1
AS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION ON SEPTEMBER 6, 2000
REGISTRATION NO. 1-15951
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
------------------------
AMENDMENT NO. 2
TO
FORM 10
GENERAL FORM FOR REGISTRATION OF SECURITIES
PURSUANT TO SECTION 12(b) OR (g) OF
THE SECURITIES EXCHANGE ACT OF 1934
------------------------
AVAYA INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
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<S> <C>
DELAWARE 22-3713430
(STATE OR OTHER JURISDICTION (I.R.S. EMPLOYER
OF INCORPORATION OR ORGANIZATION) IDENTIFICATION NUMBER)
211 MOUNT AIRY ROAD 07920
BASKING RIDGE, NJ (ZIP CODE)
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES)
</TABLE>
REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE:
(908) 953-6000
------------------------
SECURITIES TO BE REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT:
<TABLE>
<CAPTION>
TITLE OF EACH CLASS NAME OF EACH EXCHANGE ON WHICH
TO BE SO REGISTERED EACH CLASS IS TO BE REGISTERED
------------------- ------------------------------
<S> <C>
COMMON STOCK, NEW YORK STOCK EXCHANGE
PAR VALUE $0.01 PER SHARE
SERIES A JUNIOR PARTICIPATING NEW YORK STOCK EXCHANGE
PREFERRED STOCK PURCHASE RIGHTS
</TABLE>
SECURITIES TO BE REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT:
NONE
- --------------------------------------------------------------------------------
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2
AVAYA INC.
I. INFORMATION INCLUDED IN INFORMATION STATEMENT
AND INCORPORATED IN FORM 10 BY REFERENCE
Our Information Statement may be found as Exhibit 99.1 to this Form 10. For
your convenience, we have below provided a cross-reference sheet identifying
where the items required by Form 10 can be found in the Information Statement.
CROSS-REFERENCE SHEET BETWEEN INFORMATION STATEMENT
AND ITEMS OF FORM 10
<TABLE>
<CAPTION>
ITEM
NO. CAPTION LOCATION IN INFORMATION STATEMENT
- ---- ------- ---------------------------------
<C> <S> <C>
1. Business............................... "Summary," "The Distribution," "Risk Factors,"
"Forward Looking Statements," "Capitalization,"
"Management's Discussion and Analysis of Financial
Condition and Results of Operations," "Business"
and "Relationship Between Lucent and Our Company
After the Distribution"
2. Financial Information.................. "Summary," "Selected Financial Information,"
"Unaudited Pro Forma Condensed Financial
Statements" and "Management's Discussion and
Analysis of Financial Condition and Results of
Operations"
3. Properties............................. "Business -- Properties"
4. Securities Ownership of Our Beneficial
Owners and Management................ "The Distribution," "Management," "Ownership of Our
Common Stock" and "Related Transactions and Equity
Investment"
5. Directors and Executive Officers....... "Management"
6. Executive Compensation................. "Management" and "Ownership of Our Common Stock"
7. Our Relationships and Related
Transactions......................... "Relationship Between Lucent and Our Company After
the Distribution," "Management -- Employment
Agreements" and "Related Transactions and Equity
Investment"
8. Legal Proceedings...................... "Business -- Legal Proceedings"
9. Market Price of and Dividends on the
Registrant's Common Equity and
Related Shareowner Matters........... "The Distribution," "Dividend Policy" and
"Description of Capital Stock"
10. Recent Sales of Unregistered
Securities........................... Not Included (see Part II below)
11. Description of Registrant's Securities
to be Registered..................... "The Distribution," "Dividend Policy" and
"Description of Capital Stock"
12. Indemnification of Directors and
Officers............................. "Indemnification of Directors and Officers"
13. Financial Statements and Supplementary
Data................................. "Unaudited Pro Forma Condensed Financial
Statements" and "Index to Combined Financial
Statements"
14. Changes In and Disagreements with
Accountants on Accounting and
Financial Matters.................... Not Applicable
15. Financial Statements and Exhibits...... "Unaudited Pro Forma Condensed Financial
Statements" and "Index to Combined Financial
Statements"
</TABLE>
I-1
3
II. INFORMATION NOT INCLUDED IN INFORMATION STATEMENT
ITEM 10. RECENT SALES OF UNREGISTERED SECURITIES
We were incorporated under the laws of the State of Delaware under the name
"Lucent EN Corp." on February 16, 2000. Lucent EN issued 1,000 shares of its
common stock, par value $0.01 per share, to Lucent Technologies Inc., a Delaware
corporation, in consideration of a capital contribution of $10.00 by Lucent
Technologies Inc. Such issuance was exempt from registration under the
Securities Act of 1933, as amended, pursuant to Section 4(2) thereof because
such issuance did not involve any public offering of securities. As of June 27,
2000, our name was changed to "Avaya Inc."
On August 8, 2000, we entered into an agreement to sell 4,000,000 shares of
Series B convertible participating preferred stock and warrants to purchase
shares of our common stock to Warburg, Pincus Equity Partners, L.P. and several
related investment funds for a total of $400 million. This transaction will be
exempt from registration under the Securities Act of 1933, as amended, pursuant
to Section 4(2) thereof because such issuances do not involve any public
offering of the securities. For a more detailed description of this equity
investment, please see the information under the captions "Management's
Discussion and Analysis of Financial Condition and Results of
Operations -- Liquidity and Capital Resources" and "Related Transactions and
Equity Investment" in the Information Statement.
ITEM 15. FINANCIAL STATEMENTS AND EXHIBITS
(a) Financial Statements filed as part of this registration statement
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Combined Financial Statements:
Combined Statements of Income for the three fiscal
years ended September 30, 1999 and the nine months
ended June 30, 2000 and 1999 (unaudited)............ F-3
Combined Balance Sheets as of September 30, 1998 and
1999 and June 30, 2000 (unaudited).................. F-4
Combined Statements of Changes in Invested Equity for
the three fiscal years ended September 30, 1999 and
the nine months ended June 30, 2000 and 1999
(unaudited)......................................... F-5
Combined Statements of Cash Flows for the three
fiscal years ended September 30, 1999 and the nine
months ended June 30, 2000 and 1999 (unaudited)..... F-6
Financial Statement Schedule:
Schedule II- Valuation and Qualifying Accounts for
the three fiscal years ended September 30, 1999..... S-1
</TABLE>
(b) Exhibits
<TABLE>
<CAPTION>
EXHIBIT
NO. DESCRIPTION
- ------- -----------
<C> <S>
2 Contribution and Distribution Agreement+
3.1 Restated Certificate of Incorporation of Avaya Inc.+
3.2 Amended and Restated By-laws of Avaya Inc.+
4.1 Specimen Common Stock certificate**
4.2 Restated Certificate of Incorporation of Avaya Inc. (filed
as Exhibit 3.1 hereto)+
4.3 Amended and Restated By-laws of Avaya Inc. (filed as Exhibit
3.2 hereto)+
4.4 Rights Agreement between Avaya Inc. and The Bank of New
York, as Rights Agent+
4.5 Form of Certificate of Designations of Series A Junior
Participating Preferred Stock (attached as Exhibit A to the
Rights Agreement filed as Exhibit 4.4 hereto)+
4.6 Form of Right Certificate (attached as Exhibit B to the
Rights Agreement filed as Exhibit 4.4 hereto)+
</TABLE>
II-1
4
<TABLE>
<CAPTION>
EXHIBIT
NO. DESCRIPTION
- ------- -----------
<C> <S>
10.1 Contribution and Distribution Agreement (filed as Exhibit 2
hereto)+
10.2 Interim Services and Systems Replication Agreement+
10.3 Employee Benefits Agreement+
10.4 Tax Sharing Agreement+
10.5 Avaya Inc. Short Term Incentive Plan+
10.6 Avaya Inc. 2000 Long Term Incentive Plan+
10.7 Avaya Inc. 2000 Long Term Incentive Plan Restricted Stock
Unit Award Agreement+
10.8 Avaya Inc. 2000 Long Term Incentive Plan Nonstatutory Stock
Option Agreement+
10.9 Avaya Inc. Deferred Compensation Plan+
10.10 Employment Agreement of Mr. Peterson, dated August 8, 1995+
10.11 Avaya Inc. Supplemental Pension Plan+
10.12 Avaya Inc. 2000 Stock Compensation Plan for Non-Employee
Directors+
10.13 Trademark License Agreement+
10.14 Patent and Technology License Agreement+
10.15 Technology Assignment and Joint Ownership Agreement+
10.16 Development Project Agreement+
10.17 Preferred Stock and Warrant Purchase Agreement+
10.18 Certificate of Designations, Preferences and Rights of
Series B Convertible Participating Preferred Stock of Avaya
Inc. (attached as Exhibit A to the Preferred Stock and
Warrant Purchase Agreement filed as Exhibit 10.17 hereto)+
10.19 Form of Warrant (attached as Exhibit B to the Preferred
Stock and Warrant Purchase Agreement filed as Exhibit 10.17
hereto)+
21 List of Subsidiaries of Avaya Inc.+
27 Financial Data Schedule+
99.1 Avaya Inc. Information Statement dated , 2000**
</TABLE>
- ---------------
** Filed herewith.
+ Previously filed.
II-2
5
SIGNATURES
Pursuant to the requirements of Section 12 of the Securities Exchange Act
of 1934, the registrant has duly caused this Registration Statement to be signed
on its behalf by the undersigned, thereunto duly authorized.
AVAYA INC.,
(Registrant)
By: /s/ DONALD K. PETERSON
------------------------------------
Name: Donald K. Peterson
Title: President and Chief
Executive Officer
Date: September 6, 2000
II-3
6
INDEX TO EXHIBITS
<TABLE>
<CAPTION>
EXHIBIT
NO. DESCRIPTION
- ------- -----------
<C> <S>
2 Contribution and Distribution Agreement+
3.1 Restated Certificate of Incorporation of Avaya Inc.+
3.2 Amended and Restated By-laws of Avaya Inc.+
4.1 Specimen Common Stock certificate**
4.2 Restated Certificate of Incorporation of Avaya Inc. (filed
as Exhibit 3.1 hereto)+
4.3 Amended and Restated By-laws of Avaya Inc. (filed as Exhibit
3.2 hereto)+
4.4 Rights Agreement between Avaya Inc. and The Bank of New
York, as Rights Agent+
4.5 Form of Certificate of Designations of Series A Junior
Participating Preferred Stock (attached as Exhibit A to the
Rights Agreement filed as Exhibit 4.4 hereto)+
4.6 Form of Right Certificate (attached as Exhibit B to the
Rights Agreement filed as Exhibit 4.4 hereto)+
10.1 Contribution and Distribution Agreement (filed as Exhibit 2
hereto)+
10.2 Interim Services and Systems Replication Agreement+
10.3 Employee Benefits Agreement+
10.4 Tax Sharing Agreement+
10.5 Avaya Inc. Short Term Incentive Plan+
10.6 Avaya Inc. 2000 Long Term Incentive Plan+
10.7 Avaya Inc. 2000 Long Term Incentive Plan Restricted Stock
Unit Award Agreement+
10.8 Avaya Inc. 2000 Long Term Incentive Plan Nonstatutory Stock
Option Agreement+
10.9 Avaya Inc. Deferred Compensation Plan+
10.10 Employment Agreement of Mr. Peterson, dated August 8, 1995+
10.11 Avaya Inc. Supplemental Pension Plan+
10.12 Avaya Inc. 2000 Stock Compensation Plan for Non-Employee
Directors+
10.13 Trademark License Agreement+
10.14 Patent and Technology License Agreement+
10.15 Technology Assignment and Joint Ownership Agreement+
10.16 Development Project Agreement+
10.17 Preferred Stock and Warrant Purchase Agreement+
10.18 Certificate of Designations, Preferences and Rights of
Series B Convertible Participating Preferred Stock of Avaya
Inc. (attached as Exhibit A to the Preferred Stock and
Warrant Purchase Agreement filed as Exhibit 10.17 hereto)+
10.19 Form of Warrant (attached as Exhibit B to the Preferred
Stock and Warrant Purchase Agreement filed as Exhibit 10.17
hereto)+
21 List of Subsidiaries of Avaya Inc.+
27 Financial Data Schedule+
99.1 Avaya Inc. Information Statement dated , 2000**
</TABLE>
- ---------------
** Filed herewith.
+ Previously filed.
1
Exhibit 4.1
COMMON STOCK COMMON STOCK
PAR VALUE $.01 PAR VALUE $.01
CUSIP 053499 10 9
SEE REVERSE FOR CERTAIN DEFINITIONS
[AVAYA LOGO]
INCORPORATED UNDER THE LAWS OF THE STATE OF DELAWARE
This certifies that
is the owner of
CERTIFICATE OF STOCK
FULLY PAID AND NON-ASSESSABLE SHARES OF THE COMMON STOCK OF
Avaya Inc., transferable on the books of the corporation by the holder hereof
in person or by duly authorized attorney upon surrender of this certificate
properly endorsed. This certificate is not valid until countersigned properly by
the Transfer Agent and registered by the Registrar.
Witness the facsimile seal of the corporation and the facsimile signatures of
its duly authorized officers.
Dated:
Countersigned and Registered:
THE BANK OF NEW YORK
By Transfer Agent
and Registrar Pamela F. Craven Donald K. Peterson
Authorized Signature VICE PRESIDENT PRESIDENT AND CHIEF
AND SECRETARY EXECUTIVE OFFICER
2
AVAYA INC.
THE CORPORATION WILL FURNISH WITHOUT CHARGER TO EACH STOCKHOLDER WHO
WHO SO REQUESTS A STATEMENT OF THE POWERS, DESIGNATIONS, PREFERENCES AND
RELATIVE, PARTICIPATING, OPTIONAL OR OTHER SPECIAL RIGHTS OF EACH CLASS OF STOCK
OR SERIES THEREOF OF THE CORPORATION AND THE QUALIFICATIONS, LIMITATIONS OR
RESTRICTIONS OF SUCH PREFERENCES AND/OR RIGHTS. SUCH REQUEST MAY BE MADE TO THE
TRANSFER AGENT.
The following abbreviations, when used in the inscription on the face of
this certificate, shall be construed as though they were written out in full
according to applicable laws or regulations:
TEN COM - as tenants in common UNIF GIFT MIN ACT- ........Custodian..........
(Cust) (Minor)
TEN ENT - as tenant by the entireties under Uniform Gifts to Minors
JT TEN - as joint tenants with right Act..........................
of survivorship and not as (State)
tenants in common
Additional abbreviations may also be used though not in the above list.
NOTICE: The signature(s) to this assignment must correspond with the name
as written upon the face of the Certificate. In every particular, without
alteration or enlargement or any change whatever.
For value received, _______________hereby sell, assign and transfer unto
PLEASE INSERT SOCIAL SECURITY OR OTHER
INDENTIFICATION NUMBER OF ASSIGNEE
................................................................................
................................................................................
PLEASE PRINT OR TYPEWRITE NAME AND ADDRESS, INCLUDING POSTAL ZIP CODE, OF
ASSIGNEE
................................................................................
................................................................................
..........................................................................Shares
of the Common Stock represented by the within Certificate and do hereby
irrevocably constitute and appoint..............................................
........................................................................Attorney
to transfer the said stock on the books of the within-named Corporation with
full power of substitution in the premises.
Dated:
..................................
X ________________________________________
X ________________________________________
THE SIGNATURE(S) MUST BE GUARANTEED BY AN
ELIGIBLE GUARANTOR INSTITUTION (BANKS,
STOCKBROKERS, SAVINGS AND LOAN ASSOCIATIONS
AND CREDIT UNIONS WITH MEMBERSHIP IN AN
APPROVED SIGNATURE GUARANTEE MEDALLION
PROGRAM) PURSUANT TO S.E.C. RULE 17Ad-15.
THIS CERTIFICATE ALSO EVIDENCES AND ENTITLES THE HOLDER HEREOF TO CERTAIN
RIGHTS AS SET FORTH IN A RIGHTS AGREEMENT BETWEEN AVAYA INC. AND THE BANK OF
NEW YORK, DATED AS OF SEPTEMBER 29, 2000, AS AMENDED FROM TIME TO TIME (THE
"RIGHTS AGREEMENT"), THE TERMS OF WHICH ARE HEREBY INCORPORATED HEREIN BY
REFERENCE AND A COPY OF WHICH IS ON FILE AT THE PRINCIPAL EXECUTIVE OFFICES OF
AVAYA INC. UNDER CERTAIN CIRCUMSTANCES, AS SET FORTH IN THE RIGHTS AGREEMENT,
SUCH RIGHTS WILL BE EVIDENCED BY SEPARATE CERTIFICATES AND WILL NO LONGER BE
EVIDENCED BY THIS CERTIFICATE. AVAYA INC. WILL MAIL TO THE HOLDER OF THIS
CERTIFICATE A COPY OF THE RIGHTS AGREEMENT WITHOUT CHARGE AFTER RECEIPT OF A
WRITTEN REQUEST THEREFOR. UNDER CERTAIN CIRCUMSTANCES, AS SET FORTH IN THE
RIGHTS AGREEMENT, RIGHTS ISSUED TO ANY PERSON WHO BECOMES AN ACQUIRING PERSON
(AS DEFINED IN THE RIGHTS AGREEMENT) MAY BECOME NULL AND VOID.
1
LUCENT TECHNOLOGIES INC.
600 MOUNTAIN AVENUE
MURRAY HILL, NJ 07974
September , 2000
Dear Shareowner:
I am pleased to report that the previously announced spinoff of Lucent's
enterprise communications businesses is expected to become effective on
September 30, 2000. Avaya Inc., a recently formed Delaware corporation that will
own all these enterprise communications businesses, will commence operation on
that day as an independent public company. Avaya's shares of common stock will
be listed on the New York Stock Exchange under the symbol "AV."
Holders of record of Lucent common stock as of the close of business on
September 20, 2000, which will be the record date, will receive one share of
Avaya common stock for every 12 shares of Lucent common stock held. No action is
required on your part to receive your Avaya shares. You will not be required
either to pay anything for the new shares or to surrender any shares of Lucent
common stock.
No fractional shares of Avaya common stock will be issued. If you otherwise
would be entitled to a fractional share you will receive a check for the cash
value thereof, which may be taxable to you. In due course you will be provided
with information to enable you to compute your tax bases in both Lucent and
Avaya common stock. Lucent has received a ruling from the Internal Revenue
Service to the effect that, for U.S. Federal income tax purposes, the
distribution of Avaya common stock is tax-free to Lucent and to you to the
extent that you receive Avaya common stock.
The enclosed information statement describes the distribution of shares of
Avaya common stock and contains important information about Avaya, including
financial statements. I suggest that you read it carefully. If you have any
questions regarding the distribution, please contact Lucent's transfer agent,
The Bank of New York, telephone (888) 582-3686 or +1 (908) 769-9611
(International), TDD or TTY: 1-800-711-7072, or send an e-mail to The Bank of
New York at lu-shareholders-svcs@email.bony.com.
Sincerely,
RICHARD A. MCGINN
Chairman and Chief Executive Officer
2
SUBJECT TO COMPLETION, DATED SEPTEMBER 6, 2000
INFORMATION STATEMENT
[AVAYA LOGO]
DISTRIBUTION OF APPROXIMATELY 278,292,661 SHARES OF COMMON STOCK
This information statement is being furnished in connection with the
distribution by Lucent Technologies Inc. to holders of its common stock of all
the outstanding shares of common stock of Avaya Inc. Lucent has transferred or
will transfer to us its enterprise communications businesses described in this
information statement.
Shares of our common stock will be distributed to holders of Lucent common
stock of record as of the close of business on September 20, 2000, which will be
the record date. Each such holder will receive one share of our common stock for
every 12 shares of Lucent common stock held on the record date. The distribution
will be effective at 11:59 p.m. on September 30, 2000. Shareowners will receive
cash in lieu of fractional shares, which may be taxable.
No shareowner approval of the distribution is required or sought. We are
not asking you for a proxy and you are requested not to send us a proxy. Lucent
shareowners will not be required to pay for the shares of our common stock to be
received by them in the distribution, or to surrender or to exchange shares of
Lucent common stock in order to receive our common stock, or to take any other
action in connection with the distribution. Each share of our common stock
distributed will be accompanied by one preferred stock purchase right. There is
no current trading market for our common stock. We have been approved, subject
to issuance, to list our common stock on the New York Stock Exchange under the
symbol "AV."
IN REVIEWING THIS INFORMATION STATEMENT, YOU SHOULD CAREFULLY CONSIDER THE
MATTERS DESCRIBED UNDER THE CAPTION "RISK FACTORS" ON PAGES 14.
------------------------
NEITHER THE SECURITIES AND EXCHANGE COMMISSION NOR ANY STATE SECURITIES
COMMISSION HAS APPROVED OR DISAPPROVED THESE SECURITIES OR DETERMINED IF THIS
INFORMATION STATEMENT IS TRUTHFUL OR COMPLETE. ANY REPRESENTATION TO THE
CONTRARY IS A CRIMINAL OFFENSE.
------------------------
THIS INFORMATION STATEMENT DOES NOT CONSTITUTE AN OFFER TO SELL OR THE
SOLICITATION OF AN OFFER TO BUY ANY SECURITIES.
------------------------
Shareowners of Lucent with inquiries related to the distribution should
contact Lucent's transfer agent, The Bank of New York, P.O. Box 11009, Church
Street, New York, New York 10286-1009, telephone (888) 582-3686 or +1 (908)
769-9611 (International), TDD or TTY 1-800-711-7072, or send an e-mail to The
Bank of New York at lu-shareholders-svcs@email.bony.com.
The date of this information statement is September , 2000.
3
INFORMATION STATEMENT
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Summary..................................................... 1
The Distribution............................................ 8
Risk Factors................................................ 14
Forward Looking Statements.................................. 24
Dividend Policy............................................. 25
Capitalization.............................................. 26
Selected Financial Information.............................. 28
Unaudited Pro Forma Condensed Financial Statements.......... 29
Management's Discussion and Analysis of Financial Condition
and Results of Operations................................. 36
Business.................................................... 53
Relationship Between Lucent and Our Company After the
Distribution.............................................. 84
Management.................................................. 95
Ownership of Our Common Stock............................... 106
Description of Capital Stock................................ 108
Related Transactions and Equity Investment.................. 119
Shares Eligible for Future Sale............................. 122
Indemnification of Directors and Officers................... 123
Available Information....................................... 125
Index to Combined Financial Statements...................... F-1
</TABLE>
i
4
SUMMARY
The following is a summary of some of the information contained in this
information statement. In addition to this summary, we urge you to read the
entire information statement carefully, especially the risks of investing in our
common stock discussed under "Risk Factors" and our financial statements.
We describe in this information statement the businesses to be contributed
to us by Lucent Technologies Inc. immediately prior to the distribution,
described under "-- The Distribution," as if they were our businesses for all
historical periods described. Following the distribution, we will be an
independent public company, and Lucent will have no continuing stock ownership
in us. Accordingly, our historical financial results as part of Lucent contained
herein may not reflect our financial results in the future as an independent
company or what our financial results would have been had we been a stand-alone
company during the periods presented.
OUR COMPANY
We are a leading provider of communications systems and software for
enterprises, including businesses, government agencies and other organizations.
We offer voice, converged voice and data, customer relationship management,
messaging, multi-service networking and structured cabling products and
services. Multi-service networking products are products that support network
infrastructures which carry voice, video and data traffic over any of the
protocols, or sets of procedures, supported by the Internet on local area and
wide area data networks. A structured cabling system is a flexible cabling
system designed to connect phones, workstations, personal computers, local area
networks and other communications devices within a building or across one or
more campuses.
We are a worldwide leader in sales of messaging and structured cabling
systems and a U.S. leader in sales of enterprise voice communications and call
center systems. We are not a leader in multi-service networking products or in
converged voice and data products. We have entered these product areas
relatively recently, and our product portfolio is less complete than the
portfolios of some of our competitors. We are implementing a strategy focused on
these products. Our broad customer base includes approximately 78% of the
Fortune 500 companies. In fiscal 1999, we had revenue of approximately $8.3
billion and net income of approximately $300 million.
We support our customers with comprehensive global service offerings,
including remote diagnostics testing of our advanced systems, installation of
our products, on-site repair and maintenance. We believe our global service
organization is an important consideration for customers purchasing our systems
and software and is a source of significant revenue for us, primarily from
maintenance contracts. We also offer professional services for customer
relationship management and value-added services for the outsourcing of
messaging and other portions of an enterprise's communications system.
We intend to use our leadership positions in enterprise communications
systems and software, our broad portfolio of products and services and strategic
alliances with other technology and consulting services leaders to offer our
customers comprehensive eBusiness communications solutions. By eBusiness, we
mean the internal and external use of communications tools and electronic
networks to interact, collaborate and transact business with an enterprise's
customers, suppliers, partners and employees.
We have historically operated as part of Lucent. In connection with our
separation from Lucent, we are engaging in a comprehensive review of our
operations, including our organizational structure, products and services and
market segments. Based on this review, we expect to begin implementing a
company-wide restructuring in the fourth quarter of fiscal 2000, with a view
toward improving our profitability and business performance as a stand-alone
company. After our restructuring plan is finalized and approved by our board of
directors, we expect to record charges in connection with this plan of $700
million to $800 million in the fourth quarter of fiscal 2000. In addition, we
expect to incur one time expenses during the first two quarters of fiscal 2001
in connection with our separation from Lucent and our establishment as an
1
5
independent company in the range of $150 million to $200 million. As a result of
our restructuring plan and strategic initiatives, we intend to:
- reduce our costs of products and services;
- reduce our corporate overhead expenses;
- increase our investment in research and development;
- implement a tax strategy tailored to our operations as a stand-alone
company; and
- increase our revenue growth by focusing our sales and product development
efforts on the higher growth segments of our market.
Lucent was formed from the systems and technology units that were formerly
a part of AT&T Corp. and the research and development capabilities of Bell
Laboratories. On September 30, 1996, Lucent became independent of AT&T when AT&T
distributed all its Lucent shares to its shareowners in a tax-free spinoff.
Lucent, as a whole, designs, develops and manufactures communications systems,
software and products for enterprises, service providers and equipment
manufacturers.
Through this distribution, Lucent is spinning off its businesses primarily
focused on enterprise communications, which are the businesses described in this
information statement as our businesses. In fiscal year 1999, our businesses
accounted for approximately 11% of Lucent's assets, 6% of Lucent's net income
and 21% of Lucent's total revenue. Our businesses have exhibited different
growth characteristics, customers, distribution channels and technological
evolution than Lucent's other businesses which focused on service providers and
equipment manufacturers. Those differences are expected to continue in the
future. In particular, our traditional business, enterprise voice communications
systems, is characterized by a relatively low industry growth rate, as compared
to the pace of growth of the overall communications market. The market segments
addressed by Lucent's businesses focused on service providers and equipment
manufacturers are growing at significantly higher rates than the market segments
of our traditional business. The separation will allow us to focus greater
management attention and resources on opportunities for our businesses in the
communications market, including opportunities in higher growth market areas,
and to focus on better managing our cost structure. Lucent will similarly
benefit by being able to focus on its retained businesses and its growth
opportunities.
STRATEGY
Our objective is to become the leading worldwide provider of communications
solutions for enterprises operating in the rapidly changing eBusiness
environment. To accomplish this goal, we are pursuing the following three major
strategies:
- improving our profitability and business performance by using the
opportunities we believe are available to us as a stand-alone company;
- capitalizing on near-term revenue growth opportunities in international
sales, distribution and customer relationship management products and
services; and
- positioning ourselves to capitalize on long-term growth opportunities by
focusing on advanced enterprise communications products that support
eBusiness solutions, which we believe are the high growth areas of our
market.
2
6
THE DISTRIBUTION
Please see "The Distribution" for a more detailed description of the
matters described below.
DISTRIBUTING COMPANY Lucent Technologies Inc., one of the world's
leading designers, developers and manufacturers of
communications systems, software and products.
Lucent currently operates in three major business
segments: service provider networks, enterprise
networks and microelectronics and communications
technologies.
DISTRIBUTED COMPANY Avaya Inc., which will own the enterprise
communications businesses formerly conducted by
Lucent and described in this information statement.
Please see "Management's Discussion and Analysis of
Financial Condition and Results of Operations" and
"Business" for a description of these businesses.
DISTRIBUTION RATIO Each holder of Lucent common stock will receive a
dividend of one share of our common stock, and the
associated preferred stock purchase right, for
every 12 shares of Lucent common stock held on the
record date.
SECURITIES TO BE
DISTRIBUTED Based on 3,339,511,932 shares of Lucent common
stock outstanding on June 30, 2000 and assuming no
exercise of outstanding options, approximately
278,292,661 shares of our common stock, together
with the associated preferred stock purchase
rights, will be distributed. The shares of our
common stock to be distributed will constitute all
of the outstanding shares of our common stock
immediately after the distribution. Lucent
shareowners will not be required to pay for the
shares of our common stock to be received by them
in the distribution, or to surrender or exchange
shares of Lucent common stock in order to receive
our common stock, or to take any other action in
connection with the distribution.
FRACTIONAL SHARES Fractional shares of our common stock will not be
distributed. Fractional shares held by holders of
record will be aggregated and sold in the public
market by the distribution agent. The aggregate net
cash proceeds of these sales will be distributed
ratably to those shareowners who would otherwise
have received fractional interests. These proceeds
may be taxable to those shareowners.
DISTRIBUTION AGENT,
TRANSFER AGENT AND
REGISTRAR FOR THE SHARES The Bank of New York will be the distribution
agent, transfer agent and registrar for the shares
of our common stock.
RECORD DATE The record date is the close of business on
September 20, 2000.
DISTRIBUTION DATE 11:59 p.m. on September 30, 2000.
FEDERAL INCOME TAX
CONSEQUENCES OF THE
DISTRIBUTION Lucent has received a ruling from the Internal
Revenue Service to the effect that the distribution
will qualify as a tax-free transaction under
Sections 355 and 368(a)(1)(D) of the Internal
Revenue Code of 1986, as amended.
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STOCK EXCHANGE LISTING There is not currently a public market for our
common stock. We have been approved, subject to
issuance, to list our common stock on the New York
Stock Exchange under the symbol "AV." It is
anticipated that trading will commence on a
when-issued basis prior to the distribution. When
issued trading refers to a transaction made
conditionally because the security has been
authorized but not yet issued. On the first trading
day following the distribution date, when-issued
trading in respect of our common stock will end and
regular-way trading will begin. Regular way trading
refers to trading after a security has been issued
and typically involves a transaction that settles
on the third full business day following the date
of a transaction. We cannot predict the trading
prices for our common stock before or after the
distribution date, however, we believe the presence
of a when-issued trading market prior to the
distribution may have a stabilizing effect on the
price of our common stock following the
distribution.
ASSUMPTION OF LUCENT
COMMERCIAL PAPER PROGRAM Prior to the distribution, Lucent intends to issue
$700 million of short-term debt under a commercial
paper program, which will be assumed by us at the
distribution date. The $700 million of debt we will
assume from Lucent represents the portion of
Lucent's liabilities that Lucent has determined
should be attributed to our businesses. We may
assume additional debt under the commercial paper
program to the extent additional debt is incurred
by Lucent under the program to fund restructuring
or separation costs and expenses that we may incur
prior to the distribution. We may also assume
additional debt under the program for our working
capital if there is a substantial increase in our
working capital over our current plan prior to the
distribution. We also will assume Lucent's
obligations under two related revolving credit
facilities. Upon the distribution, Lucent will be
relieved of all obligations under the program.
Accordingly, upon the distribution, we will become
obligated to satisfy all payments and other terms
of this commercial paper program and the related
revolving credit facilities.
RELATIONSHIP BETWEEN LUCENT
AND US AFTER THE
DISTRIBUTION Following the distribution, we will be an
independent public company, and Lucent will have no
continuing stock ownership interest in us. Prior to
the distribution, we and Lucent will enter into a
Contribution and Distribution Agreement and several
ancillary agreements for the purpose of
accomplishing the contribution of Lucent's
enterprise communications businesses to us and the
distribution of our common stock to Lucent's
shareowners. These agreements also will govern our
relationship with Lucent subsequent to the
distribution and provide for the allocation of
employee benefit, tax and some other liabilities
and obligations attributable to periods prior to
the distribution. These agreements also include
arrangements with respect to intellectual property,
interim services and a number of on-going
commercial relationships, including product supply
arrangements. The Contribution and Distribution
Agreement includes an agreement that we generally
will indemnify Lucent against liabilities arising
out of its enterprise communications businesses
being transferred to us and that Lucent generally
will indemnify us against liabilities arising out
of Lucent's
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retained businesses. Please see "Relationship
Between Lucent and Our Company After the
Distribution" for a more detailed description of
these agreements.
POST-DISTRIBUTION DIVIDEND
POLICY We do not anticipate paying any dividends on our
common stock in the foreseeable future. The payment
and amount of dividends by us after the
distribution, however, will be subject to the
discretion of our board of directors.
ANTI-TAKEOVER EFFECTS Under the terms of the Contribution and
Distribution Agreement, if a change of control of
us occurs prior to the third anniversary of the
date of the distribution, Lucent could terminate or
cause us to reconvey some of the rights, including
important intellectual property rights, granted
under the agreements which we are entering into
with Lucent. This may discourage a change of
control transaction during that period. In
addition, some provisions of our certificate of
incorporation and by-laws, as each will be in
effect following the distribution, may have the
effect of making more difficult an acquisition of
control of us in a transaction not approved by our
board of directors. Our rights agreement also will
make more difficult an acquisition of control of us
in a transaction not approved by our board of
directors.
RISK FACTORS Shareowners should carefully consider the matters
discussed under "Risk Factors."
OUR PRINCIPAL EXECUTIVE
OFFICES 211 Mount Airy Road
Basking Ridge, NJ 07920
(908) 953-6000
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SUMMARY HISTORICAL AND PRO FORMA FINANCIAL INFORMATION
The following table sets forth our summary historical and pro forma
financial information derived from our audited combined financial statements for
the fiscal years ended and as of September 30, 1997, 1998 and 1999, our
unaudited interim combined financial statements for the nine months ended and as
of June 30, 2000, and our unaudited pro forma condensed financial statements
included elsewhere in this information statement. Such summary financial
information may not be indicative of our future performance as an independent
company. In our opinion, all adjustments, which consist only of normal and
recurring accruals, considered necessary for a fair presentation have been
included in our unaudited combined financial statements. The unaudited pro forma
combined financial statements were prepared as if the distribution and related
transactions had occurred as of June 30, 2000 for the unaudited pro forma
condensed balance sheet, and as of October 1, 1998, for the unaudited pro forma
condensed statements of income. Our fiscal year ends on September 30 each year.
The summary financial information should be read in conjunction with
"Management's Discussion and Analysis of Financial Condition and Results of
Operations," the unaudited pro forma condensed financial statements and the
notes thereto and the combined financial statements and the notes thereto
included elsewhere in this information statement.
The pro forma balance sheet gives effect to the assumption by us from
Lucent of $700 million of short-term debt under a commercial paper program that
Lucent will enter into prior to the distribution. We may assume additional debt
under the commercial paper program to the extent additional debt is incurred by
Lucent under the program to fund restructuring or separation costs and expenses
that we may incur prior to the distribution. We may also assume additional debt
under the program for our working capital if there is a substantial increase in
our working capital over our current plan prior to the distribution. Upon the
distribution, Lucent will be relieved of all obligations under the program. In
addition, we currently anticipate requiring approximately $600 million of
additional financing over the next eight months to fund costs and expenses in
connection with the planned restructuring and separation, including the portion
of these costs and expenses that we may incur prior to the distribution. We have
not yet finalized the type of this additional financing. After the distribution,
we may refinance all or a part of the commercial paper program with long-term or
other short-term debt.
The pro forma balance sheet includes the impact of the estimated net assets
and deferred taxes we will receive in connection with Lucent's prepaid pension
costs and long-term postretirement liabilities associated with the related
employees that will be transferred to us at the date of distribution. The pro
forma adjustments are based upon available information and assumptions that we
believe are reasonable. Please see the notes to unaudited pro forma condensed
financial statements for a discussion of how these adjustments are presented in
the pro forma financial statements.
The pro forma financial information does not reflect many significant
changes that may occur after the distribution in our financing plans and cost
structure, including costs or savings related to our planned restructuring or
our manufacturing initiative. In particular, we have not made adjustments for
our anticipated requirement for approximately $600 million of additional
financing over the next eight months.
The pro forma balance sheet also does not include the impact of the $400
million we expect to receive for the 4,000,000 shares of Series B convertible
participating preferred stock and the warrants to purchase shares of our common
stock we expect to issue upon consummation of the equity investment by Warburg,
Pincus Equity Partners, L.P. and related investment funds after completion of
the distribution. No amounts have yet been ascribed to potential beneficial
conversion features, as described in the "Unaudited Pro Forma Condensed
Financial Statements," which amounts will only be determinable after the
distribution. The conversion features, the accretion to liquidation value for
the Series B convertible participating preferred stock and any beneficial
conversion features will dilute both basic and diluted earnings per share. For a
more detailed description of this equity investment, please see "Management's
Discussion and Analysis of Financial Condition and Results of
Operations -- Liquidity and Capital Resources" and "Related Transactions and
Equity Investment."
