significant decline in revenues during the third quarter, which represented substantially lower revenues than the Company's expectations. As a result, the Company performed an interim quantitative goodwill impairment test as of June 30, 2022 to compare the fair value of the Services reporting unit to its carrying amount, including the goodwill. Although the Company previously used a weighting of the market approach and income approach in estimating the fair value of its reporting units, the Company did not assign a weighting to the market approach for the interim goodwill impairment assessment as of June 30, 2022 given the limited availability of publicly traded comparable companies that accurately reflect the same economic outlook and risk profile as Avaya, and instead relied solely on the income approach to estimate the fair value of the Services reporting unit as of June 30, 2022.
The result of the Company’s interim goodwill impairment test as of June 30, 2022 indicated that the carrying amount of the Company's Services reporting unit exceeded its estimated fair value primarily due to a reduction in the Company's outlook to reflect the observed earnings shortfall which was caused primarily by a slowdown in the pace and trajectory of customer migration to the Company's subscription hybrid offering and an increase in the discount rate to reflect increased risk from higher market uncertainty. As a result, the Company recorded a goodwill impairment charge of $1,471 million to write down the full carrying amount of the Services goodwill within the Impairment charges line item in the Consolidated Statements of Operations.
As a result of the goodwill triggering event described above, the Company performed a recoverability test on all of its finite-lived asset groups as of June 30, 2022 before proceeding to the goodwill impairment review and concluded that no impairment charge was necessary. The recoverability test of finite-lived asset assets was based on forecasts of undiscounted cash flows for each asset group. Similar to the goodwill impairment test, the recoverability test for finite-lived assets relies on cash flow models which include assumptions regarding revenue growth rates, projected earnings (excluding interest and taxes), working capital needs, technology expenses, business restructuring costs and associated savings, capital expenditures, and discount rates and terminal growth rates applied to the terminal year. The Company also performed an interim quantitative impairment test for its indefinite-lived intangible asset, the Avaya Trade Name, as of June 30, 2022 to compare the fair value of the Avaya Trade Name to its carrying amount. The fair value of the Avaya Trade Name was estimated using the relief-from-royalty model, a form of the income approach. Under this methodology, the fair value of the trade name was estimated by applying a royalty rate to forecasted net revenues which was then discounted using a risk-adjusted rate of return on capital. The model relies on assumptions regarding revenue growth rates, royalty rate, discount rate and terminal growth rate. Revenue growth rates inherent in the forecast were based on input from internal and external market intelligence research sources that compare factors such as growth in global economies, regional industry trends and product evolutions. The royalty rate was determined using a set of observed market royalty rates. The discount rate the Company used represents the estimated weighted average cost of capital, which reflects the overall level of inherent risk and the rate of return an outside investor would expect to earn. To estimate royalty cash flows beyond the final year of its model, the Company used a terminal value approach. Under this approach, the Company applied a perpetuity growth assumption to determine the terminal value. The Company incorporated the present value of the resulting terminal value into its estimate of fair value. The result of the interim impairment test of the Avaya Trade Name as of June 30, 2022 indicated that the carrying amount of the Avaya Trade Name exceeded its estimated fair value primarily due to a reduction in the Company's outlook to reflect the observed revenue decline which was caused primarily by a slowdown in the pace and trajectory of customer migration to the Company's subscription hybrid offering and lower than anticipated on-premise license sales and an increase in the discount rate to reflect increased risk from higher market uncertainty. As a result, the Company recorded an indefinite-lived intangible asset impairment charge of $114 million within the Impairment charges line item in the Consolidated Statements of Operations, representing the amount by which the carrying amount of the Avaya Trade Name exceeded its fair value.
At July 1, 2022, the Company performed its annual impairment test using the qualitative approach for the Avaya Trade Name and determined that no additional impairment existed since the previous assessment as of June 30, 2022.