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SUMMARY HISTORICAL AND PRO FORMA FINANCIAL INFORMATION -- (CONTINUED)
<TABLE>
<CAPTION>
PRO FORMA HISTORICAL PRO FORMA HISTORICAL
NINE MONTHS NINE MONTHS FISCAL YEAR FISCAL YEAR ENDED
ENDED ENDED ENDED SEPTEMBER 30,
JUNE 30, JUNE 30, SEPTEMBER 30, -----------------------------------
2000 2000 1999 1999 1998 1997
----------- ----------- ------------- ---- ---- ----
(UNAUDITED) (UNAUDITED) (UNAUDITED)
(DOLLARS IN MILLIONS)
<S> <C> <C> <C> <C> <C> <C>
STATEMENT OF INCOME INFORMATION:
Revenue.......................................... $5,664 $5,664 $8,268 $8,268 $7,754 $6,413
Costs............................................ 3,152 3,152 4,564 4,564 4,107 3,285
Gross margin..................................... 2,512 2,512 3,704 3,704 3,647 3,128
Operating expenses:
Selling, general and administrative............ 1,880 1,880 2,795 2,795 2,609 2,186
Research and development....................... 350 350 540 540 423 346
Purchased in-process research and
development.................................. -- -- -- -- 306 472
Total operating expenses......................... 2,230 2,230 3,335 3,335 3,338 3,004
Operating income................................. 282 282 369 369 309 124
Other income -- net.............................. 54 54 28 28 25 17
Interest expense................................. 59 59 90 90 94 59
Provision for income taxes....................... 109 109 121 121 197 230
Income (loss) before cumulative effect of
accounting change.............................. 168 168 186 186 43 (148)
Cumulative effect of accounting change (net of
income taxes of $62 for the year ended
September 30, 1999)............................ -- -- 96 96 -- --
Net income (loss)................................ 168 168 282 282 43 (148)
BALANCE SHEET INFORMATION:
Total assets..................................... 4,609 4,076 4,239 4,177 3,340
Total debt....................................... 704 4 10 14 25
</TABLE>
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THE DISTRIBUTION
GENERAL
The board of directors of Lucent has approved the distribution of all of
the outstanding shares of our common stock to the holders of Lucent common
stock. In the distribution, each holder of Lucent common stock will receive as a
dividend one share of our common stock and an associated preferred stock
purchase right for every 12 shares of Lucent common stock held on September 20,
2000, which will be the record date. Please see "Description of Capital
Stock -- Rights Agreement" for a description of these rights.
MANNER OF EFFECTING THE DISTRIBUTION
The general terms and conditions relating to the distribution are set forth
in the Contribution and Distribution Agreement between us and Lucent. Under the
Contribution and Distribution Agreement, the distribution will be effective at
11:59 p.m. on the distribution date, September 30, 2000. For most Lucent
shareowners who own Lucent common stock in registered form or participate in The
Bank of New York's BuyDIRECT(SM) program on the record date, our transfer agent
will credit their shares of Avaya common stock to book entry accounts
established to hold their Avaya common stock. Our distribution agent will send
these shareowners a statement reflecting their Avaya common stock ownership.
Book entry refers to a method of recording stock ownership in our records in
which no physical certificates are used. For shareowners who own Lucent common
stock through a broker or other nominee their shares of Avaya common stock will
be credited to these shareowners' accounts by the broker or other nominee. As
further discussed below, fractional shares will not be distributed. A delivery
of a share of our common stock in connection with the distribution also will
constitute the delivery of the preferred stock purchase right associated with
such share. These rights are intended to have anti-takeover effects. The
existence of the rights may deter a potential acquiror from making a takeover
proposal or a tender offer. For a more detail discussion of these rights, please
see "Description of Capital Stock -- Rights Agreement." Following the
distribution, shareowners whose shares are held in book entry form may request
that their shares of our common stock be transferred to a brokerage or other
account at any time, as well as delivery of physical stock certificates for
their shares, in each case without charge.
LUCENT SHAREOWNERS WILL NOT BE REQUIRED TO PAY FOR SHARES OF OUR COMMON
STOCK RECEIVED IN THE DISTRIBUTION, OR TO SURRENDER OR EXCHANGE SHARES OF LUCENT
COMMON STOCK IN ORDER TO RECEIVE OUR COMMON STOCK, OR TO TAKE ANY OTHER ACTION
IN CONNECTION WITH THE DISTRIBUTION. NO VOTE OF LUCENT SHAREOWNERS IS REQUIRED
OR SOUGHT IN CONNECTION WITH THE DISTRIBUTION, AND LUCENT SHAREOWNERS HAVE NO
APPRAISAL RIGHTS IN CONNECTION WITH THE DISTRIBUTION.
Fractional shares of our common stock will not be issued to Lucent
shareowners as part of the distribution nor credited to book entry accounts. In
lieu of receiving fractional shares, each holder of Lucent common stock who
would otherwise be entitled to receive a fractional share of our common stock
will receive cash for the fractional interest, which may be taxable to such
holder. For an explanation of the tax consequences of the distribution, please
see "-- Federal Income Tax Consequences of the Distribution." The distribution
agent will, as soon as practicable after the distribution date, aggregate
fractional shares held by holders of record into whole shares and sell them in
the open market at the prevailing market prices and distribute the aggregate
proceeds, net of brokerage fees, ratably to Lucent shareowners otherwise
entitled to fractional interests. The amount of this payment will depend on the
prices at which the aggregated fractional shares are sold by the distribution
agent in the open market shortly after the distribution date. We will be
responsible for any payment of brokerage fees. The amount of these brokerage
fees is not expected to be material to us.
In addition, at the time of the distribution, each outstanding unvested
option to purchase Lucent common stock held by our employees on the distribution
date will be converted into a similar option for our common stock.
In order to be entitled to receive shares of our common stock in the
distribution, Lucent shareowners must be shareowners at the close of business on
the record date, September 20, 2000.
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The chart set forth below illustrates the distribution ratio by showing the
number of our shares and/or the amount of cash that a Lucent shareowner would
receive pursuant to the distribution for varying amounts of Lucent shares held
as of the record date for the distribution assuming a distribution ratio of one
share of our common stock for every 12 shares of Lucent common stock held.
<TABLE>
<CAPTION>
- ----------------------------------------------------------------------------------------------------------------------
SHARES OF LUCENT
COMMON STOCK 10 Shares 12 Shares 20 Shares 48 Shares
- ---------------- --------- --------- --------- ---------
- ----------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
SHARES OF OUR COMMON 0 shares of our common 1 share of our common 1 share of our common 4 shares of our common
STOCK TO BE RECEIVED stock and cash for .83 stock and no cash stock and cash for .67 stock and no cash
UPON DISTRIBUTION fractional share fractional share
- ----------------------------------------------------------------------------------------------------------------------
</TABLE>
Because the distribution will be effected in the manner described above,
many of our shareowners may hold odd lots, or blocks of less than 100, of our
shares. An investor selling an odd lot may be required to pay a higher
commission rate than an investor selling round lots, or blocks of 100 shares.
REASONS FOR THE DISTRIBUTION
Lucent's board of directors has determined that separation of our
businesses from Lucent's other businesses is in the best interests of Lucent and
its shareowners. The separation will allow us to focus greater management
attention and resources on opportunities for our businesses in the
communications market and to focus on better managing our cost structure. Lucent
will similarly benefit by being able to focus on its retained businesses and
their growth opportunities.
In deciding how to achieve Lucent's business purpose of separating our
businesses from Lucent's, Lucent determined that a spin-off of our business was
the only transaction that would be nontaxable, practical and not unduly
expensive. In determining that the separation is in the best interests of Lucent
and its shareowners, Lucent's board of directors considered the potential
negative effect of restrictions, due to tax considerations caused by the
spin-off, on significant stock transactions for both Lucent and us following the
distribution. These tax considerations are more fully discussed under
"-- Federal Tax Consequences of the Distribution."
DIFFERENT BUSINESSES
Lucent currently operates in the three major business segments described
below.
- Service Provider Networks. This segment is comprised of businesses that
provide public networking systems and software to communications service
providers and public network operators around the world.
- Enterprise Networks. This segment is primarily comprised of the
businesses described in this information statement under "Business,"
which provide communications systems and software for enterprises around
the world, including businesses, government agencies and other
organizations.
- Microelectronics and Communications Technologies. This segment is
comprised of businesses that provide high-performance integrated
circuits, power systems and optoelectronic components to communications
service providers and equipment manufacturers for applications in the
communications and computing industries.
Our businesses have exhibited different growth characteristics, customers,
distribution channels and technological evolution than Lucent's other two
segments. Those differences are expected to continue in the future. Lucent's
management believes that the different businesses require inherently different
strategies in order to maximize their long-term value. Consequently, Lucent's
current structure, which involves the operation of each of these segments under
a single corporate entity, is not the most effective structure to design and
implement the distinct strategies necessary to operate each segment successfully
in a manner that maximizes its long-term value.
9
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GROWTH RATES
Our traditional business, enterprise voice communications systems, is
characterized by a relatively low industry growth rate, as compared to the pace
of growth of the overall communications market. The market segments addressed by
Lucent's other two segments are growing at significantly higher rates than the
market segments of our traditional business. Although our revenue increased by
approximately 6% in fiscal 1999 over fiscal 1998, the remainder of Lucent's
revenue grew in excess of 20% during the same period. We believe that our
separation from Lucent will allow us to focus our management and research and
development investments on higher growth segments of our market, while better
managing our cost structure.
CUSTOMERS AND DISTRIBUTION CHANNELS
Our customers are principally businesses, government agencies and other
organizations that use communications systems, software and services. We
generally produce a much larger number of sales transactions, among a much
larger number of customers, with a much smaller average dollar value, than the
other Lucent segments. We reach our customers through a direct sales force and
through indirect distribution channels, including a network of distributors,
dealers, value-added resellers and systems integrators.
By contrast, the customers of Lucent's service provider networks segment
are mainly the communications service providers that provide the worldwide
communications infrastructure. The customers of Lucent's microelectronics and
communications technologies segments are service providers and equipment
manufacturers, including Lucent, that develop and manufacture communications
equipment. The central need of those customers is for reliable, scalable,
open-standard platforms for providing communications services and interacting
with end-users of communications services. These segments generally have fewer
customers, and fewer sales transactions that have much larger average dollar
values, than we do. Lucent largely reaches those customers primarily through its
worldwide direct sales force.
TECHNOLOGY
The technology we use is different from the technology used by the other
two Lucent segments and technological evolution in our markets is of a different
type. Key technology developments for us are the development of eBusiness
communications solutions for enterprises to enable them to improve their
performance and converged voice and data solutions that can efficiently handle
an enterprise's voice and data traffic as well as the evolution of our existing
voice communications systems, applications and products. By eBusiness, we mean
the internal and external use of communications tools and electronic networks,
to interact, collaborate and transact business with an enterprise's customers,
suppliers, partners and employees. Our research and development spending will be
more focused on these product development areas in higher growth segments of our
market than on basic research. The focus of technological change in Lucent's
other two segments, however, is on high-speed infrastructure, next generation
components, networks and systems. Basic research underpins the scientific
advances that fuel these new products.
ADDITIONAL BENEFITS
We believe several additional benefits may result from the separation. The
ability for each of Lucent and us to pursue acquisitions and other investment
opportunities is expected to be enhanced by providing differentiated access to
the capital markets, such as using our own common stock for a transaction. Each
of Lucent and us will also be able to create more focused acquisition strategies
that meet the different needs of the businesses, as set forth above. Finally, we
believe there are opportunities to improve our profitability and our business
performance as a stand-alone company.
INTERESTS OF PERSONS IN THE DISTRIBUTION
Two of our director-nominees, Mr. Henry B. Schacht and Mr. Franklin A.
Thomas are members of the Lucent board of directors and voted to approve the
distribution. Upon becoming chairman of our board
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of directors, Mr. Schacht will resign from the Lucent board of directors. For
his service as chairman of our board of directors, Mr. Schacht will receive, at
the distribution, an option to acquire shares of our common stock equal to
48,500 Lucent shares at an exercise price of $42.00, converted into an option to
acquire our common stock at the same ratio as all other unvested Lucent options.
Mr. Thomas will not resign from the Lucent board of directors at the time of the
distribution. Please see "Management -- Executive Compensation."
RESULTS OF THE DISTRIBUTION
After the distribution, we will be an independent public company owning and
operating what has previously been Lucent's enterprise communications
businesses. Immediately after the distribution, we expect to have approximately
5 million holders of record of shares of our common stock and approximately
278,292,661 shares of our common stock outstanding, based on the number of
record shareowners and outstanding shares of Lucent common stock on June 30,
2000 and assuming no exercise of outstanding options, and after giving effect to
the delivery to shareowners of cash in lieu of fractional shares of our common
stock. The actual number of shares to be distributed will be determined on the
record date. Thereafter, upon consummation of our transaction with Warburg,
Pincus Equity Partners, L.P. and related investment funds, these investors will
own 4,000,000 shares of our Series B convertible participating preferred stock
as well as warrants to purchase shares of our common stock. For a more detailed
description of this equity investment, please see "Management's Discussion and
Analysis of Financial Condition and Results of Operations -- Liquidity and
Capital Resources" and "Related Transactions and Equity Investment."
For information regarding options to purchase our common stock that will be
outstanding after the distribution, see "Relationship Between Lucent and Our
Company After the Distribution -- Employee Benefits Agreement and Plans" and
"Management." Prior to the distribution, we will enter into several agreements
with Lucent in connection with, among other things, intellectual property,
interim services and a number of on-going commercial relationships, including
product supply arrangements. For a more detailed description of these
agreements, please see "Relationship Between Lucent and Our Company After the
Distribution."
The distribution will not affect the number of outstanding shares of Lucent
common stock or any rights of Lucent shareowners. Certificates representing
outstanding shares of Lucent common stock also will continue to represent rights
to purchase shares of Lucent's Series A junior participating preferred stock,
par value $1.00 per share, pursuant to the Rights Agreement, dated as of April
4, 1996, as amended, between Lucent and The Bank of New York, as rights agent.
The chart below sets forth the businesses of Lucent before and after the
distribution.
[Lucent Businesses Chart]
Lucent has recently announced plans to spin-off its microelectronics
business, which includes the optoelectronics components and integrated circuits
divisions, into a separate company.
ASSUMPTION OF LUCENT COMMERCIAL PAPER PROGRAM
Prior to the distribution, Lucent intends to issue $700 million of
short-term debt under a commercial paper program, which will be assumed by us at
the distribution date. The $700 million of debt we will
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assume from Lucent represents the portion of Lucent's liabilities that Lucent
has determined should be attributed to our businesses. We may assume additional
debt under the commercial paper program to the extent additional debt is
incurred by Lucent under the program to fund restructuring or separation costs
and expenses we may incur prior to the distribution or our working capital if
there is a substantial increase in our working capital over our current plan
prior to the distribution. We will also assume Lucent's obligations under two
related revolving credit facilities. Upon the distribution, Lucent will be
relieved of all obligations under the program. Accordingly, upon the
distribution, we will become obligated to satisfy all payments and other terms
of this commercial paper program and the related revolving credit facilities.
See "Management's Discussion and Analysis of Financial Condition and Results of
Operations" for a more detailed discussion of our restructuring, the commercial
paper program and the related revolving credit facilities.
FEDERAL INCOME TAX CONSEQUENCES OF THE DISTRIBUTION
Lucent has received a ruling from the Internal Revenue Service, or the IRS,
to the effect that the distribution will qualify as a tax-free transaction under
Sections 355 and 368(a)(1)(D) of the Internal Revenue Code, or the Code. The
ruling provides that for U.S. Federal income tax purposes:
- Lucent will not recognize any gain or loss upon the distribution;
- no gain or loss will be recognized by, or be includible in the income of,
a shareowner of Lucent common stock solely as the result of the receipt
of our common stock in the distribution, except, as described below, in
connection with cash received in lieu of fractional shares of our common
stock;
- the basis of the Lucent common stock and our common stock in the hands of
Lucent's shareowners immediately after the distribution will be the same
as the basis of the Lucent common stock immediately before the
distribution, allocated between the common stock of Lucent and us in
proportion to their relative fair market values on the date of the
distribution;
- the holding period of our common stock received by Lucent shareowners
will include the holding period of their Lucent common stock, provided
that such Lucent common stock is held as a capital asset on the date of
the distribution; and
- shareowners of Lucent who receive cash from the distribution agent in
respect of fractional shares will recognize gain or loss on the sale of
the fractional share interest equal to the difference between the cash
received and the holder's basis in such fractional share interest. Such
gain or loss will be capital gain or loss to such holder, provided the
fractional share interest is a capital asset in the hands of such holder.
Although the ruling relating to the qualification of the distribution as a
tax-free transaction is generally binding on the IRS, the continuing validity of
the ruling is subject to factual representations and assumptions. Lucent and we
are not aware of any facts or circumstances that would cause such
representations and assumptions to be untrue.
If the distribution were not to qualify as a tax-free transaction, Lucent
would recognize taxable gain equal to the excess of the fair market value of our
common stock distributed to Lucent shareowners over Lucent's tax basis in our
common stock. In addition, each shareowner who receives our common stock in the
distribution would generally be treated as receiving a taxable distribution in
an amount equal to the fair market value of our common stock received.
Even if the distribution otherwise qualifies for tax-free treatment under
Sections 355 and 368(a)(1)(D) of the Code, it may be disqualified as tax-free to
Lucent under Section 355(e) of the Code if 50% or more of the stock of Lucent or
us is acquired as part of a plan or series of related transactions that include
the distribution. For this purpose, any acquisitions of our stock or Lucent's
stock within two years before or after the distribution are presumed to be part
of such a plan, although Lucent or we may be able to rebut that presumption. If
such an acquisition of our stock or Lucent's stock triggers the application of
Section 355(e), Lucent would recognize taxable gain as described above but the
distribution
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would generally be tax-free to each Lucent shareowner. Under the tax sharing
agreement between Lucent and us, we would be required to indemnify Lucent
against that taxable gain if it were triggered by an acquisition of our stock.
Please see "Relationship Between Lucent and Our Company After the
Distribution -- Tax Sharing Agreement" for a more detailed discussion of the tax
sharing agreement between Lucent and us.
U.S. Treasury regulations require each Lucent shareowner that receives
shares of our stock in the distribution to attach to the shareowner's U.S.
Federal income tax return for the year in which such stock is received a
detailed statement setting forth such data as may be appropriate to show the
applicability of Section 355 of the Code to the distribution. Within a
reasonable period of time after the distribution, Lucent will provide its
shareowners who receive our common stock pursuant to the distribution with the
information necessary to comply with such requirement.
EACH LUCENT SHAREOWNER SHOULD CONSULT HIS OR HER TAX ADVISER ABOUT THE
PARTICULAR CONSEQUENCES OF THE DISTRIBUTION TO SUCH SHAREOWNER, INCLUDING THE
APPLICATION OF STATE, LOCAL AND FOREIGN TAX LAWS, AND POSSIBLE CHANGES IN TAX
LAW THAT MAY AFFECT THE TAX CONSEQUENCES DESCRIBED ABOVE.
LISTING AND TRADING OF OUR COMMON STOCK
There is not currently a public market for our common stock. We have been
approved, subject to issuance, to list our common stock on the New York Stock
Exchange under the symbol "AV." It is anticipated that trading will commence on
a when-issued basis prior to the distribution. When issued trading refers to a
transaction made conditionally because the security has been authorized but not
yet issued. On the first trading day following the distribution date,
when-issued trading in our common stock will end and regular-way trading will
begin. Regular way trading refers to trading after a security has been issued
and typically involves a transaction that settles on the third full business day
following the date of a transaction.
We cannot assure you as to the price at which our common stock will trade
before, on or after the distribution date. Although the price at which such
stock trades may fluctuate significantly until our common stock is fully
distributed and an orderly market develops, we believe the presence of a when-
issued trading market may have a stabilizing effect on the price of our common
stock following the distribution. In addition, the combined trading prices of
our common stock and Lucent common stock held by shareowners after the
distribution may be less than, equal to or greater than the trading price of
Lucent common stock prior to the distribution.
The shares distributed to Lucent shareowners will be freely transferable,
except for shares received by people who may have a special relationship or
affiliation with us. People who may be considered our affiliates after the
distribution generally include individuals or entities that control, are
controlled by, or are under common control with us. This may include some or all
of our officers and directors. Persons who are our affiliates will be permitted
to sell their shares only pursuant to an effective registration statement under
the Securities Act of 1933, as amended, or an exemption from the registration
requirements of the Securities Act, such as exemptions afforded by Section 4(2)
of the Securities Act or Rule 144 thereunder.
REASON FOR FURNISHING THIS INFORMATION STATEMENT
This information statement is being furnished by Lucent solely to provide
information to shareowners of Lucent who will receive shares of our common stock
in the distribution. It is not, and is not to be construed as, an inducement or
encouragement to buy or sell any of our securities. The information contained in
this information statement is believed by us to be accurate as of the date set
forth on its cover. Changes may occur after that date, and we will not update
the information except in the normal course of our respective public disclosure
obligations and practices.
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RISK FACTORS
You should carefully consider the following risk factors and all the other
information contained in this information statement in evaluating us and our
common stock.
RISKS RELATED TO OUR SEPARATION FROM LUCENT
WE HAVE NO HISTORY OPERATING AS AN INDEPENDENT COMPANY, AND WE MAY BE
UNABLE TO MAKE THE CHANGES NECESSARY TO OPERATE AS A STAND-ALONE BUSINESS, OR WE
MAY INCUR GREATER COSTS AS A STAND-ALONE COMPANY THAT MAY CAUSE OUR
PROFITABILITY TO DECLINE. Prior to the distribution, our businesses were
operated by Lucent as a segment of its broader corporate organization rather
than as a stand-alone company. Lucent assisted us by providing financing,
particularly for acquisitions, as well as providing corporate functions such as
negotiating acquisitions and legal and tax functions. Following the
distribution, Lucent will have no obligation to provide assistance to us other
than the interim services which will be provided by Lucent and which are
described in "Relationship Between Lucent and Our Company After the
Distribution." These interim services include, among others, various data
processing and telecommunications services and corporate support services,
including accounting, financial management, tax, payroll, legal, human resources
administration, procurement and other general support. Because our businesses
have never been operated as an independent company, we cannot assure you that we
will be able to successfully implement the changes necessary to operate
independently or that we will not incur additional costs operating independently
that will cause our profitability to decline.
We are in the process of creating our own, or engaging third parties to
provide, systems and business functions to replace many of the systems and
business functions Lucent provides us. We may not be successful in implementing
these systems and business functions or in transitioning data from Lucent's
systems to ours. If we do not have in place our own systems and business
functions or if we do not have agreements with other service providers once our
interim services agreement with Lucent expires, we may not be able to
effectively operate our business and our profitability may decline.
OUR HISTORICAL FINANCIAL INFORMATION MAY NOT BE REPRESENTATIVE OF OUR
RESULTS AS A SEPARATE COMPANY AND, THEREFORE, MAY NOT BE RELIABLE AS AN
INDICATOR OF OUR HISTORICAL OR FUTURE RESULTS. The historical financial
information we have included in this information statement may not reflect what
our results of operations, financial position and cash flows would have been had
we been a stand-alone company during the periods presented or what our results
of operations, financial position and cash flows will be in the future. This is
because:
- our combined financial statements reflect allocations, primarily with
respect to corporate overhead and basic research, for services provided
to us by Lucent, which allocations may not reflect the costs we will
incur for similar services as a stand-alone company; and
- the information does not reflect changes that we expect to occur in the
future as a result of our separation from Lucent, including changes in
how we fund our operations, conduct research and development and tax and
employee matters.
In addition, our combined financial statements include assets, liabilities,
revenue and expenses which were not historically recorded at the level of the
businesses transferred to us. For example, historically all financing was done
by Lucent at the parent level. Our combined financial statements, however,
reflect an estimated amount of interest expense that we believe we would have
incurred had we been a stand-alone company during the periods presented. We
cannot assure you that this estimated amount of interest expense or the other
allocations and estimates we have used to create our combined financial
statements are indicative of the actual amounts we would have incurred as a
stand-alone company. Therefore, our combined financial statements may not be
indicative of our future performance as an independent company. For additional
information about our past financial performance and the basis of presentation
of our combined financial statements, including our estimates of interest
expense, please see "Selected Financial Information," "Management's Discussion
and Analysis of Financial Condition and Results of
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Operations" and our combined financial statements and the notes thereto included
elsewhere in this information statement.
AT THE DISTRIBUTION WE WILL ASSUME A SIGNIFICANT AMOUNT OF DEBT AND MAY
SUBSTANTIALLY INCREASE OUR DEBT IN THE FUTURE, WHICH COULD SUBJECT US TO VARIOUS
RESTRICTIONS AND HIGHER INTEREST COSTS, AND DECREASE OUR PROFITABILITY. Because
historically Lucent provided financing to us and incurred debt at the parent
level, our combined financial statements do not include debt. For purposes of
including an estimated amount of interest expense that we may have incurred as a
stand-alone company, we have made assumptions regarding the average debt
balances outstanding and the interest rates for this debt. Please see
"Management's Discussion and Analysis of Financial Condition and Results of
Operations -- Overview" for details about these assumptions. Prior to the
distribution, Lucent intends to issue $700 million of short-term debt under a
commercial paper program, which we will assume at the distribution date. We have
not yet finalized the amount of the commercial paper program, but do not expect
the aggregate amount of the program to exceed $1.7 billion. We may assume
additional debt under the commercial paper program to the extent additional debt
is incurred by Lucent under the program to fund restructuring or separation
costs and expenses that we may incur prior to the distribution. We may also
assume additional debt under the program for our working capital if there is a
substantial increase in our working capital over our current plan prior to the
distribution. Lucent will retain the proceeds of all borrowings under this
commercial paper program made prior to the distribution and upon the
distribution will be relieved of all obligations under the program. In addition,
we intend to enter into two unsecured revolving credit facilities with third
party financial institutions, a 364-day credit facility and a five-year credit
facility. We have not yet finalized the amount of these credit facilities, but
do not expect the amount of the two facilities to exceed $1.7 billion in the
aggregate. Lucent will initially be a party to each of these credit facilities,
but will have no obligations thereunder following the distribution. We will be
able to borrow funds under these facilities for general corporate purposes,
including for the support of the commercial paper program or repayment of other
debt, working capital and acquisitions.
We may substantially increase our debt in the future. We currently
anticipate requiring approximately $600 million of additional financing over the
next eight months to fund costs and expenses in connection with the planned
restructuring and separation. If our cash flow from operations is less than we
expect, we may require more financing. We may from time to time issue additional
commercial paper under our commercial paper program, if the market permits such
borrowings, make borrowings under our revolving credit facilities or issue other
long or short-term debt, if available. We intend to file a debt shelf
registration statement in order to be able to access the capital to fund our
operations. The commercial paper program and future indebtedness may impose
various restrictions and covenants on us which could limit our ability to
respond to market conditions, to provide for unanticipated capital investments
or to take advantage of business opportunities. We also may incur higher than
expected interest expense in servicing our debt, which would decrease our
profitability.
WE COULD INCUR SIGNIFICANT TAX LIABILITY IF THE CONTRIBUTION OR THE
DISTRIBUTION DOES NOT QUALIFY FOR TAX-FREE TREATMENT, WHICH COULD REQUIRE US TO
PAY LUCENT A SUBSTANTIAL AMOUNT OF MONEY. Lucent and the Lucent shareowners
could incur significant tax liability if the contribution of the businesses or
the distribution described in this information statement do not qualify for
tax-free treatment. Should this occur, we could be jointly and severally liable
for, and could be required to indemnify and pay Lucent for, taxes imposed upon
Lucent with respect to the contribution or the distribution.
Lucent has received a private letter ruling from the Internal Revenue
Service indicating that the contribution of these businesses and the
distribution would not be taxable to Lucent or its shareowners. For a more
complete discussion of the ruling and the tax consequences of the distribution
being taxable, please see "The Distribution -- Federal Income Tax Consequences."
Although any U.S. Federal income taxes imposed in connection with the
distribution generally would be imposed on Lucent and its shareowners, we would
be liable for all or a portion of such taxes in the circumstances described
below. First, as part of the distribution, Lucent and we will enter into a tax
sharing agreement. This agreement will generally allocate, between Lucent and
us, the taxes and liabilities
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relating to the failure of the contribution or the distribution to be tax-free.
In addition, under the tax sharing agreement, if the distribution fails to
qualify as a tax-free distribution under Section 355 of the Internal Revenue
Code because of an acquisition of our stock or assets, or some other actions of
ours, then we will be solely liable for any resulting corporate taxes. For a
more complete discussion of the allocation of taxes and liabilities between
Lucent and us under the tax sharing agreement, please see "Relationship Between
Lucent and Our Company After the Distribution -- Tax Sharing Agreement." Second,
aside from the tax sharing agreement, under U.S. Federal income tax laws, we and
Lucent would be jointly and severally liable for Lucent's Federal income taxes
resulting from the distribution being taxable. This means that even if we do not
have to indemnify Lucent for any tax liabilities if the contribution or the
distribution fails to be tax-free, we may still be liable for any part of,
including the whole amount of, these liabilities and expenses if Lucent fails to
pay them.
BECAUSE THERE HAS NOT BEEN ANY PUBLIC MARKET FOR OUR COMMON STOCK AND OUR
STOCK MAY BE CONSIDERED A TECHNOLOGY STOCK, THE MARKET PRICE AND TRADING VOLUME
OF OUR COMMON STOCK MAY BE VOLATILE, AND YOU MAY NOT BE ABLE TO RESELL YOUR
SHARES AT OR ABOVE THE INITIAL MARKET PRICE OF OUR STOCK FOLLOWING THE
DISTRIBUTION. Prior to the distribution, there has been no trading market for
our common stock. Accordingly, we cannot predict the extent to which investors'
interest will lead to a liquid trading market or whether the market price of our
common stock will be volatile. The combined trading prices of Lucent common
stock and our common stock after the distribution may be less than, equal to or
greater than the trading price of Lucent common stock prior to the distribution.
The market price of our common stock could fluctuate significantly for many
reasons, including in response to the risk factors listed in this information
statement or for reasons unrelated to our specific performance. Our common stock
may be considered a technology stock by investors. Technology stocks have
recently experienced extreme price and volume fluctuations. Therefore, the
market price and trading volume of our common stock also may be extremely
volatile.
A NUMBER OF OUR SHARES ARE OR WILL BE ELIGIBLE FOR FUTURE SALE, WHICH MAY
CAUSE OUR STOCK PRICE TO DECLINE. Any sales of substantial amounts of our
common stock in the public market or the exercise of substantial amounts of
options or warrants or the conversion of the 4,000,000 shares of our Series B
convertible participating preferred stock, or the perception that such sales,
exercises or conversions might occur, whether as a result of the distribution or
otherwise, could cause the market price of our common stock to decline. Upon
completion of the distribution, we will have outstanding an aggregate of
278,292,661 shares of our common stock, based upon the shares of Lucent common
stock outstanding on June 30, 2000, and assuming no exercise of outstanding
options. All of these shares will be freely tradeable without restriction or
further registration under the Securities Act, unless the shares are owned by
one of our "affiliates," as that term is defined in Rule 405 under the
Securities Act. As of August 4, 2000, unvested options to purchase approximately
33,300,000 shares of Lucent common stock were outstanding and held by Lucent
employees who are expected to become our employees as of the distribution. It is
estimated that as a result of the distribution these options would represent
options to purchase approximately 56,000,000 of our shares of common stock, or
approximately 20.1 % of our outstanding stock; however, the actual amount will
not be determined until after the distribution. This concentration of stock
options relative to the amount of our common stock outstanding will have a
dilutive effect on our earnings per share which could adversely affect the
market price of our common stock. From time to time, we will issue additional
options to our employees under our existing plans and under new plans we may
adopt. Also as of August 4, 2000, approximately 500,000 restricted stock units
were held by Lucent employees who are expected to become our employees as of the
distribution, and it is estimated that these restricted stock units will convert
into approximately 840,000 restricted stock units of our company. Further,
holders of our Series B convertible participating preferred stock may convert
these preferred shares into common stock at any time and the warrants to be sold
to Warburg, Pincus Equity Partners, L.P. and related investment funds are
immediately exercisable. Please see "Description of Capital Stock" for a
description of the amount of our common stock into which the Series B
convertible participating preferred stock may be converted or for which the
warrants may be exercised.
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RISKS RELATING TO OUR BUSINESS
OUR PRODUCT REVENUE HAS BEEN DECLINING, AND IF WE DO NOT SUCCESSFULLY
IMPLEMENT OUR STRATEGY TO EXPAND OUR SALES IN MARKET SEGMENTS WITH HIGHER GROWTH
RATES, OUR REVENUE MAY CONTINUE TO DECLINE AND WE MAY NOT BE PROFITABLE. We
have been experiencing declines in revenue from our traditional business,
enterprise voice communications products, which represented 53% of total product
revenue in fiscal 1999. We expect, based on various industry reports, the
compound annual growth rate from 1999 to 2003 of the market segments for these
traditional products to be extremely low, at 1.2%. We are implementing a
strategy to capitalize on the higher growth opportunities in our market, such as
eBusiness communications solutions, including converged voice and data products.
Please see "Business-Strategy" for a more detailed description of this strategy.
The success of this strategy, however, is subject to many risks, including risks
that:
- we do not develop new products or enhancements to our current products on
a timely basis to meet the changing needs of our customers;
- customers do not accept our products or new technology or industry
standards develop that make our products obsolete; or
- our competitors introduce new products before we do and achieve a
competitive advantage by being among the first to market.
The market for our products and services is characterized by rapidly
changing technology, evolving industry standards, frequent new product
introductions and changing customer requests. For example, the recent advances
in voice communications over the Internet have created a demand for converged
voice and data products that we believe generally did not exist a year ago. If
we do not develop new products or enhancements on a timely basis, or if any of
our new products or product features do not achieve market acceptance, customers
may not purchase our products. If we do not successfully market our new
products, they may not achieve market acceptance. A number of factors, including
design or manufacturing difficulties, could delay or prevent us from developing,
introducing or marketing new products or enhancements. We have fewer resources
to acquire or develop and introduce new products as a stand-alone company than
we had as a part of Lucent. We must hire additional research and development
engineers to complete our research and development capability and compete
effectively. Consequently, we may have more difficulties in the future
developing and introducing new products on a timely basis. In addition, new
product development generally requires a substantial investment before any
assurance is available as to its commercial viability. We cannot assure you that
any of the eBusiness and converged voice and data products on which we are
focusing our research and development investments will achieve broad acceptance
in the marketplace or enhance our profitability.
WE ARE SIGNIFICANTLY CHANGING THE FOCUS OF OUR COMPANY IN ORDER TO
CONCENTRATE ON THE DEVELOPMENT AND MARKETING OF EBUSINESS SOLUTIONS, INCLUDING
CONVERGED VOICE AND DATA PRODUCTS, AND THE UNCERTAINTY SURROUNDING THIS NEW
MARKET OPPORTUNITY MAY RESULT IN A DECREASE IN OUR REVENUE AND
PROFITABILITY. In April 2000, we announced that we are making a significant
change in the direction and strategy of our company to focus on the development
and sales of advanced products to be used as components of comprehensive
eBusiness communications solutions, including products that facilitate the
convergence of voice and data networks. By eBusiness, we mean the internal and
external use of communications tools and electronic networks, to interact,
collaborate and transact business with an enterprise's customers, suppliers,
partners and employees. In order to implement this change, we must:
- retrain our sales staff to sell new types of products and improve our
marketing of such products;
- develop relationships with new types of distribution partners;
- research and develop more data products and products using communications
media other than voice traffic, which has historically been our core area
of expertise; and
- build credibility among customers that we are capable of delivering
advanced communications solutions beyond our historic product lines.
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Most of these items involve substantial increased costs, and we cannot
assure you that we will be successful. If we are not successful, our revenue and
profitability may decline. However, even if we are successful in making these
changes, our revenue may still decrease if the market opportunity for eBusiness
solutions, including converged voice and data products, does not develop in the
ways we anticipate. This market opportunity is in its early stages and we can
not assure you that:
- the demand for eBusiness solutions and converged voice and data products
will grow as fast as we anticipate;
- new technologies will cause the market to evolve in a manner different
than we expect; or
- we will be able to obtain a leadership position as this opportunity
develops.
WE MAY NOT BE ABLE TO HIRE AND RETAIN HIGHLY SKILLED EMPLOYEES, WHICH COULD
AFFECT OUR ABILITY TO COMPETE EFFECTIVELY AND MAY CAUSE OUR REVENUE AND
PROFITABILITY TO DECLINE. We depend on highly skilled technical personnel to
research and develop, market and service new products. To succeed, we must hire
and retain employees who are highly skilled in the rapidly changing
communications and Internet technologies. In particular, as we implement our
strategy of focusing on eBusiness solutions and the convergence of voice and
data networks, we will need to:
- hire a significant number of researchers in order to create a group
sufficiently large to support our strategy to continue to introduce
innovative products and to offer comprehensive eBusiness solutions;
- hire more employees with experience developing and providing eBusiness
products and services;
- hire and train a customer service organization to service our
multi-service networking products; and
- retrain our existing sales force to sell converged and eBusiness products
and services.
Individuals who have these skills and can perform the services we need to
provide our products and services are scarce. Because the competition for
qualified employees in our industry is intense, hiring and retaining employees
with the skills we need is both time-consuming and expensive. We might not be
able to hire enough of them or to retain the employees we do hire. Recently, the
uncertainty surrounding our separation from Lucent has caused retention of our
employees to be even more difficult. Our inability to hire and retain the
individuals we seek could hinder our ability to sell our existing products,
systems, software or services or to develop new products, systems, software or
services. For example, a recent loss of a significant percentage of our account
managers focused on our data networking products, a product area we believe is
important to our further success, has resulted in declines in revenue from these
products in the second and third quarters of fiscal 2000. In addition, we are
experiencing difficulties in hiring and retaining individuals with these skills
in our research and development, sales and service groups. If we do not improve
our hiring in these areas, we will not be able to successfully implement many of
the strategies described under "Business-Strategy" and our revenue and
profitability may decline.
BECAUSE WE HAVE CHANGED OUR NAME, OUR CUSTOMERS AND BUSINESS PARTNERS MAY
NOT RECOGNIZE OUR NEW BRAND, WHICH COULD ADVERSELY AFFECT OUR SALES AND
MARKETING EFFORTS AND CAUSE OUR REVENUE TO DECLINE. We have changed our name to
"Avaya Inc." We will change the trademarks and trade names under which we
conduct our business to Avaya. We will only have use of the Lucent name for a
transitional period after the distribution. Because we have previously marketed
our products under the Lucent name, our existing customers and business partners
and investors generally may not recognize our new brand. We believe that the
sale of our products and services has significantly benefitted from the use of
the Lucent brand name. The impact of the change in trademarks and trade names
cannot be fully predicted and could have a materially adverse impact on our
business and results of operations. We plan to incur significant sales and
marketing expense to build a new strong brand identity and if we don't succeed,
our profitability will be harmed.
THE TERMINATION OF STRATEGIC ALLIANCES OR THE FAILURE TO FORM ADDITIONAL
STRATEGIC ALLIANCES COULD LIMIT OUR ACCESS TO CUSTOMERS AND HARM OUR REPUTATION
WITH INVESTORS. Our strategic alliances are important to
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our success because they are necessary in order for us to offer comprehensive
eBusiness solutions, reach a broader customer base and strengthen brand
awareness. We may not be successful in creating new strategic alliances on
acceptable terms or at all. Under the terms of our separation from Lucent, for a
period of two years immediately after the distribution, if we enter into
strategic alliances with Nortel Networks Corporation or Cisco Systems, Inc.,
Lucent may terminate some of the rights, including important intellectual
property rights, that they granted to us under the agreements we are entering
into with Lucent in connection with the distribution. We cannot determine at
this time whether this prohibition will adversely affect us in the future. In
addition, most of our current strategic alliances can be terminated under
various circumstances, some of which may be beyond our control. Further, our
alliances are generally non-exclusive, which means our partners may develop
alliances with some of our competitors. We may become more reliant on strategic
alliances in the future, which would increase the risk to our business of losing
these alliances. Because we have announced publicly our strategy to form
alliances, as well as announced the alliances we have entered into, early
termination of our alliances may harm our reputation with our customers and the
investment community. This may cause our stock price to decline, whether or not
our alliances were material to our business. Termination of alliances also may
cause our revenue to decline to the extent we are unable to deliver new products
or our customer base is reduced.
BECAUSE WE ARE TARGETING ENTERPRISES FOCUSED ON EBUSINESS, OUR SUCCESS
DEPENDS LARGELY ON THE WIDESPREAD ACCEPTANCE OF EBUSINESS AND THE INTERNET. The
use and growth of the Internet is of critical importance to our strategy of
focusing on the development and sales of eBusiness solutions, which often
involve electronic networks, applications and other business functions that use
the Internet. Because we intend to target enterprises focusing on incorporating
eBusiness into their operations, if usage of the Internet does not continue to
grow, or grows at a rate significantly lower than current trends, our business
prospects will be harmed.
The continued adoption of eBusiness and other uses of the Internet depends
on many factors that are outside our control. These factors include the
following:
- development of cost-effective technology and applications that allow
enterprises to adopt eBusiness solutions;
- availability of new technology standards that facilitate easier
integration of multiple vendors' technology and applications;
- the performance and reliability of the Internet may decline as usage
grows;
- use of the Internet may decline if security and authentication concerns
regarding transmission of confidential information over the Internet and
attempts by unauthorized users, or hackers, to penetrate online security
systems grow; and
- use of the Internet may decline if the ability to gather information
about Internet users without their knowledge or consent results in
increased concerns about privacy protection or federal, state or foreign
governments adopt restrictive laws or regulations relating to the
Internet.
An example of the potential effect of these factors on our products is the
restrictions adopted by the European Union and some European countries on the
use of customer data. If other countries, regions or states adopt legislation or
other restrictions on the use of customer data or customer profiling
technologies, or if existing legislation or restrictions become more stringent,
our customer relationship management products and services may be less useful to
our clients and our revenue from these products may decline. These customer
relationship management solutions are dependent on the use of customer data
collected from various sources, including information collected on Web sites, as
well as other data derived from customer registrations, billings, purchase
transactions and surveys.
OUR QUARTERLY FINANCIAL RESULTS ARE SUBJECT TO SIGNIFICANT FLUCTUATIONS
BECAUSE OF MANY FACTORS, ANY OF WHICH COULD ADVERSELY AFFECT OUR STOCK
PRICE. Our quarterly financial results vary from quarter to quarter, primarily
because the compensation system for our sales force focuses on achieving full
year results and because many of our customers' buying behaviors fluctuate based
on their fiscal year. For example, our
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product revenue in the first fiscal quarter of 1999 and in the fourth fiscal
quarter of 1999 was approximately $1.4 billion and approximately $1.9 billion,
respectively. It is possible that in some future periods our operating results
may be below the expectations of public market analysts and investors. In this
event, the price of our common stock may decline.
WE PLAN TO EXPAND OUR INTERNATIONAL SALES, WHICH WILL SUBJECT US TO
ADDITIONAL BUSINESS RISKS AND MAY CAUSE OUR PROFITABILITY TO DECLINE DUE TO
INCREASED COSTS. We intend to continue to pursue growth opportunities
internationally. In many countries outside the United States, long-standing
relationships between our potential customers and their local providers and
protective regulations, including local content requirements and type approvals,
create barriers to entry. In addition, pursuit of such international growth
opportunities may require significant investments for an extended period before
returns on such investments, if any, are realized. For example, to execute our
strategy to expand internationally we are incurring additional costs to enter
into strategic alliances focused on international sales and expanding our
presence in high growth countries. International operations are subject to a
number of other risks and potential costs, including:
- the risks that because our new brand will not be locally recognized, we
must spend significant amounts of time and money to build a brand
identity without certainty that we will be successful;
- unexpected changes in regulatory requirements;
- inadequate protection of intellectual property in foreign countries;
- adverse tax consequences;
- dependence on developing relationships with qualified local distributors,
dealers, value-added resellers and systems integrators; and
- political and economic instability.
We cannot assure you that we will be able to overcome these barriers, or
that we will not incur significant costs in addressing these potential risks.
For example, we believe our association with the Bell Laboratories name is
particularly important in our international markets and our limited ability to
use this name after the distribution may cause a disruption in our international
sales. Sales to our international customers are denominated in either local
currency or U.S. dollars, depending on the country or channel used to fulfill
the customers' order. In addition to the foreign currency risk for our
receivables, there is additional risk associated with the fact that most of our
products or components are manufactured or sourced from the United States.
Should the U.S. dollar strengthen against a local currency, the impact may
hamper our ability to compete with other competitors, preventing us from
increasing our revenue and profitability in international markets. We manage our
net currency exposure through currency forward contracts and currency options.
Any of these factors could prevent us from increasing our revenue and
profitability in international markets.
IF WE ARE UNABLE TO PROTECT OUR PROPRIETARY RIGHTS, OUR BUSINESS AND FUTURE
PROSPECTS MAY BE HARMED. Although we attempt to protect our intellectual
property through patents, trademarks, trade secrets, copyrights, confidentiality
and nondisclosure agreements and other measures, intellectual property is
difficult to evaluate and these measures may not provide adequate protection for
our proprietary rights. Patent filings by third parties, whether made before or
after the date of our filings, could render our intellectual property less
valuable. Competitors may misappropriate our intellectual property, disputes as
to ownership of intellectual property may arise and our intellectual property
may otherwise become known or independently developed by competitors. The
failure to protect our intellectual property could seriously harm our business
and future prospects because we believe that developing new products and
technology that are unique to us is critical to our success. If we do not obtain
sufficient international protection for our intellectual property, our
competitiveness in international markets could be significantly impaired, which
would limit our growth and future revenue.
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. We cannot assure you that others will not
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claim that our proprietary or licensed products, systems and software are
infringing their intellectual property rights or that we do not in fact infringe
those intellectual property rights. We may be unaware of intellectual property
rights of others that may cover some of our technology. If someone claimed that
our proprietary or licensed systems and software infringed their intellectual
property rights, any resulting litigation could be costly and time consuming and
would 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. Claims of intellectual
property infringement also might require us to enter into costly royalty or
license agreements. However, we may be unable to obtain royalty or license
agreements on terms acceptable to us or at all. We also may be subject to
significant damages or an injunction against use of our proprietary or licensed
systems. A successful claim of patent or other intellectual property
infringement against us could materially adversely affect our business and
profitability.
We have historically indemnified our customers for some of the costs and
damages of patent infringement in circumstances where our product is the factor
creating the customer's infringement exposure, though we generally exclude
coverage where infringement arises out of the combination of our products with
products of others. This policy could have a material adverse effect on our
business and our profitability.
OUR RELIANCE ON LUCENT AS THE SINGLE SOURCE OF SOME OF OUR MULTI-SERVICE
NETWORKING PRODUCTS COULD LEAD TO DELAYS, ADDITIONAL COSTS, PROBLEMS WITH OUR
CUSTOMERS AND POTENTIAL CUSTOMERS AND LOSS OF REVENUE. Historically, Lucent has
been the only supplier of some of our multi-service networking products,
including the Access Point(R) virtual private network product, PacketStar(TM) AX
ATM access servers, SuperPipe multi-service routers, Max3000 access switches and
our firewall/virtual private network gateway products. Multi-service networking
products are products that support network infrastructures which carry voice,
video and data over any of the protocols, or sets of procedures, supported by
the Internet on local and wide area data networks. A virtual private network
allows an enterprise to transport voice, video or data over a public or shared
network at a level of security substantially equivalent to the traffic traveling
over that enterprise's own private network, and a firewall regulates internal
and external network resources and filters network content. For detailed
descriptions of these products, please see "Business -- Products and
Solutions -- Multi-service Networking." Although these products represented less
than 1% of our total product revenue in fiscal 1999, these products are
important to our strategy to provide comprehensive eBusiness solutions to our
customers and we expect some of these products to increase as a percentage of
product revenue over time. In addition, we purchase the fiber components of our
SYSTIMAX structured cabling systems and our wireless local area networking
products from Lucent for resale, and we also have purchased some semiconductor
components directly from Lucent. At the distribution, we intend to enter into
agreements with Lucent to procure these products. If, for any reason, Lucent
stops selling these products to us at commercially reasonable prices, we could
experience significant delays and cost increases, as well as product image
problems. Any of these problems could damage relationships with current or
prospective customers and distribution partners which could adversely affect our
operating results in a given period and impair our ability to generate future
sales. Please see "Business-Manufacturing and Supplies" for a more detailed
description of the products for which we have a sole supply source.
IF WE DO NOT SUCCESSFULLY IMPLEMENT OUR RESTRUCTURING PLAN, WE MAY
EXPERIENCE DISRUPTIONS IN OUR OPERATIONS AND INCUR HIGHER ONGOING COSTS, WHICH
MAY CAUSE OUR PROFITABILITY TO DECLINE. In connection with our separation from
Lucent, we are engaging in a comprehensive review of our operations, including
our organizational structure, products and services and market segments, with a
view toward improving our profitability and business performance as a
stand-alone company. As a result of this review, we expect to announce a
restructuring plan in the fourth quarter of fiscal 2000, and a related
restructuring charge. The restructuring plan also may disrupt our operations and
cause our profitability to decline.
IF WE SUCCESSFULLY IMPLEMENT OUR MANUFACTURING INITIATIVE, WE WILL DEPEND
ON CONTRACT MANUFACTURERS TO PRODUCE MOST OF OUR PRODUCTS AND IF THESE
MANUFACTURERS ARE UNABLE TO FILL OUR ORDERS ON A TIMELY AND RELIABLE BASIS, WE
WILL LIKELY BE UNABLE TO DELIVER OUR PRODUCTS TO MEET CUSTOMER ORDERS OR SATISFY
THEIR REQUIREMENTS. We have announced an initiative to outsource substantially
all of our manufacturing other than manufacturing of structured cabling systems.
If we successfully implement our manufacturing
21
25
initiative, we will depend on contract manufacturers to produce our products. We
cannot assure you that we will be successful in implementing this initiative. We
may experience significant disruption to our operations by outsourcing so much
of our manufacturing. If our contract manufacturers terminate their
relationships with us or are unable to fill our orders on a timely basis, we may
be unable to deliver our products to meet our customers' orders, which could
delay or decrease our revenue. The manufacturing initiative may be delayed or
prohibited by a legal proceeding currently contemplated by a government agency,
which may disrupt our operations or result in unanticipated costs. Please see
"Business -- Legal Proceedings" for a description of this legal proceeding.
Further, if we are unable to successfully implement our manufacturing
initiative, we believe we will not be able to achieve the benefits described
under "Management's Discussion and Analysis of Financial Condition and Results
of Operations -- Separation from Lucent -- Review of Operations and Related
Charges."
WE MAY ACQUIRE OTHER BUSINESSES OR FORM JOINT VENTURES THAT COULD
NEGATIVELY AFFECT OUR PROFITABILITY AND DILUTE EXISTING SHAREOWNERS. The
pursuit of additional technology, services or distribution channels through
acquisitions or joint ventures is an aspect of our business strategy. We may not
identify or complete these transactions in a timely manner, on a cost effective
basis or at all, and we may not realize the benefits of any acquisition or joint
venture. Also, we may be limited in the amount of our stock that we can issue to
make acquisitions, because the issuance of our stock may cause the distribution
to be taxable to Lucent under Section 355(e) of the Internal Revenue Code, and
under the tax sharing agreement we would be required to indemnify Lucent against
that tax. See "The Distribution -- Federal Income Tax Consequences of the
Distribution" and "Relationship Between Lucent and Our Company After the
Distribution -- Tax Sharing Agreement" for a more detailed discussions of
Section 355(e) and the tax sharing agreement between Lucent and us.
While we have been involved in acquisition activities as part of Lucent, we
will have limited experience in acquisition activities as a stand-alone company
and may have to devote substantial time and resources in order to complete
acquisitions. There may also be risks of entering markets in which we have no or
limited prior experience. In addition, if we were to make any acquisitions, we
could:
- issue equity securities that would dilute our shareowners;
- incur debt which could involve restrictive covenants;
- assume unknown or contingent liabilities; or
- experience negative effects on our reported results of operations from
acquisition-related charges and of amortization of acquired technology,
goodwill and other intangibles.
WE MAY NOT HAVE FINANCING FOR FUTURE STRATEGIC ACQUISITIONS AND INVESTMENTS
AND ANY FINANCING WE DO RECEIVE MAY INCREASE OUR DEBT OR DILUTE YOUR OWNERSHIP
OF OUR COMPANY. We may need to incur additional debt or issue equity in order
to make any strategic acquisition or investment. We cannot assure you that such
financing will be available to us on acceptable terms or at all. Our ability to
make payments on and to refinance our indebtedness, including the commercial
paper program we will assume and future indebtedness, and to fund working
capital, capital expenditures and strategic acquisitions and investments will
depend on our ability to generate cash in the future. Our ability to generate
cash is subject to general economic, financial, competitive, legislative,
regulatory and other factors that are beyond our control. Furthermore, if we
raise funds through the issuance of debt or equity securities, the securities
issued may have rights and preferences and privileges senior to those of holders
of our common stock, and the terms of the securities may impose restrictions on
our operations or dilute your ownership of us.
OUR INDUSTRY IS HIGHLY COMPETITIVE AND IF WE CANNOT EFFECTIVELY COMPETE,
OUR REVENUE MAY DECLINE. The market for our products and services is very
competitive and subject to rapid technological advances. We expect the intensity
of competition to continue to increase in the future as existing competitors
enhance and expand their product and service offerings and as new participants
enter the market. Increased competition also may result in price reductions,
reduced gross margins and loss of market share. Our failure to maintain and
enhance our competitive position would adversely affect our business and
prospects.
22
26
Following our separation from Lucent, we may compete against Lucent in some
of our current or future market segments. We also compete with a number of
equipment manufacturers and software companies in selling our communications
systems and software. Further, our customer relationship management professional
services consultants compete against a number of professional services firms.
For the names of our competitors in our various market segments, please see
"Business -- Competition." Some of our customers and strategic partners are also
competitors of ours. We expect to face increasing competitive pressures from
both current and future competitors in the markets we serve.
The sizes of our competitors vary across our market segments, as do the
resources we have allocated to the segments we target. Therefore, many of our
competitors have greater financial, personnel, capacity and other resources than
we have in each of our market segments or overall. As a result, our competitors
may be in a stronger position to respond quickly to potential acquisitions and
other market opportunities, new or emerging technologies and changes in client
requirements. Competitors with greater financial resources also may be able to
offer lower prices, additional products or services or other incentives that we
cannot match or do not offer. These competitors may be in a stronger position to
respond quickly to new or emerging technologies and may be able to undertake
more extensive marketing campaigns, adopt more aggressive pricing policies and
make more attractive offers to potential customers, employees and strategic
partners. We cannot assure you that we will be able to compete successfully
against existing or future competitors.
THE TERMS OF OUR SEPARATION FROM LUCENT, ANTI-TAKEOVER PROVISIONS OF OUR
CERTIFICATE OF INCORPORATION AND BY-LAWS, OUR RIGHTS AGREEMENT AND PROVISIONS OF
DELAWARE LAW COULD DELAY OR PREVENT A CHANGE OF CONTROL THAT YOU MAY
FAVOR. Under the terms of the Contribution and Distribution Agreement between
us and Lucent, if a change of control of us occurs during the three years
following the distribution, Lucent could terminate or cause us to reconvey some
of the rights granted under the agreements which we are entering into with
Lucent, including important intellectual property rights. Under this agreement,
a change of control means the consummation of a merger or consolidation of all
of our company, a sale or other disposition of all or substantially all of our
assets, the acquisition of 40% or more of our voting stock or changes in the
composition of a majority of our board of directors which are not supported by
our current board of directors. This may discourage a change of control
transaction during that period.
Provisions of our certificate of incorporation and bylaws, our Rights
Agreement and provisions of applicable Delaware law, which will be in effect
after the distribution, may discourage, delay or prevent a merger or other
change of control that shareowners may consider favorable or may impede the
ability of the holders of our common stock to change our management. The
provisions of our certificate of incorporation and bylaws, among other things,
will:
- divide our board of directors into three classes, with members of each
class to be elected in staggered three-year terms;
- limit the right of shareowners to remove directors;
- regulate how shareowners may present proposals or nominate directors for
election at annual meetings of shareowners; and
- authorize our board of directors to issue preferred stock in one or more
series, without shareowner approval.
Please see "Relationship Between Lucent and Our Company After the
Distribution -- Contribution and Distribution Agreement," "Description of
Capital Stock" for a more detailed description of these agreements and
provisions.
Also, acquisition of our stock could trigger the application of Section
355(e) of the Internal Revenue Code. Under the tax sharing agreement we would be
required to indemnify Lucent for the resulting tax and this indemnity obligation
might discourage, delay or prevent a change of control that shareowners may
consider favorable. Please see "The Distribution -- Federal Income Tax
Consequences of the Distribution" and "Relationship Between Lucent and Our
Company After the Distribution -- Tax Sharing Agreement" for a more detailed
discussion of Section 355(e) and the tax sharing agreement between Lucent and
us.
23
27
FORWARD LOOKING STATEMENTS
This information statement contains forward-looking statements that are
based on current expectations, estimates, forecasts and projections about the
industries in which we operate, management's beliefs and assumptions made by
management. Such statements include, in particular, statements about our plans,
strategies and prospects under the headings "Summary," "Risk Factors,"
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" and "Business." Words such as "expects," "anticipates," "intends,"
"plans," "believes," "seeks," "estimates," variations of such words and similar
expressions are intended to identify such forward looking statements. These
statements are not guarantees of future performance and involve risks,
uncertainties and assumptions which are difficult to predict. Therefore, actual
outcomes and results may differ materially from what is expressed or forecasted
in such forward looking statements. Except as required under the federal
securities laws and the rules and regulations of the Securities and Exchange
Commission, we do not have any intention or obligation to update publicly any
forward looking statements after we distribute this information statement,
whether as a result of new information, future events or otherwise.
This information statement contains information concerning our market
segments generally which is forward-looking in nature and is based on a variety
of assumptions regarding the ways in which this market will develop. These
assumptions have been derived from information currently available to us and to
the third party market observers quoted herein. They include the following
general underlying expectations:
- eBusiness will grow significantly over the next five years;
- no catastrophic failure of the Internet will occur; and
- government regulations will not prohibit or materially adversely affect
our business.
If any one or more of the foregoing assumptions is incorrect, actual market
results may differ from those predicted. While we do not know what impact any
such differences may have on our business, our future business, results of
operations and financial condition and the market price of our shares of common
stock may be materially adversely impacted.
24
28
DIVIDEND POLICY
We do not anticipate paying any dividends on our common stock in the
foreseeable future because we expect to retain our future earnings for use in
the operation and expansion of our business. Our payment and amount of
dividends, however, will be subject to the discretion of our board of directors
and will depend, among other things, upon our results of operations, financial
condition, cash requirements, future prospects and other factors which may be
considered relevant by our board of directors.
25
29
CAPITALIZATION
The following table sets forth our combined capitalization as of June 30,
2000, on a historical and pro forma basis, to give effect to the distribution
and the transactions related to the distribution. This table should be read in
conjunction with "Management's Discussion and Analysis of Financial Condition
and Results of Operation" and the unaudited pro forma condensed financial
statements and notes thereto included elsewhere in this information statement.
For an explanation of the pro forma adjustments made to our historical combined
financial statements for the distribution and the transactions related to the
distribution to derive the pro forma capitalization described below, please see
"Unaudited Pro Forma Condensed Financial Statements."
<TABLE>
<CAPTION>
AS OF JUNE 30, 2000
--------------------------
HISTORICAL PRO FORMA
(UNAUDITED) (UNAUDITED)
----------- -----------
(DOLLARS IN MILLIONS)
<S> <C> <C>
Commercial paper............................................ $ -- $ 700
Debt........................................................ 4 4
------ ------
Total debt........................................ 4 704
------ ------
SHAREOWNERS' EQUITY:
Common stock, par value $0.01 per share, 1,000 shares
authorized, issued and outstanding as of June 30, 2000,
278,292,661 shares pro forma........................... -- 3
Additional paid in capital................................ -- 1,333
Owner's net investment.................................... 1,844 --
Accumulated other comprehensive loss...................... (48) (48)
------ ------
Total shareowners' equity......................... 1,796 1,288
------ ------
Total capitalization.............................. $1,800 $1,992
====== ======
</TABLE>
Pro forma commercial paper reflects the assumption by us from Lucent of
$700 million of short-term debt under a commercial paper program that Lucent
will enter into prior to the distribution. We may assume additional debt under
the commercial paper program to the extent additional debt is incurred by Lucent
under the program to fund restructuring or separation costs and expenses that we
may incur prior to the distribution. We may also assume additional debt under
the program for our working capital if there is a substantial increase in our
working capital over our current plan prior to the distribution. Upon the
distribution, Lucent will be relieved of all obligations under the program. In
addition, we currently anticipate requiring approximately $600 million of
additional financing over the next eight months to fund costs and expenses in
connection with the planned restructuring and separation, including the portion
of these costs and expenses that we may incur prior to the distribution. We have
not yet finalized the type of financing for the costs incurred after the
distribution. Accordingly, we have not made adjustments for this additional $600
million of financing in the unaudited pro forma condensed financial statements
or the capitalization table above. After the distribution, we may refinance all
or a part of this commercial paper program with long-term or other short-term
debt.
We also have not made adjustments in the unaudited pro forma condensed
financial statements or the capitalization table above for the impact of the
$400 million we expect to receive for the 4,000,000 shares of Series B
convertible participating preferred stock and the warrants to purchase shares of
our common stock we expect to issue upon consummation of the equity investment
by Warburg, Pincus Equity Partners, L.P. and related investment funds after
completion of the distribution. No amounts have yet been ascribed to potential
beneficial conversion features, as described in the "Unaudited Pro Forma
Condensed Financial Statements," which amounts will only be determinable after
the distribution. The conversion features, the accretion to liquidation value
for the Series B convertible participating preferred stock and any beneficial
conversion features will dilute both basic and diluted earnings per share. For a
more detailed description of this equity investment, please see "Management's
Discussion and Analysis of Financial
26
30
Condition and Results of Operations -- Liquidity and Capital Resources" and
"Related Transactions and Equity Investment."
Our ability to issue additional equity is constrained because our issuance
of additional common stock may cause the distribution to be taxable to Lucent
under Section 355(e) of the Internal Revenue Code, and under the tax sharing
agreement we would be required to indemnify Lucent against that tax. See "The
Distribution Federal Income Tax Consequences of the Distribution" and
"Relationship Between Lucent and Our Company After the Distribution -- Tax
Sharing Agreement" for a more detailed discussion of Section 355(e) and the tax
sharing agreement between Lucent and us. In addition, we may refinance all or a
portion of the commercial paper program we are assuming from Lucent with
long-term or other short-term debt.
On a historical basis, the amount of Lucent's net investment in us was
recorded as Owner's net investment in our combined financial statements. The pro
forma number of shares of common stock is based on each holder of Lucent common
stock receiving a dividend of one share of our common stock for every 12 shares
of Lucent common stock and there being 3,339,511,932 shares of Lucent common
stock outstanding as of June 30, 2000 and assuming no exercise of outstanding
options.
27
31
SELECTED FINANCIAL INFORMATION
The following table sets forth our selected financial information derived
from our unaudited combined financial statements for the fiscal year ended and
as of December 31, 1995 and for the nine months ended and as of September 30,
1996, which are not included in this information statement, the audited combined
financial statements for the fiscal years ended and as of September 30, 1997,
1998 and 1999, and our unaudited interim combined financial statements as of and
for the nine months ended June 30, 1999 and 2000, included elsewhere in this
information statement. In our opinion, all adjustments, which consist only of
normal and recurring accruals, considered necessary for a fair presentation have
been included in our unaudited combined financial statements. Per share data for
net income and dividends have not been presented because we were operated
through divisions and subsidiaries of Lucent for the periods presented. The
historical financial information may not be indicative of our future performance
as an independent company. The selected financial information should be read in
conjunction with "Management's Discussion and Analysis of Financial Condition
and Results of Operations," the unaudited pro forma condensed financial
statements and the notes thereto and the combined financial statements and the
notes thereto included elsewhere in this information statement.
In reviewing the selected financial information, please note the following:
- In fiscal 1996, we changed our fiscal year end from December 31 to
September 30.
- The selected statement of income information reflects the purchase of
Octel Communications Corporation in September 1997.
- The purchased in-process research and development is attributable to the
acquisitions of Lannet Ltd., SDX Business Systems PLC, Prominet
Corporation, Octel Communications Corporation and Agile Networks, Inc. in
1998 and 1997.
- Effective October 1, 1998, we changed our method for calculating the
market-related value of plan assets used in determining the expected
return-on-asset component of annual net pension and postretirement benefit
costs.
- Total debt represents debt attributable to our ownership in foreign
entities and does not reflect the amount of financing we will have as a
stand-alone company after the distribution.
<TABLE>
<CAPTION>
NINE MONTHS NINE MONTHS NINE MONTHS
ENDED ENDED YEAR ENDED SEPTEMBER 30, ENDED YEAR ENDED
JUNE 30, JUNE 30, ------------------------ SEPTEMBER 30, DECEMBER 31,
2000 1999 1999 1998 1997 1996 1995
----------- ----------- ------ ------ ------ ------------- ------------
(DOLLARS IN MILLIONS)
<S> <C> <C> <C> <C> <C> <C> <C>
STATEMENT OF INCOME INFORMATION:
Revenue.................. $5,664 $5,870 $8,268 $7,754 $6,413 $4,544 $5,643
Purchased in-process
research and
development............ -- -- -- 306 472 -- --
Income (loss) before
cumulative effect of
accounting change...... 168 57 186 43 (148) 176 385
Cumulative effect of
accounting change...... -- 96 96 -- -- -- --
Net income (loss)........ 168 153 282 43 (148) 176 385
</TABLE>
<TABLE>
<CAPTION>
AS OF AS OF SEPTEMBER 30, AS OF
JUNE 30, ---------------------------------------- DECEMBER 31,
2000 1999 1998 1997 1996 1995
----------- ------ ------ ------ ------------- ------------
(DOLLARS IN MILLIONS)
<S> <C> <C> <C> <C> <C> <C> <C>
BALANCE SHEET
INFORMATION:
Total assets............. $4,076 $4,239 $4,177 $3,340 $2,391 $2,157
Total debt............... 4 10 14 25 7 2
</TABLE>
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UNAUDITED PRO FORMA CONDENSED FINANCIAL STATEMENTS
The unaudited pro forma condensed financial statements reported below
should be read in conjunction with our "Management's Discussion and Analysis of
Financial Condition and Results of Operations" and the combined financial
statements and the notes thereto included elsewhere in this information
statement. The following unaudited pro forma condensed financial statements have
been prepared giving effect to the distribution, the assumption of short-term
debt under the Lucent commercial paper program, and the inclusion in our balance
sheet of the estimated net assets and deferred taxes associated with our
employee benefit plans as if these transactions occurred as of June 30, 2000,
for the unaudited pro forma condensed balance sheet and as of October 1, 1998,
for the unaudited pro forma condensed statements of income.
The pro forma balance sheet gives effect to the assumption by us from
Lucent of $700 million of short-term debt under a commercial paper program that
Lucent will enter into prior to the distribution. We may assume additional debt
under the commercial paper program to the extent additional debt is incurred by
Lucent under the program to fund restructuring or separation costs and expenses
that we may incur prior to the distribution. We may also assume additional debt
under the program for our working capital if there is a substantial increase in
our working capital over our current plan prior to the distribution. Upon the
distribution, Lucent will be relieved of all obligations under the program. In
addition, we currently anticipate requiring approximately $600 million of
additional financing over the next eight months to fund costs and expenses in
connection with the planned restructuring and separation, including the portion
of these costs and expenses that we may incur prior to the distribution. We have
not yet finalized the type of financing for the costs incurred after the
distribution. After the distribution, we may refinance all or a part of this
commercial paper program with long-term or other short-term debt.
Commercial paper notes are senior unsecured obligations typically issued at
a discount from par value, repayable at par upon maturity. The maturities of
these obligations generally range from a few days to a few months. Commercial
paper obligations are thus short-term, fixed rate notes. However, as commercial
paper is often refinanced, or rolled over, at maturity or as outstanding
obligations increase or decrease, the average interest rate on outstanding
balances will vary from time to time, such as monthly, as interest rates vary.
The pro forma balance sheet includes the impact of the estimated net assets
and deferred taxes we will receive in connection with Lucent's prepaid pension
costs and long-term postretirement liabilities associated with the related
employees that will be transferred to us at the date of distribution. The pro
forma adjustments are based upon available information and assumptions that we
believe are reasonable. Please see the notes to unaudited pro forma condensed
financial statements for a discussion of how these adjustments are presented in
the pro forma financial statements.
These unaudited pro forma condensed financial statements do not reflect
many significant changes that may occur after the distribution in our financing
plans and cost structure, including costs or savings related to our planned
restructuring or our manufacturing initiative. In particular, we have not made
adjustments for our anticipated requirement for approximately $600 million of
additional financing over the next eight months. We have not yet finalized the
amount of additional financing we will require because we are currently
developing our restructuring plan, reviewing our capital structure and examining
other costs and expenses we may incur as a stand-alone company.
The pro forma balance sheet also does not include the impact of the $400
million we expect to receive for the 4,000,000 shares of Series B convertible
participating preferred stock and the warrants to purchase shares of our common
stock we expect to issue upon consummation of the equity investment by Warburg,
Pincus Equity Partners, L.P. and related investment funds after completion of
the distribution. Based on the formula set forth under "Description of Capital
Stock -- Our Preferred Stock -- Series B Convertible Participating Preferred
Stock -- Conversion," the convertible participating preferred stock is expected
to be initially convertible into approximately 5.0% of our fully diluted common
stock, calculated using a modified treasury stock method as of the 90th day
after issuance. The warrants have an exercise price equal to 130% of the
conversion price for the Series B convertible participating preferred stock. The
warrants are exercisable for 3.6% of a total number of shares of common stock to
be calculated pursuant
29
33
to the formula set forth under "Description of Capital Stock -- Warrants" as of
the 90th day after issuance. Of these warrants, warrants exercisable for 2.0% of
such total number of shares of common stock will have a four-year term and
warrants exercisable for 1.6% of such total number of shares of common stock
will have a five-year term. During a period commencing on a date that we expect
to be no later than June 30, 2001, until the second anniversary of their
issuance, if the market price of our common stock exceeds 200%, in the case of
the four-year warrants, and 225%, in the case of the five-year warrants, of the
exercise price of the warrants for 20 consecutive trading days, we can force the
exercise of up to 50% of the four-year warrants and the five-year warrants,
respectively.
The shares of Series B convertible participating preferred stock will have
an aggregate initial liquidation value of $400 million and will accrete for the
first ten years at an annual rate of 6.5%, compounded quarterly. After the third
anniversary of the issue date, 50% of the amount accreted for the year may be
paid in cash as a dividend, on a quarterly basis, at our option. From the fifth
anniversary of the issue date through the tenth anniversary, we may elect to pay
100% of the amount accreted for the year as a cash dividend on a quarterly
basis. Following the tenth anniversary of the issue date, we will pay quarterly
cash dividends at an annual rate of 12% of the then accreted liquidation value
of the Series B convertible participating preferred stock, compounded quarterly.
The Series B convertible participating preferred shares also will participate,
on an as-converted basis, in dividends paid on our common stock.
If the Series B convertible participating preferred stock or the warrants
have a conversion or exercise price that is less than the fair value of our
common stock at their measurement date, then the securities may be deemed to
have beneficial conversion features. No amounts have yet been ascribed to
potential beneficial conversion features, which will only be determinable after
the distribution. The conversion features, the accretion to liquidation value
for the Series B convertible participating preferred stock and any beneficial
conversion features will dilute both basic and diluted earnings per share. For a
more detailed description of this equity investment, please see "Management's
Discussion and Analysis of Financial Condition and Results of
Operations -- Liquidity and Capital Resources" and "Related Transactions and
Equity Investment."
The unaudited pro forma condensed balance sheet and statements of income
included in this information statement have been derived from the combined
financial statements included elsewhere in this information statement and do not
purport to represent what our financial position and results of operations
actually would have been had the distribution and related transactions occurred
on the dates indicated or to project our financial performance for any future
period. Lucent did not account for us as, and we were not operated as, a
single-stand alone entity for the periods presented.
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34
AVAYA INC. AND SUBSIDIARIES
UNAUDITED PRO FORMA CONDENSED STATEMENTS OF INCOME
FOR THE NINE MONTHS ENDED JUNE 30, 2000
(DOLLARS IN MILLIONS EXCEPT PER SHARE AMOUNTS)
<TABLE>
<CAPTION>
HISTORICAL PRO FORMA
---------- ---------
<S> <C> <C>
Revenue..................................................... $ 5,664 $ 5,664
Costs....................................................... (3,152) (3,152)
------- -------
Gross margin.............................................. 2,512 2,512
Operating expenses.......................................... (2,230) (2,230)
------- -------
Operating income.......................................... 282 282
Other income, net........................................... 54 54
Interest expense(A)......................................... (59) (59)
------- -------
Income before income taxes................................ 277 277
Provision for income taxes.................................. (109) (109)
------- -------
Net income.................................................. $ 168 $ 168
======= =======
PRO FORMA EARNINGS PER SHARE(B):
Basic....................................................... $ 0.63
=======
Diluted..................................................... $ 0.59
=======
</TABLE>
See accompanying notes to unaudited pro forma condensed financial statements.
31
35
AVAYA INC. AND SUBSIDIARIES
UNAUDITED PRO FORMA CONDENSED STATEMENTS OF INCOME
FOR THE FISCAL YEAR ENDED SEPTEMBER 30, 1999
(DOLLARS IN MILLIONS EXCEPT PER SHARE AMOUNTS)
<TABLE>
<CAPTION>
HISTORICAL PRO FORMA
---------- ---------
<S> <C> <C>
Revenue..................................................... $ 8,268 $ 8,268
Costs....................................................... (4,564) (4,564)
------- -------
Gross margin.............................................. 3,704 3,704
Operating expenses.......................................... (3,335) (3,335)
------- -------
Operating income.......................................... 369 369
Other income, net........................................... 28 28
Interest expense(A)......................................... (90) (90)
------- -------
Income before income taxes................................ 307 307
Provision for income taxes.................................. (121) (121)
------- -------
Income before cumulative effect of accounting change...... 186 186
Cumulative effect of accounting change...................... 96 96
------- -------
Net income.................................................. $ 282 $ 282
======= =======
PRO FORMA EARNINGS PER SHARE(B):
Basic....................................................... $ 1.11
=======
Diluted..................................................... $ 1.06
=======
</TABLE>
See accompanying notes to unaudited pro forma condensed financial statements.
32
36
AVAYA INC. AND SUBSIDIARIES
UNAUDITED PRO FORMA CONDENSED BALANCE SHEET
AS OF JUNE 30, 2000
(DOLLARS IN MILLIONS)
<TABLE>
<CAPTION>
HISTORICAL ADJUSTMENTS PRO FORMA
---------- ----------- ---------
<S> <C> <C> <C>
ASSETS:
Cash and cash equivalents.............................. $ 217 $ 217
Receivables, less allowances........................... 1,588 1,588
Inventories............................................ 736 736
Other current assets................................... 222 222
------ -------
Total current assets......................... 2,763 2,763
Property, plant and equipment, net..................... 727 727
Prepaid pension costs.................................. -- 659(E) 659
Other assets........................................... 586 (126)(E) 460
------ ------- -------
Total assets................................. $4,076 533 $ 4,609
====== ======= =======
LIABILITIES:
Current liabilities.................................... $1,533 $ 1,533
Commercial paper....................................... -- 700(C) 700
------ ------- -------
Total current liabilities.................... 1,533 700 2,233
Postretirement benefit liability....................... -- 341(E) 341
Long-term debt......................................... -- --
Other liabilities...................................... 747 747
------ ------- -------
Total liabilities............................ 2,280 1,041 3,321
------ ------- -------
SHAREOWNERS' EQUITY:
Series A junior participating preferred stock, par
value $1.00 per share, no shares outstanding as of
June 30, 2000........................................ -- --
Common stock, par value $0.01 per share, 1,000 shares
authorized, issued and outstanding as of June 30,
2000, 278,292,661 shares pro forma................... 3(F) 3
Additional paid-in capital............................. -- 1,333(D) 1,333
Owner's net investment................................. 1,844 (700)(C)
(1,336)(D)
192(E)
Accumulated other comprehensive loss................... (48) (48)
------ ------- -------
Total shareowners' equity.................... 1,796 (508) 1,288
------ ------- -------
Total liabilities and shareowners' equity.... $4,076 533 $ 4,609
====== ======= =======
</TABLE>
See accompanying notes to unaudited pro forma condensed financial statements.