During the fourth quarter of fiscal 2022, the Company concluded that a triggering event occurred in relation to the Avaya Trade Name primarily due to a revision in the Company's long-term revenue forecast which reflects certain strategic initiatives implemented under the Company's new CEO. As a result of the triggering event, the Company performed an interim quantitative impairment test for the Avaya Trade Name as of September 30, 2022 to compare the fair value of the Avaya Trade Name to its carrying amount using the relief-from-royalty model described above. The result of the interim impairment test of the Avaya Trade Name as of September 30, 2022 indicated that the carrying amount of the Avaya Trade Name exceeded its estimated fair value primarily due to a reduction in the Company's revenue outlook which reflects streamlining of the Company's portfolio offerings as the Company continues to right-size its internal and external cost structure. As a result, the Company recorded an incremental indefinite-lived intangible asset impairment charge of $32 million within the Impairment charges line item in the Consolidated Statements of Operations, representing the amount by which the carrying amount of the Avaya Trade Name exceeded its fair value. As of September 30, 2022, the remaining carrying amount of the Avaya Trade Name was $187 million.
As announced in a Form 8-K dated December 13, 2022, the Company was unable to reach an out-of-court resolution with certain holders of the Convertible Notes, Senior Notes, Exchangeable Notes, and the Term Loans outstanding under the Term Loan Credit Agreement, regarding one or more potential financings, refinancings, recapitalizations, reorganizations, restructurings, or investment transactions involving the Company. As a result, the Company revised its outlook to reflect the increased likelihood of an insolvency event. The Company concluded that a triggering event had occurred and performed an interim quantitative impairment test for the Avaya Trade Name as of December 31, 2022 to compare the fair value of the Avaya Trade Name to its carrying amount. The result of the interim impairment test of the Avaya Trade Name as of December 31, 2022 indicated that the carrying amount of the Avaya Trade Name exceeded its estimated fair value primarily due to the updated outlook. As a result, the Company recorded an incremental indefinite-lived intangible asset impairment charge of $9 million during the first quarter of fiscal 2023.
Based on the estimates used in the interim impairment test of the Avaya Trade Name as of December 31, 2022, an increase in the discount rate or a decrease in the long-term growth rate of 50 basis points would have resulted in an incremental impairment charge of approximately $7 million and $2 million, respectively.
To the extent that business conditions deteriorate further or if changes in key assumptions and estimates differ significantly from management's expectations, it may be necessary to record additional impairment charges in the future.
Refer to Note 24, "Subsequent Events", for additional information regarding triggering events identified subsequent to September 30, 2022.
Embedded Derivatives
The Company evaluated the terms and features of its Tranche B-3 Term Loan and Exchangeable Notes, as defined in Note 11, “Financing Arrangements,” and identified embedded features that, in certain scenarios, could modify the cash flows of their respective debt instruments.
The Company evaluated the embedded features individually and determined that a subset of the features were not clearly and closely related to the underlying debt instruments and did not qualify for any scope exceptions set forth in the accounting standards. Accordingly, these embedded features (the "Debt-related embedded derivatives") are required to be bifurcated from their host instruments and accounted for separately as an embedded derivative liability. As a result, the Company recorded the fair value of the Debt-related embedded derivatives as of the issuance date as a reduction of the initial carrying amount of the debt instruments (as part of the debt discount). The discount is amortized to interest expense using the effective interest method over the life of the debt instruments.
The Debt-related embedded derivatives will be adjusted to fair value each reported period with changes in fair value subsequent to the issuance date recognized within Interest Expense in the Consolidated Statements of Operations. The aggregate fair value of the Debt-related embedded derivatives is reflected within Long-term debt in the Consolidated Balance Sheets.