33
37
NOTES TO UNAUDITED PRO FORMA CONDENSED FINANCIAL STATEMENTS
(A) Historical interest expense of $59 million and $90 million is associated
with assumed average debt balances of $992 million and $1,320 million for
the nine months ended June 30, 2000 and the year ended September 30, 1999,
respectively. No adjustment has been made in the pro forma statements of
income to reflect the interest expense associated with the assumption by us
of $700 million of commercial paper at the time of the distribution, as
described in note (C) below. Interest expense on the $700 million of
commercial paper would have been $41 million and $48 million, based on
interest rates of 7.9% and 6.8%, for the nine months ended June 30, 2000,
and fiscal year ended September 30, 1999, respectively. For each additional
$100 million of debt assumed from Lucent, additional interest expense of $6
million and $7 million would have been incurred for the nine months ended
June 30, 2000 and the fiscal year ended September 30, 1999, respectively. A
variation of .125 percentage point in the interest rate charged under the
commercial paper program would result in a change of approximately $656,000
and $875,000 for the nine months ended June 30, 2000 and the year ended
September 30, 1999, respectively. In addition, no adjustment has been made
to reflect our anticipated requirement for approximately $600 million of
additional financing over the next eight months to fund costs and expenses
in connection with the planned restructuring and separation. A portion of
the costs and expenses associated with the planned restructuring and
separation may be incurred prior to the distribution. These costs would be
funded by Lucent through additional debt incurred under the commercial paper
program, which debt would be assumed by us at the distribution date. We have
not yet finalized the type of financing for the costs and expenses incurred
after the distribution.
(B) The computation of pro forma basic earnings per share for the periods
presented is based upon the anticipated number of common shares outstanding
upon completion of the distribution. In addition, for purposes of
calculating pro forma basic earnings per share, net income attributable to
common shareowners has not been adjusted for the accretion to liquidation
value or any beneficial conversion features in connection with the issuance
of $400 million of Series B convertible participating preferred stock and
warrants to purchase shares of our common stock. The accretion to
liquidation value, a deemed dividend, would reduce the pro forma net income
attributable to common shareowners and the related basic and diluted per
share amounts by approximately $20 million and $0.07 per share and $27
million and $0.11 per share for the nine months ended June 30, 2000 and the
year ended September 30, 1999, respectively.
Additional amounts ascribed to the beneficial conversion feature of the
Series B convertible participating preferred stock, if any, will be recorded
as a reduction to net income attributable to common shareowners in the
quarter the Series B convertible participating preferred stock is issued.
Based on our pro forma capital structure as of June 30, 2000, and an assumed
market value of our common stock and option issuance, the charge for
beneficial conversion feature related to the Series B convertible
participating preferred stock is estimated to be approximately $39 million.
The actual amount of this feature will not be determinable until after the
distribution. Changes in the fair market value of Lucent's common stock, in
the number of outstanding Lucent shares and the number of our outstanding
options could affect the actual value ascribed to the beneficial conversion
feature.
We do not expect there to be a material impact on our future results of
operations for any beneficial conversion features associated with the deemed
dividends on the Series B convertible participating preferred stock or the
warrants to purchase shares of our common stock.
The Series B convertible participating preferred stock would be convertible
into and the warrants would be exercisable for approximately 17 million and
12 million shares of our common stock, respectively, on a pro forma basis
using an assumed conversion ratio. The conversion ratio will not be known
until 90 days after the distribution date, and is calculated based on the
number of shares of our common stock and options to purchase our common
stock outstanding immediately after the distribution, the number of options
issued in the 90 days after the distribution, the exercise price of such
options and the average trading price of our common stock over the last 20
trading days during
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the period ending on the 90th day after the distribution. As of June 30,
2000, conversion of the Series B convertible participating preferred stock
and exercise of the warrants would be anti-dilutive based on the assumed
conversion ratio and, therefore, would not have an effect on diluted
earnings per share.
The computation of pro forma diluted earnings per share assumes the
outstanding unvested Lucent options held by our employees will be converted
into options to purchase our common stock. Vested Lucent stock options will
remain options to acquire Lucent common stock and have been excluded from
the pro forma earnings per share calculation. The actual number of options
assumed will not be determined until after the distribution, when it is
determined which Lucent employees have become our employees and the actual
ratio is determined for the conversion of Lucent stock options into options
of our common stock. The calculation of the pro forma diluted earnings per
share also does not reflect any conversion of the Series B convertible
participating preferred stock or exercise of warrants to purchase shares of
our common stock.
<TABLE>
<CAPTION>
PRO FORMA PRO FORMA
NINE FISCAL YEAR
MONTHS ENDED ENDED
JUNE 30, SEPTEMBER 30,
2000 1999
------------ -------------
<S> <C> <C>
Earnings per common share -- basic:
- ---------------------------------------
Income before cumulative effect of accounting
change....................................... $0.63 $0.73
Cumulative effect of accounting change.......... -- 0.38
Net income attributable to common shareowners... $0.63 $1.11
Earnings per common share -- diluted:
- -----------------------------------------
Income before cumulative effect of accounting
change....................................... $0.59 $0.70
Cumulative effect of accounting change.......... -- 0.36
Net income attributable to common shareowners... $0.59 $1.06
Number of shares (in millions):
- ----------------------------------
Common shares -- basic............................ 266 253
Effect of dilutive stock options.................. 16 14
Common shares -- diluted.......................... 282 267
Options excluded from the computation of earnings
per share -- diluted since inclusion would be
anti-dilutive................................... 3 3
</TABLE>
(C) Represents the short-term debt of $700 million expected to be issued by
Lucent under a commercial paper program, which we will assume on the
distribution date. Lucent will retain the proceeds of all borrowings under
the commercial paper program. On the distribution date, Lucent will be
released from all of its obligations under the program and we will become
obligated to satisfy all payments and other terms under the commercial paper
program. This adjustment does not reflect the $600 million of additional
financing described in footnote (A) above.
(D) On a historical basis, this amount reflects Lucent's net investment in us,
which was recorded as Owner's net investment in our combined financial
statements.
(E) To reflect the projected assets and liabilities and the deferred taxes
associated with various existing Lucent pension and other employee benefit
plans related to the employees for which the Company is assuming
responsibility.
(F) Represents 278,292,661 shares of our common stock, at a par value of $0.01
per share, based upon the number of shares of Lucent common stock
outstanding on June 30, 2000 and assuming no exercise of outstanding
options.
35
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MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
You should read the following discussion in conjunction with the combined
financial statements and the notes thereto, and the unaudited pro forma
condensed financial statements and the notes thereto, included elsewhere in this
information statement. This Management's Discussion and Analysis of Financial
Condition and Results of Operations contains forward looking statements. Please
see "Forward Looking Statements" for a discussion of the uncertainties, risks
and assumptions associated with these statements.
OVERVIEW
We are a leading provider of communications systems and software for
enterprises, including businesses, government agencies and other organizations.
We offer voice, converged voice and data, customer relationship management,
messaging, multi-service networking and structured cabling products and
services. Multi-service networking products are those products that support
network infrastructures which carry voice, video and data traffic over any of
the protocols, or set of procedures, supported by the Internet on local area and
wide area data networks. A structured cabling system is a flexible cabling
system designed to connect phones, workstations, personal computers, local area
networks and other communications devices through a building or across one or
more campuses. We are a worldwide leader in sales of messaging and structured
cabling systems and a U.S. leader in sales of enterprise voice communications
and call center systems. We are not a leader in multi-service networking
products or in converged voice and data products. We have entered these product
areas relatively recently, and our product portfolio is less complete than the
portfolios of some of our competitors. We are implementing a strategy focused on
these products.
We report our operations in three segments: Communications Solutions,
Services and Connectivity Solutions. The Communications Solutions segment
represents our core businesses, comprised of our enterprise voice communications
systems and software, communications applications, professional services for
customer and enterprise relationship management, multi-service networking
products and product installation services. The purchase prices of our products
typically include installation. The Services segment represents our maintenance
and value-added services. The Connectivity Solutions segment represents our
structured cabling systems and our electronic cabinets. The results of our
corporate operations are recorded in corporate and other.
The following table sets forth the allocation of our revenue among our
operating segments, expressed as a percentage of total external revenue,
excluding corporate and other revenue:
<TABLE>
<CAPTION>
NINE MONTHS
ENDED FISCAL YEAR ENDED
JUNE 30, SEPTEMBER 30,
-------------- -----------------------
2000 1999 1999 1998 1997
----- ----- ----- ----- -----
(PERCENTAGES)
<S> <C> <C> <C> <C> <C>
OPERATING SEGMENT
Communications Solutions................... 57.5% 60.2% 61.6% 59.2% 58.1%
Services................................... 25.6 23.8 23.0 22.6 23.8
Connectivity Solutions..................... 16.9 16.0 15.4 18.2 18.1
----- ----- ----- ----- -----
Total............................ 100.0% 100.0% 100.0% 100.0% 100.0%
===== ===== ===== ===== =====
</TABLE>
SEPARATION FROM LUCENT
We were incorporated under the laws of the State of Delaware on February
16, 2000, as a wholly owned subsidiary of Lucent. We will have no material
assets or activities until the contribution to us by Lucent, of the businesses
described in this information statement, which is expected to occur immediately
prior to the distribution. Lucent conducted such businesses through various
divisions and subsidiaries. Following the distribution, we will be an
independent public company, and Lucent will have no continuing
36
40
stock ownership interest in us. Prior to the distribution, we will enter into
several agreements with Lucent in connection with, among other things,
intellectual property, interim services and a number of ongoing commercial
relationships, including product supply arrangements. The interim services
agreement sets forth charges generally intended to allow the providing company
to fully recover the allocated direct costs of providing the services, plus all
out-of-pocket costs and expenses, but without any profit. With limited
exceptions, these interim services are not expected to extend beyond March 31,
2001. The pricing terms for goods and services covered by the commercial
agreements will reflect negotiated prices. Please see "Relationship Between
Lucent and Our Company After the Distribution" for a more detailed discussion of
these agreements.
Our combined financial statements, which are discussed below, reflect the
historical financial position, results of operations and cash flows of the
businesses to be transferred to us from Lucent as part of the distribution. The
financial information included herein, however, may not necessarily reflect our
financial position, results of operations and cash flows in the future or what
our financial position, results of operations and cash flows would have been had
we been a stand-alone company during the periods presented.
Cash, cash equivalents, debt and interest expense. Lucent uses a
centralized approach to cash management and the financing of its operations. Our
cash deposits are transferred to Lucent on a regular basis. As a result, none of
Lucent's cash, cash equivalents or debt at the corporate level were allocated to
us in our combined financial statements. We have assumed for purposes of
calculating interest expense that we would have had average debt balances of
$992 million for the nine months ended June 30, 2000, and $1,320 million, $1,439
million and $825 million, for fiscal 1999, 1998 and 1997, respectively. The
amount of debt incurred for purposes of calculating interest expense reflects
our estimates for the amount of debt we would have needed during these periods
to fund our operations, including to fund our capital expenditures and
acquisitions. For purposes of our combined financial statements, we have assumed
average interest rates of 7.9% for the nine months ended June 30, 2000, and,
6.8%, 6.5% and 7.1% per annum, for fiscal 1999, 1998 and 1997, respectively. The
interest rates used are estimates of what we believe we would have obtained with
a "BBB" rating, the assumed credit rating of our company after the distribution.
Although we believe our estimates are reasonable, these amounts of debt and
interest rates are not necessarily indicative of the amount of debt and related
interest rates we actually would have had if we were a stand-alone company
during all periods presented.
Corporate overhead and basic research. The combined financial statements
include allocations of the assets, liabilities and expenses of Lucent's
corporate headquarters relating to our businesses. General corporate overhead
has been either allocated based on the ratio of our costs and expenses to
Lucent's costs and expenses or based on our revenue as a percentage of Lucent's
total revenue, as appropriate. General corporate overhead primarily includes
cash management, legal, accounting, tax, insurance, public relations,
advertising and data services and amounted to $276 million for the nine months
ended June 30, 2000, and $449 million, $425 million and $335 million for fiscal
1999, 1998 and 1997, respectively. We believe the costs of these services
charged to us are a reasonable representation of the costs that would have been
incurred if we had performed these functions as a stand-alone company.
The combined financial statements also include an allocation from Lucent to
fund a portion of the costs of basic research conducted by Lucent's Bell
Laboratories. This allocation was based on our revenue as a percentage of
Lucent's total revenue. This allocation amounted to $56 million, for the nine
months ended June 30, 2000, and $78 million, $66 million and $59 million for
fiscal 1999, 1998 and 1997, respectively. We believe the costs of this research
charge to us are a reasonable representation of the costs that would have been
incurred if we had performed these functions as a stand-alone company. Following
the distribution, we will satisfy our corporate overhead and basic research
requirements using our own resources or through purchased services.
We intend to invest an amount equal to approximately 9% of our total
revenue in fiscal 2001 in research and development. These investments represent
a significant increase over our investments in research and development over the
previous three fiscal years which was approximately 6% of total revenue
37
41
for each of those years. Although we will spend a significant portion of our
budget on hiring research personnel as we build our group, we believe our
investments will be more effective than historically because our efforts will be
focused on our products. As a part of Lucent, we funded a portion of Lucent's
basic research, which research was not necessarily beneficial for our business.
Benefit obligations. At the distribution, we will assume responsibility
for pension and postretirement benefits for our active employees. Obligations
related to retired and terminated vested employees as of September 30, 2000 will
remain the responsibility of Lucent. Until the distribution, our employees are
participants in the Lucent pension plans and, upon retirement, will be
participants in Lucent's postretirement benefit plans. Lucent has managed its
employee benefit plans on a consolidated basis. Therefore, our share of the
Lucent plans' assets and liabilities are not included in our combined financial
statements. For purposes of the financial statements, the pension and
postretirement costs were based on estimated assets being equal to a
proportional share of plan obligations incurred by Lucent for employees who
performed services for us.
Income taxes. Income taxes were calculated as if we filed separate tax
returns. However, Lucent was managing its tax position for the benefit of its
entire portfolio of businesses, and its tax strategies are not necessarily
reflective of the tax strategies that we would have followed or will follow as a
stand-alone company.
REVIEW OF OPERATIONS AND RELATED CHARGES
We believe there are a number of opportunities as a stand-alone company to
significantly improve our profitability and business performance. In connection
with the distribution, we are currently engaged in a comprehensive review of our
operations, including our organizational structure, products and services and
market segments. Based on this review, we expect to begin implementing a
company-wide restructuring in the fourth quarter of fiscal 2000, with a view
toward improving our profitability and business performance as a stand-alone
company. After our restructuring plan is finalized and approved by our board of
directors, we expect to record charges in connection with this plan of $700
million to $800 million in the fourth quarter of fiscal 2000 of which
approximately 95% is expected to result in a usage of cash. In addition, we
expect to incur one time expenses in the first two quarters of fiscal 2001 in
connection with our separation from Lucent and our establishment as an
independent company in the range of $150 million to $200 million. We expect to
incur a portion of our total restructuring costs and separation expenses prior
to the distribution. We expect to fund our restructuring costs and separation
expenses through a combination of debt and internally generated funds. In
addition, as part of our review of operations, we are in the process of
evaluating our ongoing costs to support a contract we have with a major customer
under which we provide equipment outsourcing and related services. At this time,
we can not reasonably predict the action that may be taken as a result of this
evaluation process, however, a material cash payment or charge could result. We
expect to complete the evaluation and determine our course of action in the
fourth quarter of fiscal 2000.
Our restructuring is expected to include:
- reducing headcount in various areas, including by outsourcing some
corporate functions, redesigning our services, centralizing and
consolidating our marketing organization and consolidating our customer
call centers;
- eliminating excess capacity through consolidation of our owned and leased
real estate, involving a reduction from approximately 13 million square
feet currently occupied to approximately 11 million square feet with a
corresponding reduction in our leases and a headcount reduction for real
estate management;
- reducing administrative sales support, consolidating administrative
functions and closing some of our international sales locations, as we
implement our strategy to strengthen our distribution channels; and
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- exiting outsourcing contracts that we currently have for our systems
infrastructure and shutting down our legacy computer systems.
In addition to the current activities contemplated as part of the
restructuring, we are pursuing a contract manufacturing initiative which is not
included in the charges above. If we are successful in this initiative, we may
incur additional charges in the future. Our contract manufacturing initiative
will involve the outsourcing of substantially all our manufacturing other than
the manufacturing of our structured cabling systems. By outsourcing our
manufacturing to contractors whose business is to manufacture sophisticated
electronics equipment, we believe we will be able to focus on our strengths in
developing innovative software and systems and on increasing and improving our
services offerings, while still providing high quality products to our
customers. We believe that outsourcing our manufacturing will allow us to
improve our cash flow over the next few years through a reduction of inventory
and reduced capital expenditures. We cannot assure you that we will be able to
implement this manufacturing initiative or that, if implemented, we will achieve
these anticipated benefits. Our manufacturing initiative may be delayed or
prohibited by a legal proceeding currently contemplated by a governmental
agency, which may disrupt our operations or result in unanticipated costs.
Please see "Business -- Legal Proceeding" for a description of this legal
proceeding.
ACQUISITIONS
As part of our continued efforts to broaden our portfolio of product
offerings, Lucent, on our behalf, completed the following key acquisitions
during fiscal 1999, 1998 and 1997:
<TABLE>
<S> <C>
July 1999 Merger with Mosaix, Inc., a provider of software that
manages an enterprise's various office functions. Lucent
issued 2.6 million shares of Lucent common stock, with a
value of $145 million, for all of the outstanding stock of
Mosaix. The transaction was accounted for by Lucent as a
pooling of interests.
August 1998 Acquisition of Lannet Ltd., an Israeli-based producer of
multi-service networking products. The purchase price was
$115 million in cash.
July 1998 Acquisition of SDX Business Systems PLC, a United
Kingdom-based provider of multi-service networking products.
The purchase price was $207 million in cash.
January 1998 Acquisition of Prominet Corporation, a producer of
multi-service networking products. The purchase price was
$199 million of Lucent common stock.
September 1997 Acquisition of Octel Communications Corporation, a provider
of voice, fax and electronic messaging technologies to
service providers and enterprises. The total purchase price
was approximately $1.8 billion, in cash, and the enterprise
portion of that business along with $724 million of the
purchase price was allocated to us.
October 1996 Acquisition of Agile Networks, Inc., a provider of
multi-service networking products. The purchase price was
$135 million in cash.
</TABLE>
REVENUE
We derive revenue primarily from the sales of communication systems and
software. We sell our products both directly through our worldwide sales force
and indirectly through our global network of approximately 4,300 distributors,
dealers, value-added resellers, system integrators and contractors. The purchase
price of our systems and software typically includes installation and a one-year
warranty. We also derive revenue from:
- maintenance services, including services provided under maintenance
contracts and on a time and material basis;
- professional services for customer and enterprise relationship
management; and
- value-added services for outsourcing messaging and other parts of
communication systems.
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Maintenance contracts typically have terms that range from one to five
years. Contracts for professional services typically have terms that range from
two to four weeks for standard solutions and from six months to one year for
customized solutions. Contracts for value-added services typically have terms
that range from one to seven years.
Revenue from sales of communications systems and software is recognized
when contractual obligations have been satisfied, title and risk of loss has
been transferred to the customer and collection of the resulting receivable is
reasonably assured. Revenue from the direct sales of products with installation
services is recognized at the time the products are installed, after
satisfaction of all the terms and conditions of the underlying customer
contract. Our indirect sales to distribution partners are recognized at the time
of shipment if all contractual obligations have been satisfied. For our
value-added services, professional services and services performed under
maintenance contracts, we recognize revenue ratably over the term of the
underlying customer contract or at the end of the contract, when obligations
have been satisfied. For services performed on a time and materials basis,
revenue is recognized upon performance. We accrue a provision for estimated
sales returns and other allowances as a reduction of revenue at the time of
revenue recognition, as required.
COSTS AND OPERATING EXPENSES
Our costs of product consist primarily of materials and components, labor
and manufacturing overhead. Our costs of service consist primarily of labor,
parts and service overhead. Our selling, general and administrative expenses and
research and development expenses consist primarily of salaries, commissions,
benefits and other miscellaneous items. Please see "-- Purchased In-Process
Research and Development" for a discussion of this line item.
Total operating expenses in the fiscal years ended September 30, 1999, and
September 30, 1998, were reduced due to the reversal of $33 million and $23
million, respectively, of business restructuring reserves recorded in December
1995 primarily related to favorable experiences in employee separations for
those years.
OPERATING TRENDS
We have been, and intend to continue to, increase the percentage of our
sales made through our distribution partners. To further this strategy, in March
2000, we sold our primary distribution function for our voice communications
systems for small and mid-sized enterprises to Expanets, Inc. As the percentage
of our sales through distribution partners increases, if sales volume remained
the same, our revenue would decline. We expect, however, that the reduction in
our operating costs and expenses as a result of this shift to distribution
partners should offset the decline in revenue.
EQUITY INVESTMENT
On August 8, 2000, we entered into an agreement to sell 4,000,000 shares of
Series B convertible participating preferred stock and warrants to purchase
shares of our common stock to Warburg, Pincus Equity Partners, L.P. and several
related investment funds for a total of $400 million. Based on the formula set
forth under "Description of Capital Stock -- Our Preferred Stock -- Series B
Convertible Participating Preferred Stock -- Conversion," the Series B
convertible participating preferred stock is expected to be initially
convertible into approximately 5.0% of our fully diluted common stock,
calculated using a modified treasury stock method as of the 90th day after
issuance. The warrants have an exercise price equal to 130% of the conversion
price for the Series B convertible participating preferred stock. The warrants
are exercisable for 3.6% of a total number of shares of common stock to be
calculated pursuant to the formula set forth under "Description of Capital
Stock -- Warrants" as of the 90th day after issuance. As long as these investors
and their permitted transferees maintain ownership of a combination of shares of
common stock and Series B convertible participating preferred stock that, in the
aggregate, on an as-converted basis, represent at least 50% of the shares of our
common stock initially issuable on conversion of all the shares of Series B
convertible participating preferred stock purchased, the investors
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will be entitled to designate for election one individual to our board of
directors and to have one observer attend meetings of our board of directors.
The closing of the investment is subject to a number of conditions and we cannot
assure you that the investment will be consummated. For a more detailed
description of this equity investment, please see "-- Liquidity and Capital
Resources" and "Related Transactions and Equity Investment."
RESULTS OF OPERATIONS
The following table sets forth line items from our combined statements of
income as a percentage of revenue for the periods indicated:
<TABLE>
<CAPTION>
NINE MONTHS YEAR ENDED
ENDED JUNE 30, SEPTEMBER 30,
-------------- -----------------------
2000 1999 1999 1998 1997
----- ----- ----- ----- -----
(PERCENTAGES)
<S> <C> <C> <C> <C> <C>
Revenue.................................... 100.0% 100.0% 100.0% 100.0% 100.0%
Costs...................................... 55.6 55.4 55.2 53.0 51.2
----- ----- ----- ----- -----
Gross margin............................... 44.4 44.6 44.8 47.0 48.8
Operating expenses
Selling, general and administrative...... 33.2 35.6 33.8 33.6 34.1
Research and development................. 6.2 6.7 6.5 5.5 5.4
Purchased in-process research and
development........................... -- -- -- 3.9 7.4
----- ----- ----- ----- -----
Total operating expenses................... 39.4 42.3 40.3 43.0 46.9
Operating income (loss).................... 5.0 2.3 4.5 4.0 1.9
Other income-net........................... 1.0 0.4 0.3 0.3 0.3
Interest expense........................... 1.1 1.1 1.1 1.2 0.9
Provision (benefit) for income taxes....... 1.9 0.6 1.5 2.5 3.6
Cumulative effect of accounting change..... -- 1.6 1.2 -- --
Net income (loss).......................... 3.0% 2.6% 3.4% 0.6% (2.3)%
</TABLE>
Included in operating income (loss) for the fiscal year ended September 30,
1999, is the $97 million received on the sale in 1999 of equipment which was
previously rented to customers, net of the equipment's book value of
approximately $2 million. This equipment consisted predominately of discontinued
product lines. This effect on the total operating income of $369 million for
fiscal 1999, represented 1.2% of fiscal 1999 revenue.
NINE MONTHS ENDED JUNE 30, 2000 COMPARED TO NINE MONTHS ENDED JUNE 30, 1999
The following table shows the change in external revenue, both in dollars
and in percentage terms:
<TABLE>
<CAPTION>
NINE MONTHS ENDED
JUNE 30, CHANGE
------------------ ---------------
2000 1999 $ %
------- ------- ----- ------
(DOLLARS IN MILLIONS)
<S> <C> <C> <C> <C>
OPERATING SEGMENT:
Communications Solutions...................... $3,255 $3,529 $(274) (7.8)%
Services...................................... 1,452 1,396 56 4.0
Connectivity Solutions........................ 955 940 15 1.6
Corporate and other............................. 2 5 (3) (60.0)
------ ------ -----
Total................................. $5,664 $5,870 $(206) (3.5)%
====== ====== =====
</TABLE>
Revenue. Revenue decreased 3.5% or $206 million, from $5,870 million for
the nine months ended June 30, 1999, to $5,664 million for the same period in
2000, due to a decrease in the Communications
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45
Solutions segment, partially offset by increases in the Services and
Connectivity Solutions segments. The decrease in the Communications Solutions
segment was the result of a $135 million reduction in sales of our Merlin
Magix(TM) and Partner(R) product lines due to the shift from a direct retail
market to an indirect distribution channel resulting from our sale of this
distribution function to Expanets. In addition, sales of our messaging products
decreased by $130 million as customers purchased a higher than usual number of
systems in 1999 to upgrade their systems in anticipation of year 2000 concerns.
In addition, the Communications Solutions segment experienced a $90 million
decrease in installation revenue in line with the reduction in product sales.
These decreases were partially offset by increases in professional services as
well as in sales of our DEFINITY(R) and customer relationship management product
offerings. The increase in the Services segment was the result of strong growth
in maintenance services internationally and in existing value-added service
accounts. The Connectivity Solutions segment increase was driven by growth in
ExchangeMax(R) structured cabling systems and electronic cabinets sales of $125
million, largely offset by a decrease in SYSTIMAX(R) structured cabling systems.
Revenue within the United States decreased 6.3% or $301 million, from
$4,777 million for the nine months ended June 30, 1999, to $4,476 million for
the same period in 2000. Revenue increased outside the United States 8.7% or $95
million, from $1,093 million for the nine months ended June 30, 1999, to $1,188
million for the same period in fiscal 2000. Revenue outside the United States in
2000 represented 21.0% of revenue compared with 18.6% in 1999. We continued to
expand our business outside of the United States, with growth led by the
Asia/Pacific region for the nine months ended June 30, 2000.
Costs and gross margin. Total costs decreased 3.0% or $98 million, from
$3,250 million for the nine months ended June 30, 1999, to $3,152 million for
the same period in 2000 primarily due to the decrease in product sales. Gross
margin percentage remained essentially unchanged at 44.4% as compared with 44.6%
for the nine months ended June 30, 2000 and 1999, respectively.
Selling, general and administrative. Selling, general and administrative
expenses decreased 10.0% or $208 million, from $2,088 million for the nine
months ended June 30, 1999, to $1,880 million for the same period in 2000. The
decrease from 1999 is primarily due to reduced bonus compensation expenses
resulting from lower than anticipated financial performance and lower staffing
levels resulting from the realignment and integration of our sales force and our
information systems group. The headcount reductions for our information systems
group were associated with the ongoing implementation of a new computer software
platform. The majority of these reductions were associated with the shutdown and
elimination of support for obsolete and redundant computer systems.
Research and development. Research and development expenses decreased
11.8% or $47 million, from $397 million for the nine months ended June 30, 1999,
to $350 million for the same period in 2000. Increases in funding on call center
and converged voice and data products as well as spending associated with the
acquisition of Mosaix, were more than offset by reduced spending on more mature
product lines such as Partner and Merlin Magix. In addition, spending decreased
due to synergy realized in consolidation of the data product line research and
development operations of Prominet and Lannet.
Other income -net. Other income -net increased 107.7% or $28 million, from
$26 million for the nine months ended June 30, 1999, to $54 million for the same
period in 2000. This increase was primarily due to a gain of $45 million
realized in March 2000 on the sale of our U.S. sales division serving small and
mid-sized enterprises to Expanets, Inc., which represented the net cash proceeds
received related to this sale.
Provision for income taxes. The effective tax rates for the nine months
ended June 30, 2000 and June 30, 1999 were 39.4% and 40.0%, respectively.
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FISCAL YEAR ENDED SEPTEMBER 30, 1999 COMPARED TO FISCAL YEAR ENDED SEPTEMBER 30,
1998
The following table shows the change in external revenue, both in dollars
and in percentage terms:
<TABLE>
<CAPTION>
FISCAL YEAR ENDED
SEPTEMBER 30, CHANGE
------------------ ---------------
1999 1998 $ %
------- ------- ----- ------
(DOLLARS IN MILLIONS)
<S> <C> <C> <C> <C>
OPERATING SEGMENT:
Communications Solutions...................... $5,088 $4,583 $ 505 11.0%
Services...................................... 1,900 1,750 150 8.6
Connectivity Solutions........................ 1,274 1,408 (134) (9.5)
Corporate and other............................. 6 13 (7) (53.8)
------ ------ -----
Total................................. $8,268 $7,754 $ 514 6.6%
====== ====== =====
</TABLE>
Revenue. Revenue increased 6.6% or $514 million, from $7,754 million in
fiscal 1998 to $8,268 million in fiscal 1999 due to increases in both the
Communications Solutions segment and the Services segment. These increases were
partially offset by a decrease in the Connectivity Solutions segment. The
increase in the Communications Solutions segment was led by approximately $130
million of higher sales of DEFINITY products, increases of approximately $300
million of applications associated with our customer relationship management
products and services, multi-service networking products and unified messaging
systems, which accommodate voice, facsimile and electronic mail messages, as
well as from the sale of equipment which was previously rented to customers. The
Services segment increase was the result of increases of approximately $80
million and $70 million in sales of maintenance and value-added services,
respectively. The decrease in the Connectivity Solutions segment was the result
of $48 million, $52 million and $34 million in decreases in sales of SYSTIMAX,
ExchangeMax structured cabling systems and electronic cabinets, respectively.
Revenue within the United States increased 4.8% or $307 million, from
$6,376 million in fiscal 1998 to $6,683 million in fiscal 1999. Revenue
increased outside the United States 15.0% or $207 million, from $1,378 million
in fiscal 1998 to $1,585 million in fiscal 1999. Revenue outside the United
States in fiscal 1999 represented 19.2% of total revenue compared with 17.8% in
fiscal 1998. We continued to expand our business outside of the United States,
with growth led by the Europe/Middle East/Africa region in fiscal 1999.
Costs and gross margin. Total costs increased 11.1 % or $457 million, from
$4,107 million in fiscal 1998 to $4,564 million in fiscal 1999 primarily due to
the increase in sales. Gross margin percentage decreased 2.2 percentage points
from 47.0% to 44.8% in fiscal 1999 compared with fiscal 1998. The decrease in
gross margin percentage for the year was primarily due to price reductions,
partially offset by a more favorable product mix.
Selling, general and administrative. Selling, general and administrative
expenses increased 7.1% or $186 million, from $2,609 million in fiscal 1998 to
$2,795 million in fiscal 1999. The dollar increase is attributable to
approximately $80 million related to the full year impact associated with the
1998 acquisitions of Lannet and SDX, and approximately $40 million of costs
associated with the implementation of a new computer software platform.
Research and development. Research and development expenses increased
27.7% or $117 million, from $423 million in fiscal 1998 to $540 million in
fiscal 1999. This was due to increases of approximately $60 million resulting
from the acquisitions of Lannet and SDX, as well as approximately $60 million of
increases in our voice and data communications over the internet products and
connectivity product lines.
Purchased in-process research and development. There was no charge in
fiscal 1999 for in-process research and development. In fiscal 1998, the charges
of $306 million were associated with the acquisitions of Lannet, Prominet and
SDX.
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Other income-net. Other income-net increased 12.0% or $3 million, from $25
million in fiscal 1998 to $28 million in fiscal 1999. This increase was
primarily due to gains recorded on the sale of an Octel product line, Computer
Telephony Products.
Provision for income taxes. The effective tax rates were 39.4% and 82.1%
for the fiscal years 1999 and 1998, respectively. Excluding the impact of the
purchased in-process research and development expenses associated with the
Prominet, SDX and Lannet acquisitions in 1998, the effective tax rate for the
year ended September 30, 1998 was 36.2%. The increase to the effective tax rate
is primarily due to the tax impact of activity outside the United States.
FISCAL YEAR ENDED SEPTEMBER 30, 1998 COMPARED TO FISCAL YEAR ENDED SEPTEMBER 30,
1997
The following table shows the change in external revenue, both in dollars
and in percentage terms:
<TABLE>
<CAPTION>
FISCAL YEAR ENDED
SEPTEMBER 30, CHANGE
------------------ --------------
1998 1997 $ %
------- ------- ------ ----
(DOLLARS IN MILLIONS)
<S> <C> <C> <C> <C>
OPERATING SEGMENT:
Communications Solutions........................ $4,583 $3,721 $ 862 23.2%
Services........................................ 1,750 1,523 227 14.9
Connectivity Solutions.......................... 1,408 1,158 250 21.6
Corporate and other............................... 13 11 2 18.2
------ ------ ------
Total................................... $7,754 $6,413 $1,341 20.9%
====== ====== ======
</TABLE>
Revenue. Revenue increased 20.9% or $1,341 million, from $6,413 million in
fiscal 1997 to $7,754 million in fiscal 1998 resulting from increases in all
operating segments. The increase in the Communications Solutions segment was
primarily due to including approximately $420 million of revenue from the
messaging systems of Octel and increases of approximately $360 million in sales
of DEFINITY, multi-service networking and call center products. The increase in
the Connectivity Solutions segment was due to increases of approximately $210
million and $40 million in sales of SYSTIMAX and ExchangeMax, respectively. The
increase in the Services segment was the result of increases of $158 million and
$69 million in sales of maintenance and value-added services, respectively.
Revenue within the United States increased 19.3% or $1,033 million, from
$5,343 million in fiscal 1997 to $6,376 million in fiscal 1998. Revenue
increased outside the United States 28.8% or $308 million from $1,070 million in
fiscal 1997 to $1,378 million in fiscal 1998. Revenue outside the United States
in fiscal 1998 represented 17.8% of total revenue compared with 16.7% in fiscal
1997. We continued to expand our business outside of the United States, with
growth led by the Canadian region in fiscal 1998.
Costs and gross margin. Total costs increased 25.0% or $822 million, from
$3,285 million in fiscal 1997 to $4,107 million in fiscal 1998, primarily due to
the increase in sales. Gross margin percentage decreased 1.8 percentage points
from 48.8% to 47.0% in fiscal 1998 compared with fiscal 1997. The decrease in
gross margin percentage was primarily due to a less favorable product mix, with
21.6% growth in the Connectivity Solutions segment. Also contributing to the
percentage point decline were increased product price reductions.
Selling, general and administrative. Selling, general and administrative
expenses increased 19.4% or $423 million, from $2,186 million in fiscal 1997 to
$2,609 million in fiscal 1998. The increase is due to $200 million of increases
in sales and marketing expenses as well as $200 million of increases due to the
acquisition of Octel.
Research and development. Research and development expenses increased
22.3% or $77 million, from $346 million in fiscal 1997 to $423 million in fiscal
1998. This was due primarily to the increases resulting from the acquisition of
Octel.
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Purchased in-process research and development. Purchased in-process
research and development expenses decreased 35.2% or $166 million, from $472
million in fiscal 1997 to $306 million in fiscal 1998. These expenses reflect
charges associated with the acquisitions of Lannet, SDX and Prominet in 1998
and, for 1997, reflect charges associated with the acquisitions of Octel and
Agile.
Other income-net. Other income-net increased by 47.1% or $8 million, from
$17 million in fiscal 1997 to $25 million in fiscal 1998.
Provisions for income taxes. The effective tax rates were 82.1% and 280.5%
for the fiscal years 1998 and 1997, respectively. Excluding the impact of the
purchased in-process research and development expenses associated with the
Prominet, SDX and Lannet acquisitions in 1998 and the Octel and Agile
acquisitions in 1997, the effective tax rate for the year ended September 30,
1998 was 36.2% as compared to 41.3% for the year ended September 30, 1997. This
decrease is primarily due to increased research tax credits and the tax impact
of activity outside the United States.
HISTORICAL QUARTERLY PERFORMANCE FIRST FISCAL QUARTER 1998 THROUGH THIRD FISCAL
QUARTER 2000
The following table sets forth our historical quarterly revenue, gross
margin and net income (loss) from first fiscal quarter 1998 through third fiscal
quarter 2000:
<TABLE>
<CAPTION>
FISCAL YEAR QUARTERS
-------------------------------------
FIRST SECOND THIRD FOURTH
------ ------ ------- ------
(DOLLARS IN MILLIONS)
<S> <C> <C> <C> <C>
FISCAL YEAR ENDING SEPTEMBER 30, 2000
Revenue.................................... $1,845 $1,934 $ 1,885 --
Gross margin............................... 868 822 822 --
Net income................................. 69 66 33 --
FISCAL YEAR ENDING SEPTEMBER 30, 1999
Revenue.................................... $1,894 $1,938 $ 2,038 $2,398(2)
Gross margin............................... 840 841 939 1,084
Income (loss) before cumulative effect of
accounting change........................ 4 (34) 87 129
Cumulative effect of accounting
change(1)................................ 96 -- -- --
Net income (loss).......................... 100 (34) 87 129
FISCAL YEAR ENDING SEPTEMBER 30, 1998
Revenue.................................... $1,865 $1,690 $ 1,918 $2,281
Gross margin............................... 919 776 850 1,102
Net income (loss).......................... 105 (97) 59 (24)
</TABLE>
(1) Effective October 1, 1998, we changed our method for calculating the
market-related value of plan assets used in determining the expected
return-on-asset component of annual net pension and postretirement
benefit costs (see Note 8 to the combined financial statements).
(2) In fiscal year 1999, we sold equipment which was previously rented to
customers for $97 million. The equipment had a net book value of
approximately $2 million and consisted predominantly of discontinued
product lines.
Our quarterly financial results can vary from quarter to quarter, for
various factors including the compensation system for our sales force which
focuses on achieving full year results and because many of our customers' buying
behaviors can fluctuate quarter to quarter. For example, our product revenue in
the first fiscal quarter of 1999 and in the fourth fiscal quarter of 1999 was
$1,448 million and $1,895 million, respectively.
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LIQUIDITY AND CAPITAL RESOURCES
We generated cash flow from operations of $347 million for the nine months
ended June 30, 2000, compared with a use of $(136) million for the same period
in 1999, and $431 million, $129 million and $359 million for fiscal 1999, 1998
and 1997, respectively. The improvement in our cash flow from operations for the
nine months ended June 30, 2000, compared with the same period in 1999, and for
the fiscal year ended 1999, compared with fiscal year ended 1998, is primarily
the result of a significant reduction in working capital driven by improvement
in accounts receivable management and increases in net income. Domestic customer
support functions, which include cash collection, were centralized into four
regional customer care centers in the second half of 1999 which resulted in
accelerated cash collections. The decrease in our cash flow from operations for
the fiscal year ended 1998 compared with fiscal year 1997 was the result of
increases in accounts receivable and inventories.
Cash flow used in investing activities was $134 million for the nine months
ended June 30, 2000 compared with cash used of $114 million for the same period
in 1999. Cash flow used in investing activities was $86 million in fiscal year
1999, compared with $459 million and $1,056 million for fiscal 1998 and 1997,
respectively. Acquisitions of businesses in 1998 and 1997 drove higher levels of
cash used in investing activities in these periods. Capital expenditures and
acquisitions of businesses are the primary components of investing activities.
Generally, we have generated sufficient cash from our operating activities to
fund our working capital and capital expenditure requirements.
Net cash (used in) provided by financing activities was $(190) million for
the nine months ended June 30, 2000 compared with $288 million for the same
period in 1999. Net cash provided by (used in) financing activities was $(257)
million, $265 million and $833 million for fiscal 1999, 1998 and 1997,
respectively. We historically have relied on Lucent to provide financing for our
operations. The cash flows from financing activities reflected herein
principally reflect changes in our assumed capital structure. These cash flows
are a reasonable representation of the cash flows that would have resulted if we
were a stand-alone company.
Following the distribution, Lucent will no longer be providing funds to
finance our operations. Prior to the distribution, Lucent intends to issue $700
million of short-term debt under a commercial paper program, which will be
assumed by us at the distribution date. The commercial paper program will be
comprised of short-term borrowings in the commercial paper market at market
interest rates. We may assume additional debt under the commercial paper program
to the extent additional debt is incurred by Lucent under the program to fund
restructuring or separation costs and expenses that we may incur prior to the
distribution. We may also assume additional debt under the program for our
working capital if there is any substantial increase in our working capital over
our current plan prior to the distribution. We do not expect to incur any
permanent financing to fund working capital for the foreseeable future. Upon the
distribution Lucent will be relieved of all obligations under the program.
Accordingly, upon distribution, we will become obligated to satisfy all payments
and other terms of this commercial paper program.
In addition, we intend to enter into two unsecured revolving credit
facilities with third party financial institutions, a 364-day credit facility
and a five-year credit facility. We have not yet finalized the amount of the
credit facilities, but do not expect the amount of the two facilities to exceed
$1.7 billion in the aggregate. Lucent will initially be a party to each of these
credit facilities, but will have no obligations thereunder following the
distribution. We will be able to borrow funds under these revolving credit
facilities for general corporate purposes, including for the support of the
commercial paper program or repayment of other debt, working capital and
acquisitions. Neither we nor Lucent expect to make any borrowings under the
revolving credit facility to support the commercial paper program or, prior to
the distribution, to make borrowings under these facilities for any other
purpose. We may refinance all or a portion of the commercial paper program we
assume from Lucent with long-term or other short-term debt. We intend to file a
debt registration statement in order to be able to access the capital markets
from time to time. Interest rates on our commercial paper obligations will be
variable due to the short-term nature of this financial instrument. For a
commercial paper balance of $700 million outstanding for an entire year, a .125
percentage point increase in the average interest rate on the obligations, also
effective for an entire
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50
year, would increase pre-tax interest expense, and reduce pre-tax income, by
$875,000. Such an increase is not expected to significantly impact our future
results.
Our primary future cash needs on a recurring basis will be working capital,
capital expenditures and debt service. A portion of our restructuring and
separation costs and expenses also will be funded by internally generated funds.
We believe that our cash flows from operations will be sufficient to meet these
future cash needs. If our cash flows from operations are less than we expect, we
may need to incur additional debt. In addition, we currently anticipate
requiring approximately $600 million of additional financing in the next eight
months to fund costs and expenses in connection with the planned restructuring
and separation. We have not yet finalized the amount of additional financing we
will require because we are currently developing our restructuring plan,
reviewing our capital structure and examining other costs and expenses we may
incur as a stand-alone company. We also may from time to time issue additional
commercial paper under our commercial paper program, if the market permits such
borrowings, make borrowings under our revolving credit facilities or issue other
long or short-term debt, if available. We have not yet finalized the amount of
the commercial paper program, but do not expect the aggregate amount of the
program to exceed $1.7 billion.
On August 8, 2000, we entered into an agreement with Warburg, Pincus Equity
Partners, L.P. and related investment funds, which we refer to collectively as
the investors, to sell to them 4,000,000 shares of our Series B convertible
participating preferred stock and warrants to purchase our common stock for an
aggregate purchase price of $400 million. Based on the formula set forth under
"Description of Capital Stock -- Our Preferred Stock -- Series B Convertible
Participating Preferred Stock -- Conversion," the Series B convertible
participating preferred stock is expected to be initially convertible into
approximately 5.0% of our fully diluted common stock, calculated using a
modified treasury stock method as of the 90th day after issuance. The warrants
have an exercise price equal to 130% of the conversion price for the Series B
convertible participating preferred stock. The warrants are exercisable for 3.6%
of a total number of shares of common stock to be calculated pursuant to the
formula set forth under "Description of Capital Stock -- Warrants" as of the
90th day after issuance. Of these warrants, warrants exercisable for 2.0% of
such total number of shares of common stock will have a four-year term and
warrants exercisable for 1.6% of such total number of shares of common stock
will have a five-year term. During a period commencing on a date that we expect
to be no later than June 30, 2001, until the second anniversary of their
issuance, if the market price of our common stock exceeds 200%, in the case of
the four-year warrants, and 225%, in the case of the five-year warrants, of the
exercise price of the warrants for 20 consecutive trading days, we can force the
exercise of up to 50% of the four-year warrants and the five-year warrants,
respectively.
The shares of Series B convertible participating preferred stock will have
an aggregate initial liquidation value of $400 million and will accrete for the
first ten years at an annual rate of 6.5%, compounded quarterly. After the third
anniversary of the issue date, 50% of the amount accreted for the year may be
paid in cash as a dividend, on a quarterly basis, at our option. From the fifth
anniversary of the issue date through the tenth anniversary, we may elect to pay
100% of the amount accreted for the year as a cash dividend on a quarterly
basis. Following the tenth anniversary of the issue date, we will pay quarterly
cash dividends at an annual rate of 12% of the then accreted liquidation value
of the Series B convertible participating preferred stock, compounded quarterly.
The Series B convertible participating preferred shares also will participate,
on an as-converted basis, in dividends paid on our common stock. Any amounts
ascribed to a beneficial conversion feature of the Series B convertible
participating preferred stock will be recorded as a reduction to net income
attributable to common shareowners in the quarter the Series B convertible
participating preferred stock is issued. A beneficial conversion feature will
exist if the conversion price of the Series B convertible participating
preferred stock is less than the fair value of our common stock at the
measurement date. Based on our pro forma capital structure as of June 30, 2000,
an assumed market value of our common stock and option issuance, the beneficial
conversion feature related to the Series B convertible participating preferred
stock is estimated to be approximately $39 million. This actual amount will not
be determinable until after the distribution is consummated. Changes in the fair
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market value of Lucent's common stock, in the number of outstanding Lucent
shares and in the number of our outstanding options could affect the actual
value ascribed to the beneficial conversion feature.
We do not expect there to be a material impact on our future results of
operations for any beneficial conversion features associated with the deemed
dividends on the Series B convertible participating preferred stock or with the
warrants to purchase shares of our common stock.
At any time after the fifth anniversary of their issuance, we may force
conversion of the shares of Series B convertible participating preferred stock.
If we give notice of a forced conversion, the investors will be able to require
us to redeem the convertible participating preferred shares at 100% of the then
current liquidation value, plus accrued and unpaid dividends. Following a
change-in-control of us during the first five years after the investment, other
than a change of control transaction that is a business combination involving
solely the issuance of common stock, the accretion of some or all the
liquidation value of the Series B convertible participating preferred stock
through the fifth anniversary of the issue date will be accelerated, subject to
our ability to pay a portion of the accelerated accretion in cash in some
instances. In addition, for 60 days following the occurrence of any
change-of-control of us during the first five years after the investment, the
investors will be able to require us to redeem the Series B convertible
participating preferred stock at 101% of the liquidation value, including any
accelerated accretion of the liquidation value, plus accrued and unpaid
dividends.
The closing of the equity investment is subject to a number of conditions
and we cannot assure you that the investment will be consummated. If the
investment is consummated, we intend to use the proceeds to fund our operations
and execute our business strategy. For a more detailed description of this
equity investment, please see "Related Transactions and Equity Investment."
Our ability to issue additional equity is constrained because our issuance
of additional common stock may cause the distribution to be taxable to Lucent
under Section 355(e) of the Internal Revenue Code, and under the tax sharing
agreement we would be required to indemnify Lucent against that tax. See "The
Distribution Federal Income Tax Consequences of the Distribution" and
"Relationship Between Lucent and Our Company After the Distribution -- Tax
Sharing Agreement" for a more detailed discussion of Section 355(e) and the tax
sharing agreement between Lucent and us.
We may need to incur additional debt or issue equity to make any strategic
acquisition or investment. We can not assure you that such financing will be
available to us on acceptable terms or at all. Our ability to make payments on
and to refinance our indebtedness, including the commercial paper program and to
fund working capital, capital expenditures and strategic acquisitions will
depend on our ability to generate cash in the future, which is subject to
general economic, financial, competitive, legislative, regulatory and other
factors that are beyond our control. Further, the commercial paper program and
future indebtedness may impose various restrictions and covenants on us which
could limit our ability to respond to market conditions, to provide for
unanticipated capital investments or to take advantage of business
opportunities.
PURCHASED IN-PROCESS RESEARCH AND DEVELOPMENT
In connection with the acquisitions of Lannet, SDX, Prominet, Octel and
Agile in fiscal years ended September 30, 1998, and 1997, a portion of the
purchase price was allocated to purchased in-process research and development.
As part of the process of analyzing these acquisitions, we made a decision to
buy technology that had not yet been commercialized rather than develop the
technology internally. We based this decision on factors such as the amount of
time it would take to bring the technology to market. We also considered Bell
Laboratories' resource allocation and its progress on comparable technology, if
any. Our management expects to use a similar decision process in the future.
We estimated the fair value of in-process research and development for the
above acquisitions using an income approach. This involved estimating the fair
value of the in-process research and development using the present value of the
estimated after-tax cash flows expected to be generated by the purchased in-
process research and development, using risk-adjusted discount rates and revenue
forecasts as appropriate. The selection of the discount rate was based on
consideration of Lucent's weighted average cost of capital,
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as well as other factors, including the useful life of each technology,
profitability levels of each technology, the uncertainty of technology advances
that were known at the time, and the stage of completion of each technology. We
believe that the estimated in-process research and development amounts so
determined represent fair value and do not exceed the amount a third party would
have paid for the projects.
Where appropriate, we deducted an amount reflecting the contribution of the
core technology from the anticipated cash flows from an in-process research and
development project. At the date of acquisition, the in-process research and
development projects had not yet reached technological feasibility and had no
alternative future uses. Accordingly, the value allocated to these projects was
capitalized and immediately expensed at acquisition. If the projects are not
successful or completed in a timely manner, management's product pricing and
growth rates may not be achieved and we may not realize the financial benefits
expected from the projects.
The development efforts related to the majority of the purchased in-process
technology projects are progressing in accordance with the assumptions
underlying the appraisals. As expected in the normal course of product
development, a number of projects have experienced delays and other projects are
being evaluated due to changes in strategic direction and market conditions.
These factors are not expected to have a material adverse effect on results of
operations and financial position in future periods.
Set forth below are descriptions of the significant acquired in-process
research and development projects.
OCTEL
On September 29, 1997, Lucent completed the purchase of Octel for $1,819
million. The enterprise portion of Octel is a part of our business. The purchase
price that has been allocated to this business is $724 million. Octel was a
public company involved in the development of voice, fax and electronic
messaging technologies for both service providers and business enterprises. We
allocated $393 million to in-process research and development representing the
estimated fair value using the income approach described above of the in-process
research and development we acquired. This amount was allocated to the following
projects: Unified Messenger(R) $245 million, Octel network services projects for
$111 million and two other projects for $37 million in total.
At the acquisition date Octel was working on the development of Unified
Messenger and various Octel network services projects. Unified Messenger was a
messaging system for accessing both voice and e-mail messages with either a
phone or a computer. Messages are stored on a single mailbox, in which the user
could access all of their messages. The Octel network services projects
represented the development of new administrative software that would allow
Octel to provide the capabilities in its outsourcing contracts that customers
demand, and work with the new hardware of other product lines that it would be
producing.
Unified Messenger. Revenue attributable to Unified Messenger were
estimated to be $5 million in 1998 and $46 million in 1999. Revenue was expected
to peak in 2004 and decline thereafter through the end of the product's life in
2008 as new product technologies were expected to be introduced by us. Revenue
growth was expected to decrease from 179% in 2000 to 20% in 2004, and be
negative for the remainder of the projection period. At the acquisition date,
costs to complete the research and development efforts related to the initial
release of the project were expected to be $3 million.
Octel network services projects. Revenue attributable to the Octel network
services projects were estimated to be $18 million in 1998 and $93 million in
1999. Revenue was expected to peak in 2003 and decline thereafter through the
end of the product's life in 2006 as new product technologies were expected to
be introduced by us. Revenue growth was expected to decrease from 52% in 2000 to
10% in 2003, and be negative for the remainder of the projection period. At the
acquisition date, costs to complete the research and development efforts related
to the Octel network services projects were expected to be less than $1 million.
An average risk-adjusted discount rate of 20% was utilized to discount
projected cash flows.
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PROMINET
On January 23, 1998, Lucent completed the purchase of Prominet for $199
million. Prominet was a participant in the gigabit ethernet networking industry.
A gigabit ethernet network is a high performance local area network used by an
enterprise to connect computers, printers, workstations and the like within a
building or campus. We allocated $157 million to in-process research and
development using the income approach described above. The $157 million was
allocated to the following projects: Phase II for $12 million, Phase III for $92
million, and Phase IV for $53 million.
At the acquisition date Prominet was working on a gigabit ethernet router
with improved technological and administrative functionality. A router is an
interface between two networks. The project was expected to be completed in
three phases, Phase II through Phase IV. Each phase represented an effort to
significantly enhance the technological and administrative capabilities of the
router.
Phase II. Revenue attributable to Phase II was estimated to be $8 million
in 1999 and $18 million in 2000. Revenue was expected to peak in 2004 and
decline thereafter through the end of the product's life in 2009 as new product
technologies were expected to be introduced by us. Revenue growth was expected
to decrease from 112% in 2000 to 8% in 2004, and be negative for the remainder
of the projection period. At the acquisition date, costs to complete the
research and development efforts related to the initial release of the project
were expected to be $2 million.
Phase III. Revenue attributable to Phase III was estimated to be $47
million in 1999 and $99 million in 2000. Revenue was expected to peak in 2004
and decline thereafter through the end of the product's life in 2009 as new
product technologies were expected to be introduced by us. Revenue growth was
expected to decrease from 112% in 2000 to 8% in 2004, and be negative for the
remainder of the projection period. At the acquisition date, costs to complete
the research and development efforts related to the initial release of the
project were expected to be $4 million.
Phase IV. Revenue attributable to Phase IV was estimated to be $38 million
in 1999 and $79 million in 2000. Revenue was expected to peak in 2004 and
decline thereafter through the end of the product's life in 2009 as new product
technologies were expected to be introduced by us. Revenue growth was expected
to decrease from 106% in 2000 to 7% in 2004, and be negative for the remainder
of the projection period. At the acquisition date, costs to complete the
research and development efforts related to the initial release of the project
were expected to be $3 million.
An average risk-adjusted discount rate of 25% was utilized to discount
projected cash flows.
ENVIRONMENTAL, HEALTH AND SAFETY MATTERS
We are subject to a wide range of governmental requirements relating to
employee safety and health and to the handling of emission into the environment
of various substances used in our operations. We have not incurred material
capital expenditures for such matters during the past three years, nor do we
anticipate having to incur such expenditures during the current or succeeding
fiscal year.
We are currently conducting investigation and/or cleanup of known
contamination at approximately five of our facilities either voluntarily or
pursuant to government directives. We have established financial reserves to
govern environmental liabilities where they are probable and reasonably
estimable. Reserves for estimated losses from environmental matters are,
depending on the site, based primarily upon internal or third-party
environmental studies and the extent of contamination and the type of required
cleanup. Although we believe that our reserves are adequate to cover known
environmental liabilities, it is often difficult to estimate with certainty the
future cost of such matters. Therefore, we cannot be assured that the actual
amount of environmental liabilities will not exceed the amount of reserves for
such matters or will not have a material adverse effect on our financial
position, results of operations or cash flows. Please see
"Business -- Environmental, Health and Safety Matters" for a more detailed
discussion of these matters.
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LEGAL PROCEEDINGS
From time to time we are involved in legal proceedings arising in the
ordinary course of business. 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.
We are currently involved in two purported class action lawsuits related to
Y2K issues. Although we believe that the outcome of these Y2K actions will not
adversely affect our business prospects, if these cases progress, they will
require expenditure of significant legal costs related to their defense. We also
have been advised by Region 6 of the National Labor Relations Board that it has
been authorized to file a complaint alleging that Lucent has refused to bargain
over the outsourcing of certain of its manufacturing activities. Because the
complaint will relate to some of the manufacturing facilities that will be
transferred to us as part of the distribution, we expect to become a party to
this action. If we are unsuccessful in resolving these charges, as they relate
to us, our operations may be disrupted, our initiative to outsource
substantially all of our manufacturing may be delayed or prohibited or we may
incur additional costs that may decrease our profitability. For a more complete
description of these legal proceedings, please see "Business -- Legal
Proceedings." Other than as described above, we believe there is no litigation
pending that should have, individually or in the aggregate, a material adverse
effect on our financial position or results of operations.
RISK MANAGEMENT
We are exposed to risk from changes in foreign currency exchange rates and
interest rates that could impact our results of operations and financial
position. We manage our exposure to these market risks through our regular
operating and financing activities and, when deemed appropriate, through the use
of derivative financial instruments. We use derivative financial instruments as
risk management tools and not for speculative or trading purposes. In addition,
derivative financial instruments are entered into with a diversified group of
major financial institutions in order to manage our exposure to nonperformance
on such instruments.
We use foreign currency forward contracts, and to a lesser extent foreign
currency options, to reduce significant exposure to the risk that the eventual
net cash inflows and outflows resulting from the sale of products to non-U.S.
customers and purchases from non-U.S. suppliers will be adversely affected by
changes in exchange rates. Foreign currency exchange contracts are designated
for recorded, firmly committed or anticipated purchases and sales. The use of
these derivative financial instruments allows us to reduce our overall exposure
to exchange rate movements, since the gains and losses on these contracts
substantially offset losses and gains on the assets, liabilities and
transactions being hedged. As of September 30, 1999, our primary net foreign
currency market exposures included Canadian dollars, Euro currencies and British
pounds.
The fair value of foreign currency exchange contracts is sensitive to
changes in foreign currency exchange rates. As of September 30, 1999 and 1998, a
10% appreciation in foreign currency exchange rates from the prevailing market
rates would increase our related net unrealized gain for 1999 and loss for 1998
by approximately $8 million and $3 million, respectively. Conversely, a 10%
depreciation in these currencies from the prevailing market rates would decrease
our related net unrealized gain for 1999 and loss for 1998 by approximately $10
million and $5 million, respectively. Consistent with the nature of the economic
hedge of such foreign currency exchange contracts, such unrealized gains or
losses would be offset by corresponding decreases or increases, respectively, of
the underlying instrument or transaction being hedged.
While we hedge many foreign currency transactions, the decline in value of
non-U.S. dollar currencies may, if not reversed, adversely affect our ability to
contract for product sales in U.S. dollars because our products may become more
expensive to purchase in U.S. dollars for local customers doing business in the
countries of the affected currencies.
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We may enter into interest rate swap agreements to manage the risk between
fixed, floating and variable interest rates and long-term and short-term
maturity debt instruments. There were no interest rate swap agreements in effect
during 1999 and 1998.
The Contribution and Distribution Agreement provides that, as between us
and Lucent, we have assumed all liabilities under or otherwise relating to
derivatives and similar obligations primarily related to our business.
Initially, Lucent may continue to perform obligations under such derivatives and
similar obligations on behalf of us, but all amounts paid to or received from
third parties will be charged to, or paid over or credited to us, as the case
may be.
By their nature all such instruments involve risk including the credit risk
of nonperformance by counterparties, and our maximum potential loss may exceed
the amount recognized in our balance sheet. However, at both June 30, 2000 and
September 30, 1999, in management's opinion there was no significant risk of
loss in the event of nonperformance of the counterparties to these financial
instruments. We control our exposure to credit risk through credit approvals,
credit limits and monitoring procedures, and management believes that reserves
for losses are adequate. We do not have any significant exposure to any
individual customer or counterparty nor any major concentration of credit risk
related to any financial instruments.
EUROPEAN MONETARY UNION -- EURO
On January 1, 1999, eleven member countries of the European Union
established fixed conversion rates between their existing sovereign currencies,
and adopted the Euro as their new common legal currency. The Euro is currently
trading on currency exchanges and the legacy currencies will remain legal tender
in the participating countries for a transition period between January 1, 1999
and January 1, 2002. During the transition period, cash-less payments can be
made in the Euro, and parties can elect to pay for goods and services and
transact business using either the Euro or a legacy currency. Between January 1,
2002 and July 1, 2002, the participating countries will introduce Euro notes and
coins and withdraw all legacy currencies so that they will no longer be
available.
We will continue to evaluate issues involving introduction of the Euro
involving accounting, tax, legal and regulatory requirements. Based on current
information and our current assessment, we do not expect that the Euro
conversion will have a material adverse effect on our business or financial
position.
RECENT ACCOUNTING PRONOUNCEMENTS
In June 1998, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 133, "Accounting for Derivative Instruments
and Hedging Activities". SFAS 133 establishes new accounting and reporting
standards for derivative financial instruments and for hedging activities. SFAS
133 requires us to measure all derivatives at fair value and to recognize them
in the balance sheet as an asset or liability, depending on our rights or
obligations under the applicable derivative contract. Subsequent to the issuance
of SFAS 133, the FASB has received many requests to clarify certain issues
causing difficulties in implementation. In June 2000, the FASB issued SFAS 138
which responds to those requests by amending certain provisions of SFAS 133.
These amendments include allowing foreign-currency denominated assets and
liabilities to qualify for hedge accounting, permitting the offsetting of
selected inter-entity foreign currency exposures that reduce the need for third
party derivatives and redefining the nature of interest rate risk to avoid
sources of ineffectiveness. We will adopt SFAS 133 and the corresponding
amendments under SFAS 138 in the first quarter of fiscal year 2001. SFAS 133, as
amended by SFAS 138, is not expected to have a material impact on our combined
results of operations, financial position or cash flows.
In December 1999, the Securities and Exchange Commission staff issued Staff
Accounting Bulletin 101, "Revenue Recognition in Financial Statements." SAB 101
provides guidance on the recognition, presentation and disclosure of revenue in
financial statements and requires adoption no later than the fourth quarter of
our fiscal 2001. We are currently evaluating the impact of SAB 101 to determine
what effect, if any, it could have on our financial position and results of
operations.
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BUSINESS
OVERVIEW
We are a leading provider of communications systems and software for
enterprises, including businesses, government agencies and other organizations.
We offer voice, converged voice and data, customer relationship management,
messaging, multi-service networking and structured cabling products and
services. Multi-service networking products are those products that support
network infrastructures which carry voice, video and data traffic over any of
the protocols, or set of procedures, supported by the Internet on local area and
wide area data networks. A structured cabling system is a flexible cabling
system designed to connect phones, workstations, personal computers, local area
networks and other communications devices through a building or across one or
more campuses. We are a worldwide leader in sales of messaging and structured
cabling systems and a U.S. leader in sales of enterprise voice communications
and call center systems. We are not a leader in multi-service networking
products or in converged voice and data products. We have entered these product
areas relatively recently, and our product portfolio is less complete than the
portfolios of some of our competitors. We are implementing a strategy focused on
these products. In fiscal 1999, we had revenue of approximately $8.3 billion and
net income of approximately $300 million.
Over the last ten years, approximately 980,000 enterprises have purchased
one or more of our systems, software or services through our direct sales force.
We also have a global network of approximately 4,300 distributors, dealers,
value-added resellers, systems integrators and contractors, through which we
indirectly sell our products to enterprises. Our broad customer base includes
approximately 78% of the Fortune 500 companies.
We support our customers with comprehensive global service offerings,
including remote diagnostics testing of our advanced systems, installation of
our products, on-site repair and maintenance. We believe our global service
organization is an important consideration for customers purchasing our systems
and software and is a source of significant revenue for us, primarily from
maintenance contracts. We also offer professional services for customer
relationship management and value-added services for the outsourcing of
messaging and other portions of an enterprise's communications system.
We intend to use our leadership positions in enterprise communications
systems and software, our broad portfolio of products and services and strategic
alliances with other technology and consulting services leaders to offer our
customers comprehensive eBusiness communications solutions. By eBusiness, we
mean the internal and external use of communications tools and electronic
networks, to interact, collaborate and transact business with an enterprise's
customers, suppliers, partners and employees. We currently offer many of the
advanced products that we believe are important components of eBusiness
communications solutions. We are focusing our strong research and development
capabilities on developing new and improved eBusiness communications products
and services.
We have historically operated as part of Lucent. In connection with our
separation from Lucent, we are engaging in a comprehensive review of our
operations, including our organizational structure, products and services and
market segments, with a view toward improving our profitability and our business
performance in the near term. As a result of this review, we expect to announce
a restructuring plan, with an associated restructuring charge, in the fourth
quarter of fiscal year 2000. As a result of our restructuring plan and strategic
initiatives, we intend to:
- reduce our costs of products and services;
- reduce our corporate overhead expenses;
- increase our investment in research and development;
- implement a tax strategy tailored to our operations as a stand-alone
company; and
- increase our revenue growth by focusing our sales and product development
efforts on the higher growth segments of our market.
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We were incorporated under the laws of the State of Delaware under the name
"Lucent EN Corp.", on February 16, 2000, as a wholly owned subsidiary of Lucent.
As of June 27, 2000, our name was changed to "Avaya Inc." Lucent was formed from
the systems and technology units that were formerly a part of AT&T Corp. and the
research and development capabilities of Bell Laboratories. On September 30,
1996, Lucent became independent of AT&T when AT&T distributed all its Lucent
shares to its shareowners in a tax-free spinoff. We will have no material assets
or activities as a separate corporate entity until the contribution to us by
Lucent, immediately prior to the distribution, of the businesses described in
this information statement. Following the distribution, we will be an
independent public company, and Lucent will have no continuing stock ownership
interest in us. Prior to the distribution, we will enter into several agreements
with Lucent in connection with, among other things, intellectual property,
interim services and a number of on-going commercial relationships, including
product supply arrangements. Please see "Relationship Between Lucent and Our
Company After the Distribution" for a more detailed discussion of these
agreements.
INDUSTRY OPPORTUNITY
We currently define our market to be comprised of the enterprise voice
communications systems, communications applications, multi-service networking,
connectivity solutions, maintenance support and value-added services segments.
Multi-service networking products are those products that support network
infrastructures which carry voice, video and data traffic over any of the
protocols, or sets of procedures, supported by the Internet on local area and
wide area data networks. We estimate, based on various industry reports, that
this market will grow from approximately $113.8 billion in 1999 to approximately
$176.6 billion in 2003, a compound annual growth rate of 11.6%. We expect that
these segments will grow at rates that differ substantially from segment to
segment. For example, we estimate, based on various industry reports, that the
enterprise unified messaging, call center and traditional voice communications
portions of these segments will grow at respective compound annual growth rates
of 71.5%, 30.3% and 1.2% between 1999 and 2003. Unified messaging is an advanced
messaging solution that delivers the convenience and benefits of combining the
storage of more than one type of message, including voice, facsimile and
electronic mail.
We estimate that higher growth can be realized from the advanced enterprise
communications products in our market segments which support eBusiness
solutions. We believe there are several trends which are driving the deployment
of these advanced communications products. These trends are described below.
ADOPTION OF eBUSINESS STRATEGIES
Major advances in networking, computing and software have increased the
number and value of communications tools and have led to capabilities such as
voice mail, electronic mail, wireless communications, Web chat sessions and
voice communications over the Internet. The rapid adoption of these new
communications tools, accelerated growth in the use of the Internet and
significant expansion of the electronic marketplace for goods and services have
resulted in competitive pressures to change the way enterprises operate and
interact with their customers, suppliers, partners and employees. In order to
take advantage of the opportunities and efficiencies offered by the new
communication-based economy, enterprises are increasingly implementing eBusiness
strategies in order to:
- attract and retain customers;
- increase revenue by using the Internet to reach new markets and
customers;
- enhance relationships with suppliers, partners and employees;
- share in-house knowledge and expertise more effectively throughout their
organizations; and
- decrease their operating costs.
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Many enterprises have incorporated elements of eBusiness solutions into
their operations. As the uses and complexity of eBusiness offerings continue to
rise, we expect enterprises to increasingly demand flexible communications
systems to support their operations and to enhance and personalize their
relationships with customers, suppliers and partners. We believe that most
enterprises are just beginning to deploy the advanced communications solutions
that provide the infrastructure for eBusiness. Few enterprises, however, have
the range of skills necessary in-house to implement comprehensive eBusiness
solutions and the advanced communications solutions to support them. Therefore,
enterprises are increasingly looking to outsource their professional service
needs.
A FOCUS ON CUSTOMER RELATIONSHIP MANAGEMENT
Enterprises are increasingly focused on customer relationship management, a
business strategy for building and retaining a strong, active purchasing base of
satisfied customers through relationship oriented services and proactive
marketing and management. The development of more advanced communication tools
and the adoption of eBusiness strategies have increased an enterprise's ability
to manage its interaction with customers. The expansion of eBusiness and
resulting competitive pressures have helped focus enterprises to incorporate
customer relationship management into their strategies. Customer relationship
management strategies build upon the basic principles of customer service to use
voice, Web, facsimile and other forms of communications and software to:
- record and utilize customer preferences;
- ensure that customers are served when they prefer, using the
communications media of their choice;
- provide customer self service functionality as well as interactive
services; and
- meet customer expectations consistently and in a timely manner.
Increasingly, customer relationship management strategies rely on advanced
solutions with workflow and back-office capabilities to manage the relationship
from the initial point of contact with a customer, whether in person, on the
telephone or over the Internet, through transaction fulfillment, accounting and
ongoing customer satisfaction.
EXTENDED ENTERPRISES
The growth of eBusiness and advances in networking and software
applications have allowed enterprises to extend beyond their physical facilities
to create a broad geographical presence that requires coordination of widespread
operations. Globalization of operations and consolidation of industries through
high levels of worldwide mergers and acquisitions activity have contributed to
increased complexity of enterprises. A single enterprise may have numerous
locations that need to be linked electronically, and merged enterprises face the
challenge of coordinating their often disparate systems and organizations
quickly and effectively. These enterprises require voice communication servers
and messaging systems that can be networked together, or to the servers and
systems of other vendors, to support their dispersed operations. Communication
tools such as voice and electronic mail, facsimiles and wireless devices have
also helped to create a mobile workforce capable of working from home or other
remote locations, both during and outside traditional business hours. We believe
advanced communications systems that can grow with an enterprise and that will
integrate with existing infrastructure are needed to allow enterprises of all
sizes to extend their reach and coordinate all aspects of their operations.
EVOLUTION TOWARD CONVERGED VOICE AND DATA NETWORKS
Voice and data networks have historically been separate, using different
switching or transmission technologies because of the inherent differences in
the requirements of the traffic they support. Until recently, technology did not
exist to reliably carry voice and data traffic over a single network and satisfy
the requirements of both types of traffic. Over time, we expect voice and data
networks to converge into a single network. This convergence will be driven by
the development of eBusiness and other applications
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that require converged networks as well as the potential cost savings for
enterprises utilizing a single, integrated network for their communications as
well as by additional operational benefits. However, while converged technology
has begun to be deployed, further advances in reliability are necessary before
this technology will be widely accepted. Accordingly, enterprises are seeking
advanced applications that allow their voice and data networks to work together
efficiently. These applications enable enterprises to experience some of the
benefits of a converged network without the expense of replacing their entire
communications infrastructure. We view the converged voice and data segment to
include products which provide for the transport of voice over packet switched
networks. Packet switching is the process of breaking data up into packets and
sending those packets through a network to a remote location, at which point the
packets are reassembled. These products range from voice over Internet Protocol
applications to single networks for voice and data and are in various stages of
development. Internet Protocol is a type of protocol, or set of procedures, for
the formatting and timing of data transmission between two pieces of equipment.
OUR OPPORTUNITY
We believe there exists a significant opportunity for a communications
company, such as our company, with a broad product portfolio, strong research
and development capabilities, extensive service offerings and a large customer
base to capitalize on the needs of enterprises for advanced communications
systems. Due to the widespread base of installed communications systems, the
implementation of eBusiness strategies and related communications systems has
been, and is expected to continue to be, an adaptive and evolutionary process.
Accordingly, we believe that our company, with its ability to offer reliable
communications systems that can grow with an enterprise and be integrated with
existing infrastructure, is well-positioned to serve the near and long term
needs of this growing market segment.
STRATEGY
Our objective is to become the leading, worldwide provider of
communications solutions for enterprises operating in the rapidly changing
eBusiness environment. To accomplish this goal, we are pursuing the following
three major strategies:
IMPROVE PROFITABILITY AND THE BUSINESS PERFORMANCE OF OUR OPERATIONS
We believe there are a number of opportunities as a stand-alone company to
improve our profitability and business performance. We expect to implement the
restructuring plan we are currently developing and other initiatives as a part
of this strategy by the end of 2001. We are a transaction intensive business in
all our activities, including manufacturing, selling, ordering, shipping,
billing, servicing and collections. We intend to focus our restructuring plan on
reducing the cost of these activities through a variety of mechanisms. In
addition, we have announced our first major initiative, the outsourcing of
substantially all our manufacturing other than the manufacturing of our
structured cabling systems. By outsourcing our manufacturing to contractors
whose business is to manufacture sophisticated electronics equipment, we believe
we will be able to focus on our strengths in developing innovative software and
systems and on increasing and improving our services offerings, while still
providing high quality products to our customers. We believe that outsourcing
our manufacturing will allow us to improve our cash flow over the next few years
through a reduction of inventory and reduced capital expenditures. We cannot
assure you that we will be successful in implementing this initiative.
CAPITALIZE ON NEAR TERM REVENUE GROWTH OPPORTUNITIES
We intend to focus on the elements of this strategy described below, which
we believe are opportunities to increase our revenue in the near term.
Expanding our international sales. We have traditionally derived the
majority of our revenue from sales in the United States. We believe there is an
opportunity to increase our revenue by expanding our focus on international
sales. We began executing a strategy three years ago to strengthen our global
direct
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sales force and our worldwide network of distribution partners, and have grown
our international sales from approximately $1.1 billion in fiscal 1997 to
approximately $1.6 billion in fiscal 1999. We intend to continue to increase our
international sales by entering into additional strategic alliances focused on
international sales. We also will continue to strengthen our network of
international distribution partners, and we are seeking to expand our presence
in some of the countries where we currently have operations and believe the
market opportunity to be attractive.