The fair value of the derivatives is determined using the with-and-without model which compares the estimated fair value of the underlying debt instrument with the embedded features to the estimated fair value of the underlying debt instrument without the embedded features, with the difference representing the estimated fair value of the embedded derivative features. The with-and-without model includes significant unobservable estimates, including estimated market yield, an estimation of the Company’s probability of default and creditor recovery rates, and the probability of the occurrence of a change of control event or asset sale. Market yields are estimated using the risk-free rate commensurate with the remaining term of the instrument, an implied credit-spread based on the issuance price and the change in option adjusted spread of the traded debt instruments. The Company uses observable trading prices of its existing debt instruments to imply a probability of default and uses the S&P recovery rating to determine the creditor recovery rate each period. Management estimates the probability of the change of control or asset sale based on its assessment of entity specific factors and the status of on-going transaction negotiations, if any. Changes in the inputs into the valuation model may have a significant impact on the estimated fair value of the Debt-related embedded derivatives.
On July 12, 2022, the issuance date, the aggregate fair value of the Debt-related embedded derivatives was $34 million, which was recorded as a debt discount (contra liability) and a derivative liability within Long-term debt on the Consolidated Balance Sheets. As of September 30, 2022, the aggregate fair value of the Debt-related embedded derivatives was $72 million. As a result, the Company recorded the change in fair value of $(38) million within Interest expense during fiscal 2022.
As of September 30, 2022, a hypothetical 100 basis point change in the estimated market yield would have resulted in a change in the aggregate fair value of the Debt-related embedded derivatives of approximately $1 million. A hypothetical 1000 basis point increase or decrease in the estimated probability of default would have resulted in a change in the aggregate fair value of the Debt-related embedded derivatives of $8 million or $(7) million, respectively. A hypothetical 1000 basis point change in the estimated probability of a change of control/asset sale for the Tranche B-3 Term Loans and a hypothetical 500 basis point change in the estimated probability of a change of control/asset sale for the Exchangeable Notes would have resulted in a change in the aggregate fair value of the Debt-related derivatives of approximately $7 million.
Income Taxes
Income taxes are accounted for under the asset and liability method. Under this method, deferred tax assets and liabilities are recognized for the estimated future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases, operating loss and tax credit carryforwards. Deferred tax assets and liabilities are measured using enacted tax rates in effect for the year in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in the Consolidated Statements of Operations in the period that includes the enactment date. A valuation allowance is recorded to reduce the carrying amounts of deferred tax assets if it is more likely than not that such assets will not be realized.
Additionally, the accounting for income taxes requires the Company to evaluate and make an assertion as to whether undistributed foreign earnings will be indefinitely reinvested or repatriated.
Financial Accounting Standards Board ("FASB") Accounting Standards Codification ("ASC") subtopic 740-10, "Income Taxes-Overall" ("ASC 740-10") prescribes a comprehensive model for the financial statement recognition, measurement, classification and disclosure of uncertain tax positions. ASC 740-10 contains a two-step approach to recognizing and measuring uncertain tax positions. The first step is to evaluate the tax position for recognition by determining if the weight of available evidence indicates that it is more likely than not that the position will be sustained on audit based on the technical merits of the
position. The second step is to measure the tax benefit as the largest amount that is more than 50% likely of being realized upon settlement.
Significant judgment is required in evaluating uncertain tax positions and determining the provision for income taxes. Although the Company believes its reserves are reasonable, no assurance can be given that the final tax outcome of these matters will not be different from that which is reflected in the historical income tax provision and accruals. The Company adjusts its estimated liability for uncertain tax positions periodically due to new information discovered from ongoing examinations by, and settlements with, various taxing authorities, as well as changes in tax laws, regulations and interpretations. The Company’s policy is to recognize, when applicable, interest and penalties on uncertain tax positions as part of income tax expense.
As part of the Company’s accounting for business combinations, some of the purchase price is allocated to goodwill and intangible assets. Impairment expenses associated with goodwill are generally not tax deductible and will result in an increased effective income tax rate in the fiscal period any impairment is recorded. The income tax benefit from future releases of the acquisition date valuation allowances or income tax contingencies, if any, are reflected in the income tax provision in the Consolidated Statements of Operations, rather than as an adjustment to the purchase price allocation.