Strengthening our distribution channels. With an existing customer base
that includes 78% of Fortune 500 companies, our sales force has developed
relationships with many large and multi-national enterprises that we believe are
likely to need advanced communications systems. We will continue to focus our
direct sales force primarily on national and global accounts, providing these
customers a single point of contact and centralized purchasing process with
product fulfillment and high quality local support on a worldwide basis. To
complement our strong global direct sales force, continue to expand our sales
internationally and better serve the needs of small and mid-sized enterprises,
we intend to strengthen our worldwide network of distribution partners. We
intend to strengthen this network by developing relationships with distribution
partners that provide us with broader geographic, product segment or customer
coverage. As the communication needs of our customers have become more complex,
we believe that many small and mid-sized enterprises worldwide are increasingly
purchasing communications solutions through, or with the advice of, companies
that offer them comprehensive eBusiness and communications services such as
value-added resellers and systems integrators that not only sell products but
also design, install and test comprehensive systems and networks, including
systems integration. By focusing our direct sales force on national and global
accounts and strengthening our indirect distribution channels, we believe we can
increase sales across all channels and better serve the needs of our customers.
Capitalizing on the demand for customer relationship management products
and services. We intend to expand our sales in the growing customer
relationship management market segment by using our leadership position in sales
of call center systems, our expanded portfolio of customer relationship
management products and our approximately 900 person group of professionals
offering customer relationship management services. In September 1999, we
expanded our product portfolio from primarily call center voice applications for
voice traffic to a new product line. This product line enables enterprises to
manage customer interactions across a variety of communication channels such as
Web chat sessions and electronic mail as well as integrate an enterprise's
internal and external office functions. We are investing in our sales teams and
consultants and expanding our relationships with distribution partners. We
intend to continue to utilize relationships our consultants have developed with
our call and contact center customers to sell our new customer relationship
management products and increase the role of our professional services
consultants.
POSITION OURSELVES TO CAPITALIZE ON LONG TERM GROWTH OPPORTUNITIES
We believe we are well-positioned to capitalize on the rapidly evolving
eBusiness communications environment. We are implementing the following
strategies in order to increase our sales in the higher growth areas of our
market.
Marketing our advanced products and services as essential components of
comprehensive eBusiness communications solutions. We currently offer many of
the advanced products and services that we believe are the important components
of comprehensive eBusiness communications solutions. By eBusiness, we mean the
internal and external use of communications tools and electronic networks, to
interact, collaborate and transact business with an enterprise's customers,
suppliers, partners and employees. Examples of these include:
- our contact center and messaging systems that allow an enterprise and its
customers, suppliers, partners and employees to communicate by voice,
electronic mail, facsimile, Web chat sessions and other means of
communication;
- our network systems and software for allocating network resources among
users and applications to maximize use of an enterprise's network
capacity;
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- our communications servers that support telephone-based communications
over traditional voice networks as well as over the Internet or other
data networks; and
- our professional services consultants who can design and implement an
enterprise's customer relationship management strategy.
See "-- eBusiness Communications Solutions" for a more detailed description of
our current portfolio of eBusiness products and services.
We plan to tailor our eBusiness communications solutions both for
enterprises that seek to upgrade their existing communications systems to meet
the new requirements of eBusiness and enterprises that seek to build entirely
new communications systems using these solutions. We believe that our leading
positions in sales of enterprise voice communications and call center systems,
as well as our reputation for reliability and our technological, diagnostic and
service expertise, will support our continued introduction of our converged
voice and data solutions and communications applications for the eBusiness
environment. In addition, we intend to establish a new brand identity for our
products through brand management and product positioning efforts.
Introducing innovative products through continued investment in our
research and development capabilities. We intend to invest an amount equal to
approximately 9% of our total revenue in fiscal 2001 in research and
development. These investments represent a significant increase over our
investment in research and development over the previous three fiscal years,
which was approximately 6% of total revenue for each of those years. We are
building a research and development capability that is intended to have
approximately 3,000 engineers, including many that currently work at Lucent's
Bell Laboratories, one of the world's leading research and development
institutions. We will spend a portion of our 2001 budget on hiring research
personnel as we build our capability. We believe our research and development
spending will be more effective than it has been historically because our
efforts will be focused on higher growth segments in our market. As a part of
Lucent, we funded a portion of Lucent's basic research, which research was not
necessarily beneficial for our businesses.
We plan on using our substantial investment in research and development to
develop new systems and software to augment our current eBusiness communications
product offerings so that, together with our strategic alliances and services,
we can offer our customers comprehensive eBusiness communications solutions. We
are particularly focused on converged voice and data solutions and applications
which support eBusiness communications needs. Our research and development group
will continue to seek opportunities to work with technology leaders from other
companies and educational and research institutions to develop uniform
technological standards as the building blocks for future communications and
related enterprise systems.
Building strategic alliances and making strategic acquisitions and
investments to develop comprehensive eBusiness communications solutions. To
further our objective of offering our customers comprehensive eBusiness
communications solutions, we have entered into a number of strategic alliances
with other technology and consulting services leaders. By linking our advanced
products and enterprise communications systems experience with the expertise of
strategic partners in eBusiness consulting, applications, infrastructure and
product development, we seek to enhance the portfolio of products we offer our
customers, better positioning us to deliver these comprehensive solutions. We
are actively pursuing additional strategic alliance opportunities with partners
whose capabilities complement our product and service offerings. We also intend
to seek acquisitions of technology, services or distribution channels in order
to accelerate our time to market of new products and solutions and increase our
worldwide presence and share of international sales. We may also make
investments in companies with products, technologies or services that compliment
our product and service portfolio. At the same time, we will evaluate our
existing product lines and businesses and we may exit some of our product lines
and businesses which are no longer key to our strategy.
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PRODUCTS AND SOLUTIONS
We offer a broad array of communications systems, software and services
that enable enterprises to communicate with their customers, suppliers, partners
and employees through voice, Web, electronic mail, facsimile, Web chat sessions
and other forms of communication, across an array of devices. These devices
include telephones, computers, mobile phones and personal digital assistants. We
classify these products and services into the following principal categories:
- Enterprise Voice Communications Systems;
- Communications Applications;
- Multi-service Networking; and
- Connectivity Solutions.
Our broad portfolio of products includes products we have developed
internally, products we have obtained through acquisitions, products
manufactured by third parties which we resell and products we have developed
through our strategic alliances with other technology leaders. Our products
range from systems designed for multinational enterprises with multiple
locations worldwide, thousands of employees and advanced communications
requirements to systems designed for enterprises with a regional or local
presence, a single location, and less extensive communications requirements. We
believe that the four primary considerations for an enterprise in selecting our
systems are:
- the reliability of the system;
- the availability and level of service offered around the world;
- the features or applications offered to an enterprise; and
- the system's scalability, or ability to add users, features or
applications as the needs of the enterprise change.
ENTERPRISE VOICE COMMUNICATIONS SYSTEMS
We are a U.S. leader in sales of enterprise voice communications systems,
our core voice communications products. In fiscal 1999, we derived approximately
$3.4 billion or 41% of our total revenue from these products. We estimate, based
on various industry reports, that the market segment for traditional voice
communications, such as the DEFINITY, Merlin Magix and Partner products
described below, will grow from approximately $28 billion in 1999, to
approximately $29 billion in 2003, a compound annual growth rate of 1.2%.
We offer a broad range of systems to satisfy the communications needs of a
diverse group of enterprises. We offer systems designed for under five users, as
well as systems that can be networked to accommodate an almost unlimited number
of users. Our systems are generally designed to allow an enterprise to add or
remove users and have optional features, including over 450 in our most advanced
systems, available to enable an enterprise to activate additional features as
its communications requirements change. We also design our systems to be easy to
administer and use. We provide technical support and training to our customers,
and offer the option of purchasing remote diagnostic services for some of our
products. These diagnostic services help improve the reliability of an
enterprise's systems because we can identify, through the application of
artificial intelligence, problems and potential problems with that system, often
before the customer realizes there may be a problem.
Advanced systems. Our most advanced system is our DEFINITY Enterprise
Communications Server, which is offered in a variety of configurations in
approximately 90 countries. Our DEFINITY product line is a family of products
that provides for a reliable network for voice communication which offers
integration with an enterprise's data network. Our DEFINITY servers support a
variety of voice and data applications such as call and customer contact
centers, messaging and interactive voice response systems. Interactive voice
response systems allow an individual to access information in the enterprise's
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computer databases or conduct transactions verbally or using a touch-tone
telephone. Our DEFINITY servers support open and standard interfaces for
computer telephony integration applications, which are advanced applications
that assist in the making, receiving or managing of telephone calls. Our
DEFINITY servers facilitate the ongoing transition at many enterprises from
private voice telephone systems to advanced systems that integrate voice and
data traffic and deploy increasingly sophisticated communications applications.
DEFINITY products offer flexible networking options to enterprises.
Multiple DEFINITY servers can be integrated to work together in a single network
with centralized administration supporting transport over internet protocol,
asynchronous transfer mode, frame relay or integrated services digital networks.
Internet protocol, asynchronous transfer mode and frame relay refer to different
sets of procedures for the formatting and timing of data transmission between
two pieces of equipment. All three of these protocols support voice traffic over
a data network. Integrated Services Digital Networks use lines for voice, video
and data traffic installed as part of the public switched network. In the case
of enterprises with more than one type of network, DEFINITY allows an enterprise
to use the transport resources of any or all of these networks simultaneously.
In addition, our DEFINITY systems also may be networked with the systems of
other vendors, including those at remote locations.
We primarily sell our DEFINITY systems to large enterprises with
sophisticated communications requirements. Our DEFINITY systems are also used by
small and mid-sized enterprises with advanced communications needs and as few as
five users. Our DEFINITY systems vary primarily based on the number of users,
the features desired by the enterprise and the speed of the system. Each
DEFINITY system may be upgraded to support more users and features as the
enterprise changes, enabling the enterprise to retain the value of its initial
investment, including its investment in training employees on the DEFINITY
system. Among the over 450 different features available to an enterprise are the
ability to support multimedia interactions, advanced system administration
features, abbreviated dialing among an enterprise's multiple locations and least
cost and best service call routing. We have designed our DEFINITY systems to be
easy to administer, among other things, by providing centralized administration
of DEFINITY systems deployed across multiple locations and clear, graphical
screens that the administrator uses to monitor and adjust the systems.
Furthermore, through the DEFINITY diagnostic software and our expert systems, we
have the capabilities to resolve a substantial portion of the problems with our
customers' DEFINITY systems without dispatching a technician to that customer's
site. We are also in the final stages of testing a feature that will allow
DEFINITY servers to be configured automatically from an enterprise's human
resources directory, for example, that conforms to the emerging industry
standard interface for directories.
Converged voice and data products. Our DEFINITY product line includes the
DEFINITY IP(R) Solution and DEFINITY ATM(R), which both allow an enterprise with
separate voice and data networks to converge all or a portion of its voice
traffic on its data network. The DEFINITY IP solution consists of software and
hardware that gives our DEFINITY products the capability to operate as:
- a gateway, or point of entry to a network;
- a gatekeeper, or provider of management and flow control across an
enterprise's different types of communications networks; and
- a multipoint conferencing unit, allowing telephone traffic to be carried
along with data in a single multiprotocol network.
In addition, DEFINITY IP Solution monitors the network, and if, at any
time, the Internet Protocol network's performance is not acceptable for voice,
it will reroute the voice traffic over its alternate voice network supporting
the DEFINITY system. An enterprise with an existing DEFINITY system may upgrade
its system by adding DEFINITY IP Solution, and a purchaser of a new DEFINITY
system has the option to include DEFINITY IP Solution as a part of its DEFINITY
system or to buy a DEFINITY system exclusively comprised of Internet Protocol
telephones. Additionally, our DEFINITY ATM solution, among other capabilities,
enables a customer to utilize a single DEFINITY switch for voice
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communications in conjunction with its ATM, or asynchronous transfer mode,
network across multiple geographic locations. This capability gives our
customers the benefit of using geographically dispersed human resources while
getting the benefits of a centralized family of application servers.
Primarily in Europe, Australia and Japan, we offer two other advanced
systems, the INDeX and Alchemy product lines, which are targeted to small to
mid-sized enterprises. These systems are price sensitive offerings and provide a
variety of integrated voice and data applications. INDeX, for enterprises with
20 to 400 users, supports such functions as Internet Protocol telephony and
customer contact center capability with real time reporting and interactive
voice response systems. Alchemy systems provide basic voice and data
communication capabilities in a single system for small to mid-sized enterprises
with two to 192 users. As part of the system, a variety of data functions are
packaged including network routing and a corporate firewall. A firewall is a
combination of hardware and software which functions as a security mechanism
both to limit the exposure of a network to unauthorized infiltration and to
prevent internal users from transmitting information to unauthorized sources
outside the network. This combination simplifies the purchase and use of
advanced network functionality for a small enterprise.
Additional systems. In addition to our advanced systems, we offer two
primary voice communications systems, our Merlin Magix and Partner product
lines, targeted at small and mid-sized enterprises with less extensive to
moderately sophisticated communications requirements. As opposed to our DEFINITY
servers, which utilize a switch to allow for the sharing of outside lines to
which the user typically gains access by dialing "9", the selection of an
available line and setting up the connection, these products are key/hybrid
systems, which require that the user make the selection of an available outside
line by pressing an unlit line-selection button on their telephone.
Our Merlin Magix product line offers an array of features for an enterprise
with moderately sophisticated communications requirements. These features
include the ability to network more than one system at a single or multiple
locations with other Merlin Magix or with DEFINITY systems for the purpose of
sharing centralized voice messaging or providing a uniform dial plan. Merlin
Magix systems support up to 200 users and provide networking access to the
public switched telephone network using a variety of technologies. Merlin Magix
also offers the ability to support wireless technology and Internet applications
such as a router, a firewall, an enterprise's own electronic mail and Web
hosting. A router is an interface between two networks and a firewall regulates
internal and external network resources and filters network content. This
product line has optional features for small and mid-sized enterprises that seek
to integrate their voice and data networking including software to support
applications such as interactive voice response systems. According to a 2000
Monitor report by Eastern Management Group, our sales of Merlin Magix products
in 1999 represented approximately 23% of total new sales of key/ hybrid
communications systems to enterprises with 11 to 40 telephones in the United
States and approximately 20% of total new sales of key/hybrid communications
systems to enterprises with more than 40 telephones.
Our Partner products include features suitable for a small, single location
enterprise with less extensive communications needs but which still requires a
system that facilitates communication internally and with customers. These
systems are priced to provide good value relative to the features offered, which
include voice mail and conference calling. According to the same report by
Eastern Management Group, our sales of Partner products in 1999 represented an
estimated 46% share of total sales of key/hybrid communications systems to
enterprises with two to ten telephones in the United States. Each of these
product lines is designed to be easy to use and administer, including providing
an administrator the ability to make moves, adds and changes without the use of
an on-site technician.
Business telephones. According to a report by Eastern Management Group, we
were the leading United States manufacturer of business telephones in 1999,
shipping 29% of the 15.9 million business telephones shipped in the United
States during that year. Our business telephones are primarily sold in
conjunction with our enterprise voice communications systems. Our telephones are
available worldwide in a variety of styles and support a number of languages.
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COMMUNICATIONS APPLICATIONS
We offer a broad range of communications applications products which
enhance an enterprise's interactions with its customers, suppliers, partners and
employees. In fiscal year 1999, we derived approximately $1.3 billion or 16% of
our total revenue from our communications applications products. We estimate,
based on various industry reports, that the market segment for customer
relationship management will grow from approximately $11.5 billion in 1999, to
approximately $33.2 billion in 2003, a compound annual growth rate of 30.3%. We
also estimate, based on various industry reports, that the market segment for
traditional voice messaging will grow from approximately $3.8 billion in 1999 to
approximately $6.1 billion in 2003, a compound annual growth rate of 12.6%, and
that the market segment for enterprise unified messaging will grow from
approximately $57 million in 1999, to approximately $490 million in 2003, a
compound annual growth rate of 71.5%. Unified messaging is an advanced messaging
solution that delivers the convenience and benefits of combining the storage of
more than one type of message, including voice, facsimile and electronic mail.
Customer relationship management solutions. We offer products that are
essential components of many customer relationship management, or CRM,
solutions, including:
- call and customer contact center systems;
- customer self-service applications, including the integration of voice
communications;
- Web collaboration;
- electronic mail response management;
- Web chat; and
- workflow and business process automation products.
We believe our leading products and our portfolio of advanced applications
position us to capitalize on the growing importance of customer relationship
management in the eBusiness environment and on the increased focus within
customer relationship management solutions on workflow and administrative
capabilities. We also offer professional services that assist our customers in
integrating our products into their specific business environments and
comprehensive customer relationship management solutions. Typically, a customer
that purchases our customer relationship management products purchases
customization and integration services from our professional services group. We
believe that our ability to provide these professional services is an important
consideration in selecting our communications applications.
According to a Cahners In-Stat report in 2000, we are a U.S. leader in
sales of call center systems based on their estimates that our sales of systems
in 1999 represented approximately 27% of total U.S. sales and our call center
systems support approximately 46% of the total number of U.S. customer agent
seats. We are particularly strong in the sale of systems that support over 400
agent seats. We also are a leading provider of automatic call distribution, or
ACD systems, which route incoming call traffic. According to a Cahners In-Stat
report in 2000, we are the leader in interactive voice response products, having
11% of the total global sales of interactive voice response systems sold in
1999. We believe that the deployment of these products gives us an important set
of customer relationships that we can use to sell our other customer
relationship management products as well as upgrades to existing systems.
CUSTOMER CONTACT CENTERS
Our core product offerings are hardware and software systems and software
applications for customer contact centers, which are a key component of many
customer relationship management solutions. By customer contact center, we are
referring to the customer service and support function served by the combination
of customer agents, an enterprise's voice and data communications systems, as
well as an enterprise's related software applications, such as software
applications designed to respond to customer requests for information and to
service their needs. Database servers, which contain customer records,
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product information and trouble-shooting tips, and any related peripheral
equipment, such as the agent's telephone and personal computer are also
integrated into the customer contact center system. The integration of
multimedia interactions into traditional call centers has led to the emergence
of customer contact centers. We use the term contact center to refer to
traditional call centers, which primarily manage an enterprise's interactions
with customers via the telephone, and to contact centers that allow a customer
to interact with an enterprise using multiple mediums of communication,
including electronic mail, access from a Web site, chat rooms, interactive voice
response systems, telephone calls and facsimiles. For example, our customer
contact center products can be implemented so that a potential customer can
browse through our customer's existing Web page, enter a chat room and then
click on an icon to reach the customer service representative. Our customer
contact center solutions include software that manages customer interactions
from the initial point of contact through the operational functions, such as
order processing and billing, to fulfillment of the transaction with the
customer, as well as any subsequent accounting or tracking that needs to be
done.
Our customer contact centers are scalable and can support as few as ten
customer service representatives in a single location, to thousands of customer
service representatives spanning multiple physical locations. We have
traditionally sold our solutions to large and mid-sized enterprises in single or
multiple locations. Due to the growth of eBusiness and the increased focus on
customer relationship management, however, we are expanding our focus to include
selling our products to smaller enterprises which are seeking to enhance
relationships with customers, suppliers, partners and employees and to improve
operational efficiencies through automation of some customer service and
back-office functions.
A contact center requires a variety of hardware, such as an enterprise
communications server or switch to route traffic. Our core customer contact
center voice communications applications currently work only with our DEFINITY
servers. We are developing new versions of some of these products to be
compatible with servers of multiple vendors. Our customers' comprehensive
customer relationship management solution typically includes automated sales and
services systems that are linked to contact center technology, complemented by
one or more databases that store the information generated through the automated
sales system and contact center. Our customer contact center solutions integrate
with these other third party applications and major databases, such as Oracle
and Sybase.
STAND-ALONE CUSTOMER RELATIONSHIP MANAGEMENT APPLICATIONS
We offer a number of products that can be used either as part of a customer
contact center or on a stand-alone basis. Our customer self-service products
include interactive voice response systems and Web-based self-service
applications. Interactive voice response systems allow an individual to access
information in the enterprise's computer databases or conduct transactions
verbally or using a touch-tone telephone. We also offer our workflow and
business process automation applications separately from our customer contact
center solutions to perform functions such as order processing, billing,
document processing and accounts payable integration. These applications are
often used by government agencies and companies in the financial services,
health care, and utilities industries.
KEY CUSTOMER RELATIONSHIP MANAGEMENT PRODUCT OFFERINGS
We offer a broad range of applications to meet the needs of enterprises of
various types and sizes. These products can be implemented for specific,
stand-alone functionality and can also be implemented in combinations for
broader solutions. For example, the CentreVu product line for contact centers
can be expanded with products including CRM Central 2000 outbound contact
systems and interactive voice response product lines. CRM Central 2000 adds
workflow and advanced computer telephony applications to our CentreVu portfolio.
CRM Central 2000 can also be used stand-alone for multimedia business process
automation functionality. Our applications are generally customized for each
enterprise by our professional services consultants. Our product portfolio
includes the following customer contact center solutions and stand-alone
products:
- CentreVu. Our CentreVu product line is a suite of customer contact
products offering predictive and adaptive routing of inbound customer
interactions, primarily via telephone. CentreVu also offers capabilities
to support other types of customer interactions, such as Web chat,
Internet Protocol
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telephony and electronic mail management which enterprises can utilize as
they slowly expand towards servicing their customers with multi-media
interactions. This suite of products effectively manages contact centers
and enables enterprises to pursue their business strategies through the
integration of Internet-based interactions. Customers are then able to
interact with the enterprise in the manner they prefer. Our CentreVu
product line also includes software that intelligently routes inbound
communications to the agent best suited to handle the interaction, based
on service levels, business rules, customer profiles and the agent's
skill set, work load and usage and software which allows agents to
operate from remote locations. This suite of voice communications
applications can only be used on our DEFINITY servers.
- CRM Central 2000. Our CRM Central 2000 software is a suite of
applications designed for enterprises that interact with their customers
over a variety of communications media and provides the related office
management required to process and fulfill customer requests. These
interactions include:
- telephone calls;
- Internet Protocol telephony;
- Web chat;
- data sharing;
- Web collaboration; and
- electronic mail management and response activities.
This suite of solutions is in an early stage of adoption by customers. CRM
Central 2000 is an integrated solution which is comprised of five key
software components, the combination of which provide customized,
integrated capabilities for managing customer-oriented work process across
an enterprise and helping an enterprise build lasting, profitable customer
relationships. Our current version of CRM Central 2000 can integrate with
many third party applications, such as interactive voice response systems
and can be used with our DEFINITY server to support voice communications.
We are developing a new version which will be able to integrate voice
communications on other vendors' servers. This application can be used
either on a stand-alone basis or as part of a customer contact center.
- Viewstar(R). Our Viewstar 5.0 workflow and business process software
automates the business processes associated with delivering quality
customer service and is typically used on a stand-alone basis. Viewstar
reduces costs and shortens turn around times for critical business
applications such as loan origination, claims processing and order entry.
- Mosaix(TM). Our Mosaix product line automates and synchronizes the
outbound and inbound telephone calls in contact centers and includes
associated call progress analysis tools. Sophisticated calling "campaign"
management and unique call blending applications with multiple options
for integrating inbound and outbound calls are enabled through these
products. Mosaix allows an enterprise to handle sporadic inbound call
overloads and to reduce down time of the customer service agents.
- CONVERSANT(R). Our CONVERSANT Interactive Voice Response System is an
integrated solution that automates common customer interactions for
customers to choose service options themselves, enables people to speak
with computers over the telephone and supports eBusiness with access to
self-service applications. This system can assume some of an enterprise's
repetitive and time consuming tasks such as giving directions or hours of
operation or faxing back order confirmations, which reduces the number of
customer agents an enterprise needs and allows agents to handle matters
which require their knowledge and personal attention. Some small and
mid-sized companies use this product as a stand-alone self-service
application. Further, CONVERSANT can be run with DEFINITY or with other
vendors' servers.
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PROFESSIONAL SERVICES
We have a team of approximately 900 consultants dedicated to assisting
enterprises in improving their customer relationship management, technology and
execution. Approximately 90% of our consultants are employees, with the
remainder being independent contractors. Our services range from designing and
implementing an enterprise's customer relationship management technology
strategy to setting up and integrating software applications that an enterprise
purchases from us as part of its customer contact center. Our consultants also
work with our sales force in selling our customer relationship management
products. We estimate, based on various industry reports, that customer
relationship management professional services will grow from approximately $7.4
billion in 1999, to approximately $22.6 billion in 2003, a compound annual
growth rate of 32.2%.
Typically, a customer that purchases our customer relationship management
products purchases consulting services from us. We generally provide our
services on a time and materials basis, but occasionally enter into fixed-price
arrangements. The majority of our consulting services are related to our
software and other products. Our service capabilities are a critical part of the
solutions we implement and deliver in connection with our customer relationship
management products. We work with our clients to customize and integrate our
solutions into their contact centers and operations in order to maximize
performance from their processes and systems.
Another key aspect of our business is our relationships with system
integrators. Our practice is structured to not only provide subject matter
advice to systems integrators as part of an overall customer relationship
management strategy, but also to provide guidance to achieve the integration of
multi-vendor solutions. We also provide our services to systems integrators that
seek to integrate their office applications with our software systems. The
extent of our services in these engagements is determined by the systems
integrator.
Voice and unified messaging solutions. We offer a wide variety of voice
messaging and unified messaging solutions designed to serve the telephone call
answering, voice, facsimile and unified messaging communications needs of
enterprises. Unified messaging is an advanced messaging solution that delivers
the convenience and benefits of combining the storage of more than one type of
message, including voice, facsimile and electronic mail. This facilitates access
to these messages through the most convenient device, including Internet
browsers, LAN-based personal computers and wireline or wireless telephones,
using text-to-speech technology for telephonic e-mail retrieval. These products
are marketed under a number of brands, including our primary brands, Octel
Messaging and INTUITY(TM) AUDIX(R) Messaging. The ease and speed of our voice
and facsimile messaging can improve an enterprise's efficiency by allowing
messages to be sent instantly to teams, groups or an entire workforce across
multiple locations.
We believe that, within a given price range, enterprises purchase our
systems primarily based on:
- reliability;
- the availability of local installation and maintenance;
- the advanced set of features, such as our flexible voice mail networking
capabilities
- the ease and familiarity of our Octel and AUDIX messaging user
interfaces; and
- the ability to configure a system that meets the needs of enterprises of
virtually any size.
While most enterprises require only one voice messaging system per site,
larger companies will generally cluster two to six systems per site, and may
network clusters located at several sites, to meet the service levels required
by the size and communications needs of the enterprise. All of our messaging
servers can be networked, over the Internet or public or private voice networks,
to provide enterprise-wide voice and facsimile messaging through a single
system. Message networking delivers cost savings as compared to direct telephone
or facsimile calls, especially for international communications or
communications with large groups.
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We are the worldwide leader in sales of messaging systems. According to a
Cahners In-Stat report in 2000, that our sales of voice messaging systems in
1999 represented approximately 28% of voice messaging mailbox capacity shipped
worldwide to enterprises by the suppliers of such systems in the United States.
This latter share is almost twice that of our nearest competitor. By the end of
fiscal year 1999, we had sold over 200,000 systems worldwide since 1993,
representing a total of over 100 million messaging mailboxes. Our broad family
of messaging products is serving enterprises today with systems that range from
supporting as few as two users to systems supporting up to 50,000 users and
networks of over 100,000 users. Messaging systems include message servers and
their associated server software and messaging-based applications. These systems
are configured both as stand-alone servers or as embedded software or hardware
in communications servers. Many of our messaging systems are compatible with the
voice communications systems of other vendors so that an enterprise may choose
our messaging system as the standard for all its locations. Most of our products
provide spoken prompts in multiple languages for greeting callers and for user
retrieval of messages and are compatible with international standards.
Our unified messaging capability, which accommodates voice, facsimile and
electronic mail messages, is available for our Octel Messaging and INTUITY AUDIX
systems and is also provided by our innovative Octel Unified Messenger for
Microsoft Exchange, developed in cooperation with Microsoft Corporation. The
Octel Unified Messenger system is a unified messaging system software solution
that stores voice and facsimile messages directly in a user's Microsoft Exchange
electronic mailbox and enables user access to this mailbox by telephone or fax
machine. The Octel Unified Messenger system is designed to reduce overhead by
providing a single directory, common administration and a single system for all
voice, facsimile and electronic mail messages and is intended to enhance
productivity by combining pertinent task information in a single working
environment.
Our messaging systems also support a number of enhanced business
applications. Using auto-attendant features, Octel Designer and Octel Access
Server systems, customers have implemented telephone-based transaction
processing, workflow and business process management applications. These
applications include purchase order approvals, sales tracking and automated
customer service. We have recently begun to commercially offer the Web
Communications Server for our Merlin Magix small business system to provide a
small business with a complete Web presence, including hosted Web home pages and
electronic commerce support for on-line customer purchases. Operating in
conjunction with an application service provider, or ASP, we believe this is a
unique offering for small enterprises.
Internet Protocol applications and conferencing. We are developing and
delivering new communications solutions that use the advantages of the Internet
Protocol operating on the Internet, wireless networks and telephone networks.
These solutions are being designed to serve new areas of customer communications
needs. One of these solutions is our iCosm(TM) suite of communications
applications. iCosm is intended to reshape how individuals organize their days,
both personally and professionally, through new applications for scheduling
meetings with others, for filtering incoming calls, for organizing, scheduling
and routing incoming calls and messages and for advanced forms of conferencing.
iCosm solutions are intended for use both on standard enterprise servers and via
application service providers. Several iCosm applications are currently
available, and we plan to release additional applications later this year.
We also provide audio, video and data conferencing products for enterprises
of varying sizes. These products enable customers to conduct multimedia
communication sessions with a geographically dispersed workforce or across
company boundaries, thereby making possible cost savings over typical in-person
meetings and productivity increases over traditional voice-only modes of
communication. Through partners and internal development, we offer our customers
a broad portfolio of multimedia collaboration solutions, backed by the full
support capability of our nationwide services organization. Our products include
the feature-rich multipoint conferencing unit, a highly-reliable server for
multipoint video conferencing. We also offer the DEFINITY AnyWhere software
product, which, when used in conjunction with our DEFINITY server, enables
spontaneous audio and data conferencing capability for office workers and
telecommuters. Through our purchase of products from third party manufacturers,
we have broadened our portfolio to include a family of industry-leading video
endpoints and a line of highly-scalable audio conferencing products, ranging
from 24 to 1,152 endpoints.
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MULTI-SERVICE NETWORKING
We offer a portfolio of products to support multi-service network
infrastructures which carry voice, video and data traffic over any of the
protocols supported by the Internet on local area and wide area data networks.
In fiscal 1999, we derived $269 million or 3.3% of our total revenue from these
products. We are not a leader in multi-service networking products or in
converged voice and data products. We have entered these product areas
relatively recently, and our product portfolio is less complete than the
portfolios of some of our competitors. We are implementing a strategy focused on
these products. We estimate, based on various industry reports, that the market
segment for multi-service networking will grow from approximately $35.3 billion
in 1999, to approximately $50.7 billion in 2003, a compound annual growth rate
of 9.5%. Our multi-service networking products are sold primarily to enterprises
with a future emphasis on application service providers and internet service
providers that are focused on hosted networks and applications. We believe our
products are attractive to customers because of their performance, reliability
and centralized management capabilities.
Local area network solutions. Our Cajun(TM) switches support voice, video
and data traffic over a local area network. Each switch is designed for
interoperability with the hardware of numerous other vendors and is comprised of
hardware and software that enable the switch to perform configuration, fault
management and traffic prioritization functions. Configuration is the adding,
deleting and modifying of connections and supported addresses within a network.
Fault management is the detection and correction of network faults.
Prioritization is the capability to consider the nature of the requirements of
various transmissions to determine the relative order and priority of dealing
with several different types of transmissions. Some transmissions, such as voice
transmissions, tolerate little to no delay for quality reasons and a higher
level of priority is assigned to those transmissions.
Our Cajun switches also support additional advanced applications, such as
our switch monitoring, known as SMON, the industry standard network monitoring
software for switched network infrastructures, which was developed by Lucent.
SMON is an open standard application which allows simultaneous real time
monitoring of traffic across multiple switches in a network. As an analytical
tool, SMON enables network managers to review global traffic across an entire
network as well as individual connectivity between two users.
Wide area network solutions. We offer wide area network solutions,
including Access Point virtual private network routers. A virtual private
network allows an enterprise to transport voice, video or data over a public or
shared network at a level of security substantially equivalent to the traffic
traveling over that enterprise's own private network. This increased level of
security is accomplished through encryption and encapsulation of this voice,
video or data traffic into a format which is protected from unauthorized access.
Our wide area network access products are sold to many types of enterprises and
are designed to meet varying access needs. Our virtual private network routers
are used primarily by enterprises with remote workers and branch or home
offices. Like our switches, our wide area network access products are compatible
with a variety of industry products and provide excellent security, scalability
and reliability.
In addition, we offer firewall hardware and software which function as a
security mechanism to limit the exposure of a network to unauthorized
infiltration. The firewall regulates internal and external network resources and
filters network content. Our firewall products have been designed to meet the
testing standards of the U.S. federal government and allow for a single
administrator to manage multiple firewalls for an entire network from a single
location.
Policy management software. We offer automated policy management software
called RealNet Rules. RealNet Rules allows network managers to define, manage
and enforce policies which establish priorities and levels of security for
network traffic, based on parameters such as traffic type, application or user
identification. Examples include a policy which gives voice traffic priority
over data traffic in a network, a policy which gives finance applications
priority at the end of a reporting period, a policy that gives bandwidth
priorities to designated users, such as senior management, or policies that
restrict access to sensitive applications, such as human resources applications,
to only authorized users. Our policy
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management software products are designed to allow a single administrator to set
policies for all users and locations from a central location.
CONNECTIVITY SOLUTIONS
As communications technology requirements have increased over recent years
and as moves, adds and changes have become regular events within enterprises,
enterprises have increasingly required flexible cabling systems solutions for
wiring phones, workstations, personal computers, local area networks and other
communications devices through their buildings or across their campuses. To meet
these needs, we market our SYSTIMAX product line of structured cabling systems
primarily to enterprises of various sizes and our ExchangeMAX product line
primarily to central offices of service providers, such as telephone companies
or Internet service providers. We also offer electronic cabinets to enclose an
enterprise's electronic devices and equipment. In fiscal 1999, we derived $1.3
billion or approximately 16% of total revenues from our connectivity solutions.
We estimate, based on various industry reports, that the market segment for
connectivity solutions will grow from approximately $12.1 billion in 1999 to
approximately $16.9 billion in 2003, a compound annual growth rate of 8.7%.
SYSTIMAX structured cabling systems. We estimate, based on a Phillips
InfoTech report in 1999, which is the most recent report currently available,
that we are the worldwide leader in sales of structured cabling systems to
enterprises. We primarily market these products under the brand name SYSTIMAX.
In fiscal 1999, we derived approximately 45% of our SYSTIMAX revenue from sales
domestically and approximately 55% internationally. Our SYSTIMAX cabling systems
provide high speed multifunctional local area network interconnections within a
single building or a campus through an infrastructure of copper or fiber cabling
and associated connecting apparatus. The SYSTIMAX copper and fiber apparatus
portfolio includes a broad line of distribution boxes, interconnects, shelves,
racks, connectors and outlets necessary to connect and manage large building
infrastructure networks.
We believe that through our SYSTIMAX products we are well-positioned to
capitalize on the increasing use by enterprises of advanced data applications
which require a reliable infrastructure that can provide high speed data
transmission. The current SYSTIMAX product line includes PowerSum and
GigaSPEED(R), which are copper cable systems, and LazrSPEED(TM) and
OptiSPEED(TM), which are optical fiber cable systems. PowerSum and OptiSPEED
each support up to one gigabit transmission and are targeted to price sensitive
customers. GigaSPEED and LazrSPEED are the performance leaders in their
respective markets. GigaSPEED allows the implementation of gigabit ethernet, a
high performance protocol for data transmission, within a building using low
cost network electronics. LazrSPEED offers the industry's first 10 gigabit
capability.
Our SYSTIMAX systems compete on the basis of performance, flexibility,
reliability and overall customer value. A key component of our marketing
strategy is to highlight SYSTIMAX's ability to support the future bandwidth
needs of an enterprise. Another of the SYSTIMAX systems' selling points is that
the need to recable and the costs relating to recabling can be reduced by
installing a high quality structured cabling system that is designed to
accommodate an enterprise's move to more advanced applications. We believe that
the SYSTIMAX brand name is recognized worldwide by our customers and competitors
as the technology leader in the structured cabling system industry. We provide a
warranty that our SYSTIMAX cabling systems will support an enterprise's
standards-based applications and that our products are free of manufacturing
defects for 20 years.
In addition to cabling systems, SYSTIMAX also offers the alternative of
implementing a wireless local area network infrastructure. These products
provide high speed wireless in-building connectivity in situations where cabling
is impractical. The capability to include wireless LAN connectivity in the total
SYSTIMAX system provides customers with increased flexibility to expand their
existing networks.
ExchangeMAX structured cabling system. We sell our ExchangeMAX structured
cabling systems primarily to central offices of service providers such as
telephone companies or Internet service providers. Central offices are locations
that house switches to serve the subscribers of a service provider. Our
ExchangeMAX system combines our family of high quality central office
connectivity products with an
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overall system architecture to support the copper and fiber cable distribution
networks of a central office. Our products include copper distributing frames,
copper cable, connectors, patchcords and cable management software. The
ExchangeMAX product line is engineered to meet the site-specific needs of our
customers, and may be utilized either to address the discreet maintenance and
upgrading needs of a central office or to serve as the foundation of a central
office's comprehensive wire center modernization. Like our SYSTIMAX product
line, we believe that customers choose our ExchangeMAX systems on the basis of
performance, flexibility, reliability and overall customer value.
Electronic cabinets. An electronic cabinet is a sturdy environmental
enclosure for electronics devices and equipment, designed to optimize system
integration performance, including thermal characteristics. We have developed an
extensive cabinet product portfolio to meet application needs with respect to
protecting its current electronic networking as well as providing the thermal
capacity to protect network technology. Our product portfolio, combined with our
extensive experience, allows us to integrate the electronics products of
numerous manufacturers. Further, our cabinets are designed to meet environmental
challenges, both expected and unexpected, as well as the technological
challenges of network evolution.
VALUE-ADDED SERVICES
Our value-added services are outsourcing services we provide to both
enterprises and to communications service providers, such as local exchange
carriers, or telephone companies, or Internet service providers, worldwide to
operate and maintain a portion of their communications systems. In fiscal year
1999, we derived approximately $235 million or 3% of our total revenue from our
value-added services. We estimate, based on various industry reports, that the
market segment for value-added services will grow from approximately $4.6
billion in 1999, to approximately $8.7 billion in 2003, a compound annual growth
rate of 17.3%.
Our enterprise customers which use our value-added services are generally
large and mid-sized businesses. For enterprise customers, we provide outsourcing
of messaging systems, portions of voice communications systems and contact
centers. We offer these customers a full range of maintenance, management and
support services. We provide either managed services where the customer owns the
communications system or outsourcing services where we both manage and own the
communications system. Our services include the following:
- fault management, including maintenance and help desk support;
- remote provisioning and administration, such as establishment of voice
mail boxes;
- remote monitoring; and
- recording, reporting and billing.
For service providers, we primarily outsource the operation of their
messaging systems. We outsource messaging systems for established service
providers, emerging service providers and other competitive local exchange
carriers. Currently, we derive the majority of our revenue in value-added
services from customers in the United States.
We contract with our clients to provide these services, in varying levels,
under agreements that require us to meet service level requirements that vary
from agreement to agreement. Fee arrangements vary by contract, but are
generally made on a per unit or per subscriber basis, with up front charges to
cover initial expenses. These agreements typically have terms ranging from five
to seven years with varying termination provisions.
STRATEGIC ALLIANCES
In order to offer our customers comprehensive eBusiness communications
solutions, we are creating strategic alliances with other technology and
technology consulting services leaders. Listed below are the principal alliances
we have entered into or are currently negotiating in connection with our
strategy. The agreements underlying these alliances to which Lucent is a party
will be assigned to us at the time of the
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distribution. We have generally entered into alliances for one to three year
terms with various provisions to extend the initial terms. We are actively
pursuing additional strategic alliances. Under the terms of our separation from
Lucent, Lucent may terminate some of the rights, including important
intellectual property rights, that they granted to us if we enter into strategic
alliances with Nortel Networks Corporation or Cisco Systems, Inc. Except for our
alliance with NICE Systems, Inc. described below, all of our alliances for which
we have entered agreements have been entered into within the last year and are
still in their initial stages of planning and development. Alliances which we
have announced but do not yet have definitive agreements are under negotiation.
TECHNOLOGY ALLIANCES
Blue Pumpkin Software, Inc. In April 2000, we entered into an agreement
with Blue Pumpkin to provide solutions that help enterprises successfully
allocate and balance workload across human resources in multimedia contact
centers. Under the agreement, Blue Pumpkin has granted us a non-exclusive
license, for a fee, to resell Blue Pumpkin's workforce management software by
incorporating it into our suite of customer relationship management solutions.
In addition, Blue Pumpkin will be developing customized versions of its products
to enhance the capabilities of our combined products.
eLoyalty Corporation. We have announced our intention to work with
eLoyalty to develop, sell and integrate enterprise-wide eBusiness solutions.
Microsoft Corporation. In October 1999, we entered into an agreement with
Microsoft Corporation to provide a new unified messaging solution to service
providers based on Microsoft Exchange and our Octel Unified Messenger systems.
Under the agreement, Microsoft has granted us a non-exclusive, worldwide license
to resell Microsoft Exchange, an electronic mail platform, to service providers.
Our product is intended to provide customers with a single point of access to
voice mail, facsimile and electronic mail messages. Service providers in turn
will be able to offer our unified messaging solutions, which may include
hardware, software, services and support, to enterprises both as a hosted
application where hardware and software resides on a service provider's network
or as an on-premises managed service, where the equipment is located at an
enterprises's location and the service provider provides managers and maintains
the equipment remotely.
NICE Systems, Inc. In October 1997, we entered into a non-exclusive
worldwide distribution agreement with NICE Systems to re-sell some of NICE's
computer telephony integration products, used in call and contact centers, to
provide high reliability call logging, quality monitoring and customer
management solutions for voice and data. We believe these products enable
enterprises to improve the quality of the relationship with their customers
focusing on contact center customer interactions. We are currently selling these
products in the United States and are developing a strategy with NICE to
coordinate sales of these products outside the United States.
Siebel Systems. In August 1999, we entered into an alliance with Siebel
Systems, a leading provider of eBusiness application software, in which we will
jointly market our workflow management applications with Siebel's eBusiness
applications software to provide a complete multi-channel contact center
solution.
Sun Microsystems. In December 1999, we announced our intention to form an
alliance with Sun Microsystems to jointly package and market communications
networking systems and Internet services and solutions that will assist
enterprises and network services providers to host applications and to create
hosted "market places" that centralize the management of customer interactions.
It is intended that our alliance will create solutions relating to intelligent
customer relationship management and intelligent policy-enabled electronic
commerce.
CONSULTING SERVICES ALLIANCES
Andersen Consulting LLP. We have announced our intention to work with
Andersen Consulting to develop, sell and integrate enterprise-wide eBusiness
solutions.
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Origin International. In April 2000, we entered into an agreement with
Origin International, an information consulting and services company based in
the Netherlands, to jointly develop and market eBusiness solutions to enterprise
customers in Europe. The alliance will bring together our eBusiness
communications solutions and Origin's worldwide customer relationship management
and eBusiness consulting and systems integration capabilities. Under the
alliance, we intend to create solutions which will include offerings in the
areas of eBusiness, customer relationship management, multi-channel customer
interaction and unified messaging.
SEMA Group plc. In April 2000, we entered into an agreement forming a
worldwide strategic alliance with SEMA Group, an information technology and
business service company based in Europe. Under this strategic alliance, we will
create comprehensive solutions for enterprises that will include
jointly-developed or complementary offerings in the areas of electronic
commerce, customer relationship management, integrated messaging, data and voice
convergence, one-to-one marketing, network management and customer care and
billing. Under the agreement, SEMA Group will furnish to us its convergent
customer care and billing applications, its messaging products and its mobile
commerce offering, in addition to its worldwide systems integration
capabilities. We will furnish to SEMA Group our converged voice and data
networking technology, including our enterprise infrastructure, communications
and networking software, as well as our systems engineering and technical
support capabilities.
eBUSINESS COMMUNICATIONS SOLUTIONS
We define eBusiness as the internal and external use of communications
tools and electronic networks to interact, collaborate and transact business
with an enterprise's customers, suppliers, partners and employees. As
individuals and enterprises increasingly utilize a wide array of communications
devices, including telephones, computers, mobile phones, personal digital
assistants and other wireless devices, there is a growing need to integrate the
applications and services and to allow these applications and services to
communicate with any device being used to interact with the enterprise. A
fundamental goal of eBusiness communications solutions is to overcome the
traditional limitations of particular communications devices, infrastructures or
applications and enable users to access information in a media form not
customarily supported by those devices, infrastructures or applications. Such
interactions give rise to previously unrealized flexibility allowing, for
example, conversion of electronic mail or other text to spoken word for access
via wireless telephone or conversion of voice messages to text for access
through an electronic mailbox.
We believe that the development of open industry standards for
communications products that facilitate interactions between products and
applications from multiple vendors is critical to the widespread adoption of
eBusiness. We are actively working with technology leaders from other companies,
as well as educational and research institutions, to promote and continue to
develop open standards necessary to provide consistent communications
integration. We also are making the development of a greater number of products
that can work with other vendors' products a priority for our product
development group.
We believe there are four layers of capabilities and services that together
form the components of an integrated, flexible communications system that
supports and delivers real eBusiness solutions. The following table describes
these four layers and lists the capabilities and services we offer today to
enable customers to begin to reap the benefits of this communication
integration.
<TABLE>
<CAPTION>
SYSTEM LAYER OUR CAPABILITIES AND SERVICES
<S> <C>
Portals and Other Integrated Access - our interactive voice response systems and
Capabilities: capabilities which allow users telephone user interfaces, which allow
using various devices to access the users to access computer information or
information and services they need and conduct transactions verbally or using a
alleviate potential discontinuities resulting touch-tone telephone
from the interaction of different modes of - our graphical user interfaces, which use
communication graphics to enable users to access computer
information using a pointing device, such
as a mouse
</TABLE>
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<TABLE>
<CAPTION>
SYSTEM LAYER OUR CAPABILITIES AND SERVICES
<S> <C>
- our Internet browser based calling,
conferencing and data collaboration product,
DEFINITY AnyWhere
- our Internet browser based messaging
product, used in conjunction with our Octel
message services, www.messenger(TM)
- our voice browser, which enables Web sites
and other electronic applications to respond
to voice commands
- our computer telephone integration
products, which coordinate interactions
between telephone and computers within an
enterprise
- our Internet Protocol softphones, which use
software applications allowing for
telephone-style communications over the
Internet through a personal computer
Applications and Services: capabilities - our range of customer care capabilities
designed to provide operational benefits, to that provide multimedia access and response,
address enterprise processes and to support operational support and management of
the interactions between the communications contact centers and related workflow
devices and network infrastructures automation, CentreVu, CRM Central(TM) 2000,
and Customer Care Solutions
- our range of voice and integrated messaging
capabilities, Octel, INTUITY, Unified
Messenger, MERLIN Mail(R) and INDeX
- our personal productivity solutions which
organize personal and relationship-based
communications, our iCosm solutions
- our capabilities which allow users to
create customized telephone applications
using a range of our messaging services,
our Octel software designer - our
capabilities which automate common customer
interactions,
allowing for
communications
across a
variety of
media,
CONVERSANT
IVR
Network Infrastructure: capabilities and - our enterprise communications systems,
services supporting integrated eBusiness Merlin Magix, INDeX and IP Exchange(R)
applications and services, including voice, - our local area network switching
data and converged voice and data capabilities, supporting multiple network
applications, local area network access, protocols and speeds, Cajun local area
interaction between local and wide area network switching devices
networks, policy management and security - our policy management products, RealNet
Rules
- our firewall solutions which function as a
security mechanism both to limit the exposure
of a network to unauthorized infiltration
and to prevent internal users from
transmitting information to unauthorized
sources outside the network
- our SMON switch monitoring products
</TABLE>
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<TABLE>
<CAPTION>
SYSTEM LAYER OUR CAPABILITIES AND SERVICES
<S> <C>
- our wide area network capabilities, which
provide bandwidth, speed, protocol support
and security to connect and transmit voice
and data traffic from the local area
network across the wide area network
- our structured cabling system, SYSTIMAX,
which is a flexible enabling system designed
to connect phones, workstations, personal
computers, local area networks and other
communications devices within a building or
across one or more campuses
Business and Technology Consulting Services: - our customer relationship management
expertise to help an enterprise integrate professional services
these separate categories of capabilities and - our strategic alliances with technology
services consulting companies
</TABLE>
Please see "-- Products and Solutions" and "-- Strategic Alliances" for a
more detailed description of many of the products and services described above.
CUSTOMER SERVICE, INSTALLATION AND MAINTENANCE
We have customer service, installation and maintenance organizations in the
United States and internationally, with approximately 11,500 employees engaged
in these services as of March 31, 2000. Our service organization is designed to
provide a comprehensive set of services in support of direct and indirect
channels, which we believe is an important consideration for many customers
which purchase our products. We provide these services globally either directly
or through our distribution partners. Installation generally is included in the
purchase price of our products, and most of our products have a one year
warranty. For additional service, our customers can elect to enter into
maintenance contracts with us or, if they do not choose to enter into such
contracts, may have us provide service for them on a time and materials basis.
In fiscal 1999, we derived approximately $1.9 billion or 23% of total revenue
from these services, not including the installation services. In addition, we
offer value-added services for the outsourcing of messaging and other portions
of an enterprise's communications system to our existing customer base. We
estimate, based on various industry reports, that the market segment for
services other than value-added services, but including installation services,
will grow from $13.9 billion in 1999, to $16.7 billion in 2003, a compound
annual growth rate of 4.6%.
U.S. SERVICES
Our U.S. service organization is comprised of our Field Services
Organization, our National Customer Care Centers and our Technical Services
Organization, with approximately 10,700 employees as of March 31, 2000.
Installation and repair of our products are performed primarily by our Field
Services Organization. Account support in the United States is conducted
primarily through our National Customer Care Centers. Technical support and
maintenance under contracts for our voice communications products are provided
by our Technical Services and Field Service Organizations. We use Lucent and our
distribution partners to service our converged voice and data products. We are
currently establishing our own internal data service capabilities, using as a
base, the data service technicians and managers that will be transferred to us
from Lucent in connection with the distribution.
Field Services Organization. Our Field Services Organization provides
installation, on-site repair and move, add and change services for our
customers, and represents the largest part of our U.S. services organization.
This organization is uniform across the 48 contiguous states, which allows our
national accounts to receive the same type and level of support in each
location. Most of our Field Services Organization employees are based in the
field, performing site visits to customer premises. When on-site
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technical presence is required for a repair, a customer service representative
from our Technical Services Organization will dispatch a technician or a team of
technicians from our Field Services Organization, which provides installation
and provisioning support to the customer. Installation and aftermarket moves,
adds and changes will be dispatched to the Field Services Organization from a
National Customer Care Center. At installation of a system, our Field Services
Organization, directly or through third parties, also provides training on the
system that is tailored to the individual needs of our customers to assist them
in maximizing performance of our products.
National Customer Care Centers. We have three primary National Customer
Care Centers in the United States, as well as several smaller centers for
specific market segments such as centers that service some of our federal
government customers. Our National Customer Care Centers serve as the hub of our
domestic customer service operations. Customers can contact us at these centers
to place orders for parts relating to our products or systems or to request
other services. As needed, service representatives at these centers route calls
from customers to the appropriate office such as requests for maintenance
contracts or repairs, which are directed to the Technical Services Organization.
Our billing and collection activities also are administered at our National
Customer Care Centers.
In addition to supporting our customers, our National Customer Care Centers
are designed to generate revenue for us. Our customer service representatives at
these centers have frequent interactions with our customers and are trained to
market product and systems upgrades during these interactions, routing to the
account teams as appropriate. We also generate revenue from customers which do
not have maintenance contracts with us but which call our National Customer Care
Centers seeking moves, adds and changes to their systems. Our customer service
representatives will dispatch technicians to these customers to provide the
services requested and these customers will in turn be billed for the
technicians' time and the materials used.
Technical Services Organization. We have three Technical Services
Organization Centers in the United States. Customers can contact us at these
centers to obtain remote technical assistance, request on-site technical
support, or request maintenance or repair services.
In addition to routine maintenance and support, we offer our customers a
remote diagnostic service which is administered by our Technical Service
Centers. We have developed systems that can access a customer's systems
remotely, whether purchased directly from us or from one of our distribution
partners, and can identify, through the application of artificial intelligence,
problems and potential problems with that system often before the customer
realizes that there may be a problem. We can often solve the problems that we
identify without the customer ever knowing that we intervened. If we cannot
solve the problem remotely, we arrange to have a technician from our Field
Services Organization dispatched to the customer's premises to provide the
necessary solution. This service is covered under the terms of the customer's
maintenance contracts, and is charged on an hourly time and materials basis if
the customer is not under our warranty or maintenance terms. Maintenance
contracts are administered and contract entitlement verification is conducted by
our Technical Services Organization. Generally, these maintenance contracts have
terms of one to four years and are entered into when a customer purchases one of
our systems. The more complex the product or system, the more likely the
customer will enter into a maintenance contract.
For our less sophisticated products and systems, customers enter into
maintenance contracts or, more often, receive service from us on a time and
materials basis or from third parties. We have entered into agreements with
Expanets, by which we have sold them the maintenance contracts for some of our
less sophisticated products and have allowed them to provide maintenance
services to those customers to which they sell products and systems, or
customers which do not have maintenance contracts with us. We have agreed to
provide outsourcing services for the maintenance contracts we transferred to
Expanets until March 31, 2003, and for remote diagnostics and maintaining
technical support for their contracts until March 31, 2005.
We will continue to develop our Data Technical Services Organizations in
the United States, using as a base the field data service technicians and
managers that will be transferred to us from Lucent in
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connection with the distribution. The Data Technical Support Organization, which
provides worldwide support for data networking and converged environments, is
also being transferred from Lucent and will continue remote support of voice,
data and video applications.
INTERNATIONAL SERVICES
Our international service organization is comprised of Field Services
Organizations, a Global Support Organization and a Customer Support Center which
provide installation, maintenance and customer service support, with
approximately 850 employees, as of March 31, 2000. Our international service
organization is divided into four regions which are (1) Asia Pacific, (2)
Canada, (3) the Caribbean and Latin America and (4) Europe, Middle East and
Africa.
Field Services Organizations. We have our own Field Services Organizations
in 21 countries. Our Field Services Organizations currently provide
installation, on-site and remote maintenance, and some training for our voice
and data products. These organizations primarily support customers which have
purchased from us directly. In those countries in which we have no direct
services presence, customers of our products rely on local distribution partners
which have been trained and certified by us. Our Field Services Organizations
supplement their engineer and technician resource requirements via the use of
sub-contractors on an as needed basis for responsive service levels and broad
geographic coverage.
Customer service also is currently performed by the Field Service
Organizations. Their services include customer call receipt, contract
entitlement verification, quoting of service rates, administering of maintenance
agreements, providing remote maintenance support on communications systems and
software applications, dispatching engineers and technicians and billing and
collection. Some of these activities will be transitioned to our Customer
Support Centers in the future.
Global Support Organization. Similar to our U.S. Technical Services
Organization, our Global Support Organization is a network of support centers
which provide remote technical and engineering support to the Field Service
Organizations, distributors and resellers and select multi-national customers
with multi-national maintenance agreements. This organization is comprised of
twelve regional centers, which we call "Centers of Excellence," which are
located to provide wide geographic coverage to our international customers.
These twelve centers provide a higher level of skilled technical and
engineering support to Field Services Organizations and distribution partners on
complex communications products, such as voice, data and video and application
solutions for both installation and maintenance services. Each Center of
Excellence utilizes a sophisticated suite of desktop technology, tools and
software applications to deliver high quality, effective remote support. Our
distribution partners are responsible for providing installation and basic
maintenance support to their customers for products sold by them. Our Global
Support Organization provides remote installation and maintenance support to the
international services organizations and our network of international
distribution partners.
The Global Support Organization is in the process of integrating our data
oriented remote technical support organizations to deliver technical support for
integrated data and voice communications solutions. We expect integration of
these organizations will be completed by the end of 2000.
Customer Support Centers. We have established a Customer Care Center in
our Europe, Middle East and Africa region and expect to open an additional
Customer Care Center in our Asia Pacific region by the end of 2001. We intend
the level of customer service to be provided at our Customer Care Centers to
include servicing requests received via telephone, facsimile and electronic
mail, receipt of product orders, order fulfillment and tracking, contract
management and administration, contract entitlement verification, invoicing,
billing and collection. We expect some of the support functions currently
performed by the Field Service Organizations also will migrate to the Customer
Support Centers by the end of 2001.
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CUSTOMERS, SALES AND DISTRIBUTION
CUSTOMERS
Over the past ten years, approximately 980,000 worldwide customers have
purchased one or more of our systems, software or services directly from us. Our
customer base includes approximately 78% of the Fortune 500 companies. A broad
set of enterprises ranging from large, multinational enterprises to small and
mid-sized enterprises to governments and schools are our customers. They include
established enterprises, dot.coms and other start-up ventures, as well as
service providers, including application service providers and Internet service
providers.
SALES AND DISTRIBUTION
In fiscal 1999, we derived 81% or approximately $6.7 billion of our total
revenue from sales in the United States and 19% or approximately $1.6 billion
from international sales. Our products other than our SYSTIMAX structured
cabling systems are sold both directly and through our worldwide network of
distribution partners. Our SYSTIMAX structured cabling systems are sold only
indirectly through a worldwide network of distribution partners. Our ExchangeMAX
structured cabling systems and our value-added messaging services are sold to
service providers and enterprises worldwide. With respect to service providers,
our value-added services are marketed primarily through the Lucent service
provider sales organization and we are currently analyzing alternatives to our
current distribution channel. We also have a Government Solutions Group that
focuses on sales of our products and services, including our connectivity
solutions, to government and government agencies in the United States and
internationally.
Our multi-channel sales organization, including our direct sales force and
our network of distribution partners, is described below.
Direct sales. Our worldwide direct sales organization markets and sells
our voice, data, messaging and customer relationship management products and
services, as well as our value-added services. As of March 31, 2000, our
worldwide sales organization was comprised of approximately 6,100 individuals,
including managers, sales representatives, technical and operational support
personnel, and indirect channel support. Within the United States, the majority
of our large, end-user customers are served directly through direct sales
account managers. Outside the United States, we conduct direct sales focused on
large enterprises in major areas, including Western Europe, South America,
Mexico, Australia, Central America and Russia with other customers and
geographic areas served by our network of distribution partners. Our account
managers are responsible for selling our systems, software and professional
services as well as managing customer relationships on an on-going basis. Until
recently, the majority of our account managers focused on our voice
communications products. We are implementing programs to train our account
managers also to sell our multi-service networking products, applications and
eBusiness solutions. Multi-service networking products are those products that
support network infrastructures which carry voice, video and data traffic over
any of the protocols, or sets of procedures, supported by the Internet on local
area and wide area data networks. In addition, our data sales and technical
specialists work with our account managers to provide sales support in this
area. We believe our sales force has developed relationships with many of the
large, multinational enterprises that are likely to seek advanced, comprehensive
eBusiness solutions. We intend to improve the efficiency and expand the capacity
and capabilities of the direct sales force by utilizing our growing network of
global partners to provide product fulfillment and to deliver high quality local
service on a worldwide basis.
Within this sales organization, our Government Solutions Group focuses on
sales of our products and services to governments and government agencies
worldwide. In the United States, the Government Solutions Group is responsible
for selling our entire line of products and services to federal government
agencies. Internationally, the Government Solutions Group sells our products and
services both to foreign governments and to federal government offices located
outside of the United States.
Indirect Sales. We have a worldwide network of distribution partners which
comprise our indirect sales channel. When selling our products indirectly, we
primarily sell our products through approximately
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20 distributors worldwide from whom our network of approximately 2,800 dealers,
value-added resellers and system integrators purchase and resell our products to
the end user. Our relationships with distributors, dealers, value-added
resellers and systems integrators for our voice and data products and our
structural cabling systems are generally not exclusive. We typically enter into
agreements with our distributors, dealers and value-added resellers that
generally set forth sales quotas and service levels, with terms of one to two
years and rights to terminate by either party upon 120 days notice. Specific
terms vary from agreement to agreement. We are in the process of developing
formal global alliance agreements with our systems integrator partners. We
intend that these agreements will be structured as joint-development,
joint-marketing and/or joint-sales-and-delivery agreements. We expect these
agreements will vary by alliance.
DISTRIBUTORS
Distributors generally purchase products from us directly and pass those
products on to dealers, value-added resellers and system integrators which sell
our products to the end user. Internationally, distributors also may support our
direct sales by supplying or installing products sold by our account managers.
As of March 31, 2000, we had relationships with approximately 10 distributors in
the United States and approximately 10 distributors internationally that
resulted in sales of our systems and software, which were material relative to
total distributor sales. Many of our distributors only resell our products to
resellers such as dealers and value-added resellers and do not sell to the
end-user customer.
DEALERS, VALUE-ADDED RESELLERS AND SYSTEMS INTEGRATORS
Dealers and value-added resellers primarily purchase our products from our
network of distributors to sell our products to customers on a retail basis. As
of March 31, 2000, we had relationships with approximately 1,200 dealers and
value-added resellers in the United States. Approximately 800 of these
distribution partners sell one or more of our voice products and approximately
300 sell one or more of our converged voice and data products. Internationally,
we generally have relationships with dealers and value-added resellers on a
country-by-country basis, with the number per country ranging based on the sales
potential.
Our principal U.S. dealer is Expanets, which in March 2000, purchased the
sales function of our voice communications systems for small and mid-sized
enterprises with 250 or fewer employees. Expanets is the largest dealer for this
market segment in the United States. These sales were formerly conducted by us
using a direct sales force of approximately 1,800 employees, including sales
associates, sales support and management, substantially all of whom were
transferred to Expanets. This sale was part of our strategy to use multiple
distribution channels designed to better serve our customers by using their
preferred distribution channel. We believe small to mid-sized enterprises
increasingly prefer to purchase through distributors, dealers, value-added
resellers and systems integrators rather than from our direct sales force
because the distribution partners are better able to focus on their specific
customer segment and can provide a variety of technologies and services aimed at
small and mid-sized enterprises. Our sale to Expanets was also part of our
efforts to focus our direct sales force on segments of the market that we can
more cost effectively serve.
Systems integrators generally design complete, made-to-order communications
and eBusiness communications systems and solutions, often utilizing the products
of several manufacturers. Systems integrators primarily recommend our systems
and software to customers as part of a system, and we bill the customers
directly. They also purchase products from our distribution partners directly
for incorporation into their systems. We have partnered with both local systems
integrators, which provide services catered to the individual needs of our
geographically diverse customer base, as well as regional and global systems
integrators to meet the technology and application driven needs of our large,
multinational customers. As of March 31, 2000, we had relationships with
approximately 20 global systems integrators, as well as with smaller local and
regional system integrators.
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SYSTIMAX STRUCTURED CABLING SALES CHANNEL
Substantially all of our SYSTIMAX structured cabling systems are sold
through our approximately 50 distributors, and a majority of these sales are
through two of these distributors. The distributors sell both to our worldwide
network of approximately 2,400, dealers, value-added resellers, systems
integrators and contractors and to end-user customers. If our relationship with
either of our two main distribution partners should terminate, we may experience
short-term delays in the United States, but we believe we could use other
parties to replace these distributors. Internationally, we generally have
relationships with our distribution partners on a country-by-country basis, with
the number per country ranging based on the sales potential.
RESEARCH AND DEVELOPMENT
We intend to invest an amount equal to approximately 9% of our total
revenue in fiscal 2001 in research and development. These investments represent
a significant increase over our investments in research and development over the
previous three fiscal years, which was approximately 6% of total revenue for
each of those years. We are building a research and development capability that
is intended to have approximately 3,000 engineers, including many that currently
work at Lucent's Bell Laboratories, one of the world's leading research and
development institutions. After the distribution, our research engineers will
form a group with centralized management. Our product development engineers will
work in various divisions and report to the management of those divisions.
Although we will spend a significant portion of our budget on hiring
research and development personnel as we build our capability, we believe our
investments will be more effective than they have been historically because our
efforts will be focused on higher growth segments in our market. As a part of
Lucent, we funded a portion of Lucent's basic research, which research was not
necessarily beneficial for our businesses. We currently perform our research and
development activities, including prototype testing, in 24 facilities located in
the United States, Israel, United Kingdom, Australia, Ireland and India.
We plan on using a significant portion of our investments in research and
development to develop new systems and software to augment our current eBusiness
communications product offerings so that, together with our strategic alliances,
we can offer our customers comprehensive eBusiness communications solutions. We
are particularly focused on converged voice and data solutions and applications
which support eBusiness communications solutions. Our research and development
group will continue to seek opportunities to work with other technology leaders
to develop uniform technological standards as the building blocks for future
communications and related enterprise systems.
MANUFACTURING AND SUPPLIES
Currently, we employ approximately 5,000 employees to perform our
manufacturing in 11 facilities located in China, France, India, Ireland, Israel,
the United Kingdom, the United States, Australia and Venezuela. Of these
employees, approximately 2,900 employees are engaged in the manufacturing of our
connectivity solution product offerings in four facilities located in China, the
United States, Australia and Venezuela. As part of our manufacturing initiative,
we intend to outsource substantially all of our manufacturing, including
assembly and testing, other than the manufacturing of our connectivity solution
product offerings. We believe that outsourcing our manufacturing will enable us
to improve our cash flow over the next few years through a reduction in
inventory and reduced capital expenditures. This will allow us to focus our
internal resources on new product development, as we continue to offer high
quality products to our customers. Our manufacturing initiative may be delayed
or prohibited by a legal proceeding currently contemplated by a governmental
agency, which may disrupt our operations or result in unanticipated costs.
Please see "Business -- Legal Proceeding" for a description of this legal
proceeding.
Products which we purchase from third party manufacturers for resale
account for approximately 5% of our total revenue. We believe we have adequate
sources for the supply of the components of our products and for the finished
products that we purchase from these third parties. We currently have only a
single source of supply for several of our wide area network multi-service
networking products, including
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the Access Point virtual private network product, PacketStar AX ATM access
servers, SuperPipe multi-service routers, Max3000 access switches and our
firewall/virtual private network gateway products. Multi-service networking
products are those products that support network infrastructures which carry
voice, video and data traffic over any of the protocols, or sets of procedures,
supported by the Internet on local area and wide area data networks. A virtual
private network allows an enterprise to transport voice, video or data over a
public or shared network at a level of security substantially equivalent to the
traffic traveling over that enterprise's own private network, and a firewall
regulates internal and external network resources and filters network content.
As part of the distribution, we expect to enter into a long-term relationship
with Lucent to purchase some of these products as well as other local area
networking products. In addition, we purchase the fiber components of our
SYSTIMAX structured cabling systems and our wireless local area networking
products from Lucent. Also, we will enter into an agreement with Lucent for the
supply of various semiconductor components. These contracts will be terminable
upon customary terms such as material breach or insolvency. We intend to
continue to purchase our ClearTrac frame relay voice access devices from ACT
Networks, Inc. and our wide area networking devices from Paradyne Corporation.
Our contract with ACT Networks allows us to purchase similar products from
alternative manufacturers as needed. Our contract with Paradyne restricts our
ability to purchase similar products. Each contract expires in 2001 and is
terminable upon customary terms such as material breach or insolvency. We intend
to renegotiate each of these contracts prior to their expiration. After the
distribution, we intend to expand our own wide area network capabilities.
If we were unable to purchase products for which we have a single source of
supply, it would be difficult to replace them and our competitive position in
supplying converged voice and data products would be harmed. Because of the
growing importance of converged voice and data products, our overall competitive
position also may be harmed if a termination occurs unless we develop our own
products or find other similar products on a timely basis. We may offer
additional products for sale in the future purchased from a single source of
supply.
For detailed descriptions of the products described in this section, please
see "-- Products and Solutions."
COMPETITION
The market for communications systems and software is quickly evolving,
highly competitive and subject to rapid technological change. Because we offer a
wide range of systems and software for several types of enterprises, we have a
broad range of competitors. Many of our competitors are substantially larger
than we are and have significantly greater financial, sales, marketing,
distribution, technical, manufacturing and other resources. Competition for one
or more of our communications systems and software, other than our structured
cabling systems, include products manufactured or marketed by a number of large
communications equipment suppliers, including Nortel Networks Corporation, Cisco
Systems, Inc., Siemens Aktiengesellschaft, Alcatel and LM EricssonAB, as well as
by a number of other companies, some of which focus on particular segments of
the market such as customer relationship management. Some of our other
competitors include Aspect Communication Corporation and NEC Corporation. Our
structured cabling systems' primary competitors are ADC Telecommunications,
Inc., Siecor Corporation, Marconi plc, Nordx/CDT, Commscope, Inc. and Belden
Inc. Our professional services compete primarily with services from vendors such
as Nortel Networks Corporation, eLoyalty Corporation, PricewaterhouseCoopers
LLC, Cap Gemini S.A., IBM Global Services, Oracle Corporation and Alcatel that
offer similar products and professional services. Our value-added services
compete with Cisco Systems, Inc., Williams Communications Group, Inc., Nortel
Networks Corporation, Siemens Aktengesellschaft, KPMG Consulting, Inc., Compaq
Computer Corporation and Amteva Technologies, Inc. We expect to face increasing
competitive pressures from both current and future competitors in the markets we
serve.
Our competitive position varies depending on the segment of our market. We
are a leader worldwide in messaging and structured cabling systems and the U.S.
leader in call center and enterprise communications systems. With respect to the
data communications products segment, we are relatively
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new and our product portfolio is less complete than that of many of our
competitors. Our professional services and value-added service groups primarily
serve customers which purchase our systems and software and are relatively small
as compared to our competitors. As part of the distribution, our name will
change. We believe that the Lucent name has significant value and has enhanced
our competitive position historically. It is too early to assess whether this
change will affect our competitive position. We will have agreements with Lucent
that allow us to use Lucent's name and logo and to verbally describe our
previous relationship with Lucent for a period of time following the
distribution. Please see "-- Patents, Trademarks and Other Intellectual
Property" for a discussion of these agreements.
Technological developments and consolidation within the communications
industry result in frequent changes to our group of competitors. The principal
competitive factors in the product segment of our market include:
- product features and reliability;
- customer service and technical support.
- relationships with distributors, value-added resellers and systems
integrators;
- an installed base of similar or related products;
- relationships with buyers and decision makers;
- price;
- brand recognition;
- the ability to integrate various products into a customer's existing
network; and
- the ability to be among the first to introduce new products;
The principal competitive factors in the professional services segment of
our market include:
- focus on the customer's specific needs;
- project management and change management skills;
- business model as well as technical architecture and information systems
design skills;
- product-specific expertise;
- eBusiness experience and expertise;
- speed of delivery;
- industry, business process and general business expertise; and
- objectivity of advice provided.
PATENTS, TRADEMARKS AND OTHER INTELLECTUAL PROPERTY
Upon consummation of the distribution, we will own rights to a number of
patents, trademarks, copyrights, trade secrets and other intellectual property
directly related to and important to our business. Lucent and its subsidiaries
also will grant rights and licenses to those of their patents, trademarks,
copyrights, trade secrets and other intellectual property which enable us to
manufacture, market and sell all our products. In addition, Lucent will convey
to us numerous sublicenses under patents of third parties.
Under the intellectual property agreements we are entering into with Lucent
as part of the distribution, Lucent and one of its subsidiaries will assign to
us approximately 1,500 U.S. patents and patent applications and their respective
corresponding foreign patents and patent applications. In connection with these
patents, we will enter into a cross license agreement with Lucent. In addition
Lucent will assign to us numerous trademarks, both in the United States and in
foreign countries. It is contemplated that the primary trademarks used in the
sale of our products and services will be transferred to us, except for the
Lucent or Bell Laboratories names.
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We have commenced marketing our products under our new name, "Avaya".
However, for three months after the distribution, we will have the limited
ability to use Lucent's corporate mark and logo on a royalty-free basis without
other marks, and in conjunction with the name "Avaya" and trademarks in a
transition mark or logo. With respect to the manufacture of certain products,
this period will be nine months. Beginning three months after the distribution
date, for an additional six months in the United States and twelve months
outside of the United States, we will have the limited ability to refer to
Lucent's corporate name without use of Lucent's logo on a royalty-free basis
without other marks and in conjunction with our own trade name and trademarks.
The rights granted to use the Lucent name and logo are applicable only to our
current products and not to any products developed by us after the distribution.
Our intellectual property policy will be to protect our products and
processes by asserting our intellectual property rights where appropriate and
prudent. We will also obtain patents, copyrights, and other intellectual
property rights used in connection with our business when practicable and
appropriate.
PROPERTIES
As of March 31, 2000, we operated 8 manufacturing facilities, 68 warehouse
locations and 3 repair sites in the United States and 21 other countries. We
also have 536 offices located in 50 countries and 24 research and development
facilities located in Australia, India, Israel, France, Singapore, the United
Kingdom and the United States. Our principal manufacturing facilities are
located in Australia, China, France, India, Ireland, Israel, the United Kingdom,
the United States and Venezuela. We also have a 25.5% interest in one joint
venture located in Gandhinagar, India which is predominantly used as a
manufacturing site and is mostly on owned property. These facilities have an
aggregate floor space of approximately 13 million square feet, of which
approximately 4 million square feet is owned and approximately 9 million square
feet is leased. Our lease terms range from monthly leases to 19 years. In
connection with our restructuring initiative to outsource the manufacturing of
our systems and software other than our structured cabling systems, we are
assessing the potential disposition of manufacturing sites by the end of 2001.
We believe that all of our facilities and equipment are in good condition and
are well maintained and able to operate at present levels.
EMPLOYEES
As of March 31, 2000, we employed approximately 34,000 full-time employees,
including approximately 4,300 research and development employees, 3,400 account
managers, 6,700 field service employees and 800 employees in professional
service. Of these 34,000 employees approximately 20,000 are management and
non-union-represented employees and approximately 14,000 are U.S.
union-represented employees covered by collective bargaining agreements. On May
31, 1998 Lucent entered into a collective bargaining agreement with the
Communications Workers of America and the International Brotherhood of
Electrical Workers. In connection with the distribution, we will assume the
obligations under the agreement with respect to our union-represented employees.
The agreement will be effective until May 31, 2003 unless the parties reach a
mutual agreement to amend its term. We believe that we generally have a good
relationship with our employees and the unions that represent them. We are
subject from time to time to unfair labor charges filed by the unions with the
National Labor Relations Board. If we are unsuccessful in resolving these
charges or the legal proceeding which we expect Region 6 of the National Labor
Relations Board to bring against Lucent results in an adverse decision, our
operations may be disrupted, our initiative to outsource substantially all of
our manufacturing may be delayed or prohibited or we may incur additional costs
that may decrease our profitability. See "-- Legal Proceedings" for a
description of the legal proceeding that we are currently anticipating will be
brought against Lucent and will affect us.
BACKLOG
Our backlog, which represents the aggregate of the sales price of orders
received from customers, but not yet recognized as revenue, was approximately
$788 million and $786 million on September 30, 1999 and September 30, 1998,
respectively. At June 30, 2000, our backlog was $538 million. The majority of
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these orders are fulfilled within two months. However, all orders are subject to
possible rescheduling by customers. Although we believe that the orders included
in the backlog are firm, some orders may be cancelled by the customer without
penalty, and we may elect to permit cancellation of orders without penalty where
management believes it is in our best interests to do so. We expect our backlog
will grow for the remainder of the year, reflecting the traditionally stronger
second half of our annual business cycle.
ENVIRONMENTAL, HEALTH AND SAFETY MATTERS
We are subject to a wide range of governmental requirements relating to
employee safety and health and to the handling and emission into the environment
of various substances used in our operations. Our facilities are subject to
regular internal audits governing all aspects of employee protection, materials
handling and environmental compliance. In addition, many of our facilities are
subject to third-party certified 14001 environmental compliance programs. Based
upon these reviews, we believe that we are in substantial compliance with all
applicable environmental, health and safety laws. We have not incurred material
capital expenditures for such matters during the past three years, nor do we
anticipate having to incur such expenditures during the current or succeeding
fiscal year.
We are subject to environmental laws, particularly in the United States,
governing the cleanup of soil and groundwater contamination. Such provisions
impose liability on us for the costs of investigating and remediating releases
of hazardous materials at sites currently or formerly owned, operated or leased
by us. This liability may also include the cost of cleaning up historical
contamination, whether or not caused by us. Some of our facilities are located
in areas where industrial activities have been ongoing for many years.
We are currently conducting investigation and/or cleanup of known
contamination at approximately five of our facilities, either voluntarily or
pursuant to government directives. We have established financial reserves to
cover environmental liabilities where they are probable and reasonably
estimable. Reserves for estimated losses from environmental matters are,
depending on the site, based primarily upon internal or third-party
environmental studies and the extent of contamination and the type of required
cleanup. Although we believe that our reserves are adequate to cover known
environmental liabilities, it is often difficult to estimate with certainty the
future cost of such matters. Therefore, we cannot be assured that the actual
amount of environmental liabilities will not exceed the amount of reserves for
such matters or will not have a material adverse effect on our financial
position, results of operations or cash flows.
LEGAL PROCEEDINGS
From time to time we are involved in legal proceedings arising in the
ordinary course of business. 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.
Two separate purported class action lawsuits are pending against Lucent in
state court in West Virginia and in federal court in California. The case in
West Virginia was filed in April 1999 and the case in California was filed in
June 1999. Following the distribution, we expect to be named a party to these
actions. A class has not been certified in either of the two cases. Both cases
allege that Lucent acted contrary to state statutory consumer protection laws
with respect to Y2K compliance of some of its products. The complaints seek
monetary relief, certain equitable relief and counsel fees. Although we believe
that the outcome of these Y2K actions will not adversely affect our business
prospects, if these cases progress, they will require expenditure of significant
legal costs related to their defense.
In addition, from time to time we are subject to unfair labor charges filed
by the unions with the National Labor Relations Board. For example, we have been
advised by Region 6 of the National Labor Relations Board, which is located in
Pittsburgh, Pennsylvania, that it has been authorized to file a complaint
alleging that Lucent has refused to bargain over the outsourcing of certain of
its manufacturing activities. In that proceeding, the General Counsel of the
National Labor Relations Board will act as prosecutor and the charging party,
IBEW System Council EM-3, which is the union representing the workers at the
manufacturing facilities in question, will be an interested party entitled to
participate in the
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proceeding. Because the complaint will relate to some of the manufacturing
facilities that will be transferred to us as part of the distribution, we expect
to become a party to this action.
The union alleges that Lucent did not provide relevant information relating
to the outsourcing of bargaining unit work, specifically the outsourcing of
circuit packs. The union also claims that Lucent bargained in bad faith during
1998 bargaining by withholding its intention to outsource the circuit pack
production. Moreover, the union alleges that Lucent has failed to bargain in
good faith over its decision to outsource certain of its manufacturing
operations.
Region 6 has advised Lucent that it will seek a return of the outsourced
work to the bargaining unit and back pay for affected employees. It has also
advised Lucent that if Lucent pursues its current plans to outsource additional
bargaining unit work, injunctive relief may be sought. If we are unsuccessful in
resolving these charges, as they relate to us, our operations may be disrupted,
our initiative to outsource substantially all of our manufacturing may be
delayed or prohibited or we may incur additional costs that may decrease our
profitability.
Other than described above, we believe there is no litigation pending that
should have, individually or in the aggregate, a material adverse effect on our
financial position or results of operations.
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RELATIONSHIP BETWEEN LUCENT AND OUR COMPANY
AFTER THE DISTRIBUTION
In connection with the distribution, we will enter into the Contribution
and Distribution Agreement and a number of ancillary agreements with Lucent for
the purpose of accomplishing the contribution to us of the businesses described
in this information statement and the distribution. These agreements will govern
the relationship between Lucent and us subsequent to the distribution and
provide for the allocation of employee benefit, tax and other liabilities and
obligations attributable to periods prior to the distribution. The ancillary
agreements include:
- Interim Services and Systems Replication Agreement;
- Global Purchase and Service Agreement;
- General Sales Agreement;
- Microelectronics Product Purchase Agreement;
- Reseller Agreements;
- Master Subcontracting Agreement;
- Master Services Agreement;
- Original Equipment Manufacturing and Value Added Reseller Agreement;
- Employee Benefits Agreement;
- Trademark License Agreement;
- Trademark and Service Mark Assignment;
- Trade Dress Assignment;
- Patent and Technology License Agreement;
- Patent Assignment;
- Technology Assignment and Joint Ownership Agreement;
- Development Project Agreement;
- Tax Sharing Agreement; and
- Real Estate Agreements.
In addition, the current Federal Tax Allocation Agreement and the current
State and Local Income Tax Allocation Agreement by and among Lucent and its
subsidiaries governing the allocation of income taxes among Lucent and its
subsidiaries will continue to apply to us for taxable periods prior to and
including the distribution. Of the agreements summarized below, the material
agreements have been filed as exhibits to the registration statement of which
this information statement forms a part and the summaries of such agreements are
qualified in their entirety by reference to the full text of such agreements.
CONTRIBUTION AND DISTRIBUTION AGREEMENT
The Contribution and Distribution Agreement will set forth the agreements
between us and Lucent with respect to the principal corporate transactions
required to effect the contribution and the distribution, and other agreements
governing the relationship between Lucent and us.
THE CONTRIBUTION
To effect the contribution, Lucent will transfer or agree to transfer, or
to cause its subsidiaries to transfer, the assets of the businesses described in
this information statement. We will assume, or agree to
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assume, and will agree to perform and fulfill all of the liabilities of the
contributed businesses in accordance with their respective terms. Except as
expressly set forth in the agreement or in any other ancillary agreement,
neither we nor Lucent will make any representation or warranty as to the assets,
businesses or liabilities transferred or assumed as part of the contribution, as
to any consents or approvals required in connection with the transfers, as to
the value or freedom from any security interests of any of the assets
transferred, as to the absence of any defenses or freedom from counterclaim with
respect to any claim of either us or Lucent, or as to the legal sufficiency of
any assignment, document or instrument delivered to convey title to any asset
transferred. Except as expressly set forth in any other ancillary agreement, all
assets will be transferred on an "as is," "where is" basis, and the respective
transferees will agree to bear the economic and legal risks that any conveyance
is insufficient to vest in the transferee good and marketable title, free and
clear of any security interest and that any necessary consents or approvals are
not obtained or that requirements of laws or judgments are not complied with.
THE DISTRIBUTION
The Contribution and Distribution Agreement will provide that, subject to
the terms and conditions contained in the agreement, we and Lucent will take all
reasonable steps necessary and appropriate to cause all conditions to the
distribution to be satisfied, and to effect the distribution as of 11:59 p.m. on
September 30, 2000. Lucent's agreement to consummate the distribution will be
subject to the satisfaction or waiver by the Lucent board, in its sole
discretion, of the following conditions:
- a private letter ruling from the IRS, which we obtained on August 3,
2000, shall continue in effect, to the effect that, among other things,
the distribution will qualify as a tax-free distribution for federal
income tax purposes under Section 355 of the Internal Revenue Code and
the transfer to us of the assets and the assumption by us of the
liabilities in connection with the contribution will not result in
recognition of any gain or loss for federal income tax purposes to
Lucent, us or Lucent's or our shareowners, and such ruling shall be in
form and substance satisfactory to Lucent, in its sole discretion;
- any material governmental approvals and consents necessary to consummate
the distribution shall have been obtained and be in full force and
effect;
- no order, injunction or decree issued by any court or agency of competent
jurisdiction or other legal restraint or prohibition preventing the
consummation of the distribution shall be in effect, and no other event
outside the control of Lucent shall have occurred or failed to occur that
prevents the consummation of the distribution; and
- no other events or developments shall have occurred that, in the judgment
of the board of directors of Lucent, would result in the distribution
having a material adverse effect on Lucent or Lucent's shareowners.
If the Lucent board of directors waives a material condition to the
distribution after the date of this information statement, we intend to issue a
press release disclosing this waiver and file this press release in a Form 8-K
with the Securities and Exchange Commission.
RELEASES AND INDEMNIFICATION
The Contribution and Distribution Agreement will provide for a full and
complete release and discharge of all liabilities existing or arising from all
acts and events occurring or failing to occur or alleged to have occurred or to
have failed to occur and all conditions existing or alleged to have existed on
or before the date of the agreement, between or among us or any of our
subsidiaries or affiliates, on the one hand, and Lucent or any of its
subsidiaries or affiliates other than us, on the other hand, except as expressly
set forth in the agreement. The liabilities released or discharged will include
liabilities arising under any contractual agreements or arrangements existing or
alleged to exist between or among any such members on or before the date of the
agreement.
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We will agree to indemnify, hold harmless and defend Lucent, each of its
affiliates and each of their respective directors, officers and employees, from
and against all liabilities relating to, arising out of or resulting from:
- the failure of us or any of our affiliates or any other person to pay,
perform or otherwise promptly discharge any liabilities associated with
the contributed businesses, or any contracts associated with the
contributed businesses, in accordance with their respective terms;
- the contributed businesses, liabilities or contracts;
- any material breach by us or any of our affiliates, of the agreement or
any of the other ancillary agreements; and
- any untrue statement or alleged untrue statement of a material fact or
omission or alleged omission to state a material fact required to be
stated in the registration statement or this information statement or
necessary to make the statements in the registration statement or this
information statement not misleading.
Also, we will indemnify Lucent and its affiliates, subject to limited
exceptions, against any claims of patent, copyright or trademark infringement or
trade secret misappropriation with respect to any product, software or other
material provided by or ordered from the contributed businesses prior to the
distribution.
Lucent will agree to indemnify, hold harmless and defend us, each of our
affiliates and each of our respective directors, officers and employees from and
against all liabilities relating to, arising out of or resulting from:
- the failure of Lucent or any affiliate of Lucent or any other person to
pay, perform or otherwise promptly discharge any liabilities of Lucent or
its affiliates other than liabilities associated with the contributed
businesses;
- the Lucent businesses or any liability of Lucent or its affiliates other
than liabilities associated with the contribution of the businesses; and
- any material breach by Lucent or any of its affiliates of the agreement
or any of the other ancillary agreements.
Also, Lucent will indemnify us and our affiliates, subject to limited
exceptions, against any claims of patent, copyright or trademark infringement or
trade secret misappropriation with respect to any product, software or other
material provided by or ordered from Lucent's retained businesses prior to the
distribution.
The Contribution and Distribution Agreement also will specify procedures
with respect to claims subject to indemnification and related matters.
CONTINGENT LIABILITIES AND CONTINGENT GAINS
The Contribution and Distribution Agreement will provide for
indemnification by us and Lucent with respect to contingent liabilities
primarily relating to our respective businesses or otherwise assigned to each of
us, subject to the sharing provisions described below. In the event the
aggregate value of all amounts paid by us or Lucent, in each case, together with
any affiliates in respect of any single contingent liability or any set or group
of related contingent liabilities is in excess of $50 million, we and Lucent
will share portions in excess of the threshold amount based on agreed upon
percentages.
The Contribution and Distribution Agreement will also provide for the
sharing of some contingent liabilities, which are defined as:
- any contingent liabilities that are not primarily contingent liabilities
of Lucent or contingent liabilities associated with the contributed
businesses;
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- some specifically identified liabilities, including liabilities relating
to terminated, divested or discontinued businesses or operations; and
- shared contingent liabilities within the meaning of the separation and
distribution agreement with AT&T Corp.
Lucent will assume the defense of, and may seek to settle or compromise,
any third party claim that is a shared contingent liability, and those costs and
expenses will be included in the amount to be shared by us and Lucent.
The Contribution and Distribution Agreement will provide that we and Lucent
will have the exclusive right to any benefit received with respect to any
contingent gain that primarily relates to the business of, or that is expressly
assigned to, us or Lucent respectively.
The Contribution and Distribution Agreement will provide for the
establishment of a contingent claims committee comprised of one representative
designated from time to time by each of Lucent and us and sets forth procedures
for the purpose of resolving disagreements among the parties as to contingent
gains and contingent liabilities.
DISPUTE RESOLUTION
The Contribution and Distribution Agreement will contain provisions that
govern, except as otherwise provided in any ancillary agreement, the resolution
of disputes, controversies or claims that may arise between us and Lucent. These
provisions contemplate that efforts will be made to resolve disputes,
controversies and claims by escalation of the matter to senior management or
other mutually agreed representatives of us and Lucent. If such efforts are not
successful, either we or Lucent may submit the dispute, controversy or claim to
non-binding mediation, subject to the provisions of the agreement.
RESTRICTIONS ON BUSINESS TRANSACTIONS
Subject to Lucent's ability to terminate some of the rights, including
important intellectual property rights granted to us and our affiliates under
the ancillary agreements, the Contribution and Distribution Agreement will
provide that none of Lucent, us, or our respective subsidiaries or affiliates
will have any duty to refrain from engaging in similar activities or lines of
business, or from doing business with any potential or actual supplier or
customer of any other person.
CHANGE OF CONTROL; RESTRICTIONS ON STRATEGIC ALLIANCES
In the event that, at any time prior to the third anniversary of the
distribution, there is a change of control of us as defined in the Contribution
and Distribution Agreement or, if prior to the second anniversary of the
distribution, we or any of our affiliates enters into a strategic alliance with
Nortel Networks Corporation or Cisco Systems, Inc. or any of their respective
affiliates, then Lucent could terminate or cause us to reconvey some of the
rights, including important intellectual property rights granted to us under the
agreements which we are entering into with Lucent.
PROVISIONS RELATING TO THIRD-PARTY INTELLECTUAL PROPERTY LICENSE AGREEMENTS
The Contribution and Distribution Agreement will provide, generally, for
the grant by Lucent to us of a sublicense under numerous third-party
intellectual property license agreements. The Patent and Technology License
agreement will provide similar grants to us from Lucent's subsidiary, Lucent
Technologies GRL Corporation, with respect to third party patent license
agreements executed by that subsidiary.
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EXPENSES
Except as expressly set forth in the Contribution and Distribution
Agreement or in any other ancillary agreement, whether or not the distribution
is consummated, all third party fees, costs and expenses paid or incurred in
connection with the distribution will be paid by us.
TERMINATION
The Contribution and Distribution Agreement may be terminated and the
distribution may be amended, modified or abandoned at any time prior to the
distribution date in the sole discretion of Lucent without our approval or the
approval of the shareowners of Lucent. In the event of such termination, no
party shall have any liability of any kind to any other party or any other
person. After the distribution date, the agreement may not be terminated except
by an agreement in writing signed by both Lucent and us.
AMENDMENTS AND WAIVERS
No provisions of the Contribution and Distribution Agreement or any other
ancillary agreement will be deemed waived, amended, supplemented or modified by
any party, unless such waiver, amendment, supplement or modification is in
writing and signed by the authorized representative against whom it is sought to
enforce such waiver, amendment, supplement or modification.
FURTHER ASSURANCES
In addition to the actions specifically provided for elsewhere in the
Contribution and Distribution Agreement, both we and Lucent will agree to use
our reasonable best efforts, prior to, on and after the distribution date, to
take, or cause to be taken, all actions, and to do, or cause to be done, all
things, reasonably necessary, proper or advisable under applicable laws,
regulations and agreements to consummate and make effective the transactions
contemplated by the agreement and the other ancillary agreements.
INTERIM SERVICES AND SYSTEMS REPLICATION AGREEMENT
We and Lucent will enter into an Interim Services and Systems Replication
Agreement to provide each other, on an interim, transitional basis, with various
data processing services, telecommunications services and corporate support
services, including: accounting, financial management, information systems
management, tax, payroll, legal, human resources administration, procurement and
other general support. Furthermore, under the terms of this agreement Lucent
will provide us with technical support for our converged voice and data products
for an agreed upon period of time. The agreed upon charges for such services are
generally intended to allow the providing company to fully recover the allocated
direct costs of providing the services, plus all out-of-pocket costs and
expenses, without profit.
The Interim Services and Systems Replication Agreement also provides for
the replication and transfer of designated computer systems used for
administrative support or used in our businesses or Lucent's businesses. The
systems include hardware, software, data storage or maintenance and support
components. Costs and expenses of purchasing new hardware or obtaining new
software licenses will be borne by the party purchasing the new hardware or
licensing the new software.
In general, the services shall commence on October 1, 2000 and shall expire
on March 31, 2001 unless an earlier termination date has been agreed upon with
respect to a particular service. The agreement may be extended by the parties in
writing either in whole or in part. The company receiving data processing
services, telecommunications services and corporate support services may
terminate the agreement with respect to one or more of those services upon
ninety days notice. The company receiving systems replication and transfer
services may terminate the agreement immediately, with respect to those
services, upon written notice to the providing company. A small number of
corporate support services related to accounts receivable, accounts payable and
payroll processing that are currently performed by Lucent non-management
employees, and some other corporate support services related to administration
of
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programs for the benefit of non-management employees that become our employees
or their beneficiaries, may extend until May 31, 2003.
COMMERCIAL AGREEMENTS
We and Lucent will enter into a Global Purchase and Service Agreement, a
General Sales Agreement, a Microelectronics Product Purchase Agreement, two
Reseller Agreements, a Master Subcontracting Agreement, a Master Services
Agreement and an Original Equipment Manufacturing and Value Added Reseller
Agreement. The pricing terms for the products and services covered by the Global
Purchase and Service Agreement and all other ancillary commercial agreements
will reflect negotiated prices.
Under the Global Purchase and Service Agreement we will provide to Lucent
communications and other related products for Lucent's internal operational use.
These products include some of our enterprise voice communications products and
our multi-service networking products. Under the agreement, we will also provide
warranty and post-warranty maintenance support services for products that are
already installed in Lucent offices as well as for new products installed
thereafter. The agreement neither grants to us an exclusive right to provide
Lucent any or all of these products or services, nor does it require the
procurement of products or services from us by Lucent. The agreement shall
commence on October 1, 2000, and will expire on September 30, 2003. We and
Lucent may extend this agreement for additional one year periods with a written
mutual agreement.
The General Sales Agreement and the Microelectronic Product Purchase
Agreement govern transactions pursuant to which Lucent will provide goods and
services that are part of the businesses not being transferred to us. These
agreements neither grant to Lucent an exclusive right to provide us with any or
all products, or services, nor require the procurement of products, or services
from Lucent by us. The General Sales agreement and the Microelectronic Product
Purchase Agreement will commence on October 1, 2000, and expire on September 30,
2003. We and Lucent may extend both of these agreements for additional one year
periods with written mutual agreements.
The Reseller Agreements govern transactions in which either we or Lucent
furnish items to the other for resale. Each agreement covers specified products
and licensed materials of both Lucent and ours, respectively. Either party may
add to or delete products upon ninety days notice. The agreements do not grant
to either us or Lucent an exclusive right to resell the products, and both we
and Lucent may contract with others. The pricing in each Reseller Agreement
shall be determined by our or Lucent's list price in effect on the date of the
applicable reseller's receipt of an order less any applicable reseller
discounts. These agreements will be effective as of October 1, 2000 and shall
expire on September 30, 2003. We and Lucent may extend these agreements for
additional one year periods with a written mutual agreement. Either we or Lucent
may terminate these agreements without cause upon sixty days written notice.
The Global Purchase and Service Agreement, General Sales Agreement,
Microelectronic Sales Agreement and Reseller Agreement also contain provisions
governing:
- ordering and delivery;
- payment terms;
- intellectual property matters;
- product warranties;
- product support and documentation;
- engineering, installation, maintenance and other services;
- dispute resolution; and
- liability issues.
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The Master Subcontracting Agreement sets forth the terms by which we and
Lucent may subcontract for services and related deliverables from each other to
support our respective customers. The prime contractor will pay the
subcontractor according to the rates established in the statement of work. The
subcontractor may not subcontract any portion of the services or deliverables
without advising the prime contractor first. The agreement also covers
intellectual property matters, warranties, dispute resolution and liability
issues. This agreement will be effective as of October 1, 2000 and shall expire
on September 30, 2003. This agreement may be extended for additional one year
periods upon ours and Lucent's written mutual consent.
The Master Services Agreement covers any order for services not addressed
in any other commercial agreement between us and Lucent. Under this agreement
either we or Lucent or our or Lucent's affiliates may place orders for services
from the other party including maintenance service, professional services,
changes in services, and extension of services. Prices shall be set forth in a
statement of work and paid for by the ordering party. The agreement also covers
intellectual property matters, warranties, dispute resolution, and liability
issues. This agreement is effective as of October 1, 2000 and shall expire on
September 30, 2003. We and Lucent may extend this agreement for additional one
year periods with a written mutual agreement.
The Original Equipment Manufacturing and Value Added Reseller Agreement
governs transactions pursuant to which we and Lucent will buy, on an ordered
basis, products from each other for integration into finished products for sale
or resale or for resale in combination with enhancements added by the other
party. The agreement neither grants to the supplier an exclusive right to sell
to the buyer any or all products nor does it require the purchase of products
from the supplier by the buyer. The agreement also covers intellectual property
matters, warranties, dispute resolution, and liability issues. This agreement is
effective as of October 1, 2000 and shall expire September 30, 2003. This
agreement may be extended for additional one year periods upon our and Lucent's
written mutual consent.
EMPLOYEE BENEFITS AGREEMENT AND PLANS
We will adopt a variety of employee benefit plans in connection with the
distribution.
EMPLOYEE BENEFITS AGREEMENT
We will enter into an employee benefits agreement with Lucent, pursuant to
which we will create independent pension and other employee benefit plans that
are substantially similar to Lucent's existing pension and other employee
benefit plans. This agreement will provide for the transfer of assets and
liabilities of various existing Lucent pension and other employee benefit plans
covering Lucent employees who are transferring to us. Generally, following the
distribution, Lucent will cease to have any liability or obligation to our
active employees and their beneficiaries, and to our employees who leave our
employ after September 30, 2000 under any of Lucent's benefit plans, programs or
practices. Our benefit plans will assume and be responsible for liabilities and
obligations to those employees under all these benefit plans, programs and
practices which we may adopt. The employee benefits agreement does not preclude
us from discontinuing or changing such plans at any time thereafter, subject to
the exceptions noted below.
RETIREMENT PLANS
We will establish and administer defined benefit pension plans for our
employees who, immediately prior to the distribution, participated in Lucent's
retirement plans. Lucent has agreed to transfer particular assets and
liabilities, based on formulas set forth in the employee benefits agreement,
from the trust for Lucent's defined benefit pension plans to the trust for our
defined benefit pension plans. Each of our eligible employees will, for all
purposes under our defined benefit pension plans, be credited with the service
and any accrued benefit credited to him or her under the terms of the
corresponding Lucent plans as of the distribution.
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SAVINGS PLANS
We will establish defined contribution savings/401(k) plans. Our
savings/401(k) plans will include all active employees who immediately prior to
the distribution date were participants in Lucent's savings/401(k) plans. Each
employee who participates in savings/401(k) plans will be credited with the
service and the account balance credited to him or her as of the distribution
date under the terms of Lucent's savings/401(k) plans. Lucent will transfer
those account balances from its savings/401(k) plans to our savings/401(k)
plans.
WELFARE PLANS
We will adopt appropriate welfare benefit plans to provide welfare
benefits, including retiree medical and life benefits, to our employees and
retirees. The assets funding such liabilities under these plans, including
assets held in trusts constituting voluntary employee beneficiary associations,
will be transferred from trust and other funding vehicles associated with
Lucent's plans to the corresponding trusts and other funding vehicles associated
with our plans according to formulas set forth in the employee benefits
agreement.
LUCENT STOCK OPTIONS AND RESTRICTED STOCK UNITS
Pursuant to the employee benefits agreement, unvested Lucent stock options
and restricted stock units held by our employees will be converted to our stock
options and restricted stock units at the time of the distribution. As part of
the conversion, we will multiply the number of shares purchaseable under each
converted stock option by a ratio determined at the time of the distribution and
divide the exercise price per share of each option by the same ratio. The number
of shares covered by each restricted stock unit will be multiplied by the same
ratio. Fractional shares will be rounded down to the nearest whole number of
shares. All other terms of the converted stock options and restricted stock
units will remain the same as those in effect immediately prior to the
distribution. Vested Lucent stock options will remain options to acquire Lucent
common stock, subject to adjustments based on the same ratio.
DEFERRED COMPENSATION PLANS
Account balances of our employees under the Lucent deferred compensation
plans will be credited to them under a frozen deferred compensation plan, and we
will thereafter be solely responsible for such obligations.
TRADEMARK LICENSE AGREEMENT; TRADEMARK AND SERVICE MARK ASSIGNMENT; TRADE DRESS
ASSIGNMENT
It is contemplated that the primary trademarks used in the sale of our
products and services will be transferred to us, except for Lucent's name and
logo and the Bell Laboratories name. We also expect to have the use of the
Lucent name and logo, but not the Bell Laboratories name, on a royalty-free
basis, for a transitional period.
TECHNOLOGY ASSIGNMENT AND JOINT OWNERSHIP AGREEMENT
On or prior to the distribution date, we and Lucent will execute and
deliver assignments and other agreements, including the technology assignment,
related to technology currently owned or controlled by Lucent and its
subsidiaries. Technology will include copyrights, mask works and other
intellectual property other than trademarks, trade names, trade dress, service
marks and patent rights. The technology assignment will generally divide
ownership of technology between us and Lucent, with each owning technology that
was developed by or for, or purchased by, each company for their respective
businesses. Other technology will be owned jointly by us and Lucent.
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PATENT ASSIGNMENT
On or prior to the distribution date, we and Lucent will execute and
deliver patent assignments and other agreements, related to patents currently
owned or controlled by Lucent and its subsidiaries. The patent assignments will
divide ownership of patents, patent applications and foreign counterparts
between us and Lucent.
The ownership of patents will be divided as follows. First, a Lucent
subsidiary, Lucent Technologies Guardian Corp., will transfer to Avaya
Technologies Corporation approximately 800 patents and approximately 500 patent
applications that relate principally to our businesses. Second, Lucent will
transfer to Avaya Technologies Corporation several hundred patent applications
and a small number of issued patents held by Lucent that relate principally to
our businesses. Third, the shares of Avaya Technologies Corp. will be
contributed to us under the Contribution and Distribution Agreement. Lucent and
its other subsidiaries including Guardian, will retain ownership of all other
patents and patent applications. Fourth, the patents held by some of the wholly
owned subsidiaries of Lucent will be transferred to us as a result of the
transfer of shares of the subsidiaries to us.
PATENT AND TECHNOLOGY LICENSES AND RELATED MATTERS
The Contribution and Distribution Agreement provides that we and Lucent
will execute and deliver a Patent and Technology License Agreement, related to
patents and technology currently owned or controlled by Lucent and its
subsidiaries.
The Patent and Technology License Agreement to be entered into by us and
Lucent provides for cross-licenses to each company, and a balancing payment to
Lucent to reflect the balance of values exchanged by us and Lucent under the
agreement. We and Lucent will grant to each other, under the patents that each
of us has, a nonexclusive, personal, nontransferable license to make, have made,
use, lease, import, offer to sell, and sell any and all products and services of
the businesses in which the licensed company, including related companies, is
now or hereafter engaged. The cross-licenses also permit each company, subject
to limitations, to have third parties make items under the other company's
patents, as well as to pass through to customers rights under the other
company's patents with respect to products and services furnished to customers
by the licensed company. The right to sublicense to unaffiliated third parties
will not be granted under the cross-licenses, except for limited rights to
sublicense a divested business. The cross-licenses between us and Lucent cover
all of each company's patents, including patents issued on patent applications
with a filing date prior to October 1, 2002.
The Patent and Technology License Agreement will also provide for personal,
worldwide, nonexclusive, and non-transferable cross-licenses to each company to
designated technology existing as of the distribution date. These rights include
the right to copy, modify and improve any portion of the licensed technology.
Subject to exceptions set forth in the agreement, no right will be granted to
sublicense any of the technology other than in connection with the sale or
licensing of products. Subject to restrictions set forth in the agreement, this
agreement will further grant to us joint ownership rights in other designated
technology. This agreement becomes effective October 1, 2000.
DEVELOPMENT PROJECT AGREEMENT
We and Lucent will enter into a Development Project Agreement governing
Lucent's and our future commercial relationship under which Bell Laboratories
will perform some research and development activities for us. Under this
agreement, Bell Laboratories will perform specific research and development
projects on a contract basis for us. The fees paid under this agreement are
expected to be comparable to those that would be agreed upon by unrelated
parties. The agreement will commence on October 1, 2000 and expire on September
30, 2003. We and Lucent may extend this agreement for additional one year
periods with a written mutual agreement. The agreement will terminate at any
time if either we or Lucent materially breaches the agreement, and fails to cure
the default sixty days after written notice has been given.
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TAX SHARING AGREEMENT
We and Lucent will enter into a Tax Sharing Agreement which will govern
Lucent's and our respective rights, responsibilities and obligations after the
distribution with respect to taxes for the periods ending on or before the
distribution. Generally, pre-distribution taxes that are clearly attributable to
the business of one party will be borne solely by that party, and other
pre-distribution taxes will be shared by the parties based on a formula set
forth in the Tax Sharing Agreement. In addition, the Tax Sharing Agreement will
address the allocation of liability for taxes that are incurred as a result of
restructuring activities undertaken to implement the distribution. If the
distribution fails to qualify as a tax-free distribution under Section 355 of
the Internal Revenue Code because of an acquisition of our stock or assets, or
some other actions of ours, then we will be solely liable for any resulting
corporate taxes. The Tax Sharing Agreement will commence on October 1, 2000.
REAL ESTATE AGREEMENTS
Lucent's real estate has been divided between Lucent and us. After the
distribution, however, we and Lucent will continue to share some current work
locations for our respective work forces. The shared locations will be
approximately 100 of Lucent's 1,300 real estate locations. Approximately 15% of
these shared locations will continue to be owned by either Lucent or us; the
remaining 85% will continue to be leased commercially.
Generally, ownership of Lucent's buildings and assignment of commercially
leased buildings has been divided between Lucent and us based on which company
is the primary user of the respective building. Based on that allocation method,
we and Lucent currently contemplate that, out of approximately 60 million square
feet of space, Lucent would be the landlord or sublandlord of us for
approximately 1.2 million square feet of space, and we will be the landlord or
sublandlord of Lucent for approximately 700,000 square feet of space.
A standard form of lease and a standard form of sublease based on
commercial models and comparable to arm's-length agreements has been employed
regardless of which company owns a building or is the assignee for a leased
building. Subleases for space in commercially leased locations have varying
terms generally to match the terms of the underlying leases. All commercial
landlord charges, such as rent, additional rent, building services and taxes
paid directly by the sublandlord, will be based on the proportionate share of
space occupied by the subtenant and marked up by a management fee payable to the
sublandlord intended to cover the costs of administering the sublease. Any other
building services provided by the sublandlord to the subtenant will be at cost
plus an administrative fee, increased annually to match the consumer price
index.
Subject to limited exceptions, leases for space in owned buildings have a
two-year term if the space occupied by the tenant is 20,000 square feet or less
and a three-year term if the space occupied by the tenant is greater than 20,000
square feet. In general, rent in owned buildings is at market price for
comparable tenants. Real estate taxes will be allocated proportionately to the
tenant, subject to a management fee. Any building services provided by the
landlord will be at cost plus an administrative fee, increased annually to match
the consumer price index.
It is contemplated that all necessary leases and subleases for transitional
shared real estate will be effective October 1, 2000. The tenant in owned
buildings and the subtenant in commercially leased buildings will be responsible
for their proportionate share of the full lease obligation, except that:
- for space occupied by a tenant or subtenant equal to or less than 5
percent of the total space, not to exceed 5,000 square feet, the tenant
or subtenant may cancel its lease or sublease on 90-day written notice
without further liability;
- for space occupied by a tenant or subtenant equal to or less than 5
percent of the total space, not to exceed 15,000 square feet, the
tenant/subtenant or landlord/sublandlord may cancel the lease or sublease
on 9 months written notice without further liability; and
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- for property owned in fee by a landlord which is sold, conveyed or
transferred, the rent will then increase to fair market value, after
which determination the tenant may cancel the lease on six months'
written notice, without further liability.
OTHER AGREEMENTS
We and Lucent will continue the existing State and Local Income Tax
Allocation Agreement and the existing Federal Tax Allocation Agreement by and
among Lucent and its subsidiaries. These tax agreements govern the allocation of
state, local and federal income taxes for periods prior to and including the
distribution date. In addition, after the distribution, we will become a party
to Lucent's two existing collective bargaining agreements. See
"Business -- Employees" for a description of these collective bargaining
agreements and how they will operate after the distribution.
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MANAGEMENT
OUR DIRECTORS AND EXECUTIVE OFFICERS
Following the distribution, our board of directors will be comprised of up
to eight directors, only one of whom will be an executive officer. Pamela F.
Craven, Jean F. Rankin and Richard J. Rawson, who are employees of Lucent, are
currently serving as directors and have been our directors since our inception.
In connection with the distribution, these individuals will resign, and Henry B.
Schacht, Donald K. Peterson, Daniel C. Stanzione, Franklin A. Thomas and up to
three other non-employee directors will be elected to the board prior to the
distribution date. After consummation of the equity investment in us by Warburg,
Pincus Equity Partners, L.P. and related investment funds, these investors will
be entitled to designate for election one individual to our board of directors
and to have one observer attend meetings of our board of directors as long as
the investors and their permitted transferees maintain ownership of a
combination of shares of Series B convertible participating preferred stock and
common stock that, in the aggregate, on an as-converted basis, represent at
least 50% of the shares of our common stock initially issuable on conversion of
all the shares of Series B convertible participating preferred stock purchased
by them. Our board of directors will use reasonable efforts to cause the
designee of Warburg, Pincus Equity Partners, L.P. to be elected. Jeffrey A.
Harris will be Warburg, Pincus Equity Partners, L.P.'s initial designee.
Our board of directors will be divided into three classes. It is expected
that Mr. Harris and Mr. Thomas will be Class 1 directors, with terms expiring at
the annual meeting of shareowners to be held in fiscal 2002, Mr. Schacht and Dr.
Stanzione will be Class 2 directors with terms expiring at the annual meeting of
shareowners to be held in fiscal 2003 and Mr. Peterson will be the Class 3
director, with a term expiring at the annual meeting of shareowners to be held
in fiscal 2004. Commencing with the annual meeting of shareowners to be held in
fiscal 2002, directors for each class will be elected at the annual meeting of
shareowners held in the year in which the term for such class expires and
thereafter will serve for a term of three years.
The following table sets forth information as to persons who serve or who
are expected to serve as our directors, executive officers or key employees
immediately following the distribution.
<TABLE>
<CAPTION>
NAME AGE POSITION
- ---- --- --------
<S> <C> <C>
Henry B. Schacht................ 65 Chairman of the Board
Donald K. Peterson.............. 51 President, Chief Executive Officer and Director
Steve Aaronson.................. 48 Vice President of Communications
Dana Becker Dunn................ 49 Vice President of Transition Operations
Pamela F. Craven................ 46 Vice President, General Counsel and Secretary
Michael A. Dennis............... 41 Vice President of U.S. Services
Maryanne DiMarzo................ 49 Vice President of Human Resources
David P. Johnson................ 40 Vice President of Worldwide Sales and International Services
Karyn Mashima................... 46 Vice President of Global Strategy and Technology
Garry K. McGuire Sr. ........... 53 Chief Financial Officer
Ravi Sethi...................... 52 Vice President of Research
Jeffrey A. Harris............... 44 Director
Daniel C. Stanzione............. 55 Director
Franklin A. Thomas.............. 66 Director
</TABLE>
Henry B. Schacht will be our Chairman of the Board following the
distribution. Mr. Schacht has been a director for Lucent since February 1996,
and will resign this position upon taking office with us. He was Chairman of the
Lucent Board from February 1996 to February 1998 and Chief Executive Officer of
Lucent from February 1996 until October 1997. Mr. Schacht also served as Senior
Advisor to Lucent from
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February 1998 to February 1999. Mr. Schacht was a director of Cummins Engine
Company, Inc. from 1977 to April 2000, and was Chief Executive Officer of
Cummins from 1973 to 1994 and Chairman of the Board for Cummins from 1977 to
1995. Mr. Schacht was a member of the AT&T Corp. board of directors from 1981
until taking office with Lucent in 1996 prior to its spin-off from AT&T. Mr.
Schacht is a managing director and senior advisor of E.M. Warburg, Pincus and
Company, LLC., and a director of The