Pension and Post-retirement Benefit Obligations
The Company sponsors non-contributory defined benefit pension plans covering a portion of its U.S. employees and retirees, and post-retirement benefit plans covering a portion of its U.S. employees and retirees that include healthcare benefits and life insurance coverage. Certain non-U.S. operations have various retirement benefit programs covering substantially all of their employees. Some of these programs are considered to be defined benefit pension plans for accounting purposes.
The Company’s pension and post-retirement benefit costs are developed from actuarial valuations. Inherent in these valuations are key assumptions, including the discount rate, expected long-term rate of return on plan assets, rate of compensation increase and healthcare cost trend rate. Salary growth and healthcare cost trend assumptions are based on the Company's historical experience and future outlook. Material changes in pension and post-retirement benefit costs may occur in the future due to changes in these assumptions, in the number of plan participants, in the level of benefits provided, in asset levels and in legislation.
The discount rate is subject to change each year, consistent with changes in rates of return on high-quality fixed-income investments currently available and expected to be available during the expected benefit payment period. The Company selects the assumed discount rate for its U.S. pension and post-retirement benefit plans by applying the rates from the Aon AA Above Median and Aon AA Only Bond Universe yield curves to the expected benefit payment streams and develops a rate at which it is believed the benefit obligations could be effectively settled. The Company follows a similar process for its non-U.S. pension plans by applying the Aon Euro AA corporate bond yield curve for the plans based in Europe and relevant country-specific bond indices for other locations.
The market-related value of the Company’s plan assets for the Company’s U.S. and international pension plans and post-retirement medical plans as of the measurement date is developed using a five-year smoothing technique. First, a preliminary market-related value is calculated by adjusting the market-related value at the beginning of the year for payments to and from plan assets and the expected return on assets during the year. The expected return on assets represents the expected long-term rate of return on plan assets adjusted up to plus or minus 2% based on the actual ten-year average rate of return on plan assets. A final market-related value is determined as the preliminary market-related value, plus 20% of the difference between the actual return and expected return for each of the past five years. As a result of the partial settlement of the post-retirement life insurance in fiscal 2021, which is further described within Note 15, “Benefit Obligations,” the market-related value of the Company’s plan assets for other post-retirement life insurance plan is determined using the fair market value technique.
While the Company believes that the assumptions used in these calculations are reasonable, differences in actual experience or changes in assumptions could materially affect the expense and liabilities related to the Company's defined benefit plans. For the U.S. pension; non-U.S. pension; and post-retirement plans combined, a hypothetical 25 basis point change in the discount rate would affect expense for fiscal 2022 by approximately $2 million. A hypothetical 25 basis point increase or decrease in the discount rate would change the projected benefit obligation as of September 30, 2022 by approximately $(28) million or $29 million, respectively. A hypothetical 25 basis point change in the expected long-term rate of return would affect expense for fiscal 2022 by approximately $2 million.
Loss Contingencies
In the ordinary course of business, the Company is involved in litigation, claims, government inquiries, investigations and proceedings, including but not limited to, those relating to intellectual property, commercial, employment, environmental indemnity and regulatory matters. The Company records accruals for loss contingencies to the extent that it has concluded that it is probable that a liability has been incurred and the amount of the loss can be reasonably estimated. When a material loss contingency is reasonably possible but not probable, the Company does not record a liability, but instead discloses the nature and the amount of the claim, and an estimate of the loss or range of loss, if such an estimate can be made. Due to the inherent
uncertainties related to these matters, significant judgment is required in the determination of the risk of loss and whether the loss is reasonably estimable. This assessment is based on our current understanding of relevant facts and circumstances, including but not limited to, the status of the legal or regulatory proceedings, the merits of its defenses and consultations with internal and external counsel to determine whether such accruals should be made or adjusted. Any accruals or revisions in estimates could have a material impact on our results of operations or financial position.
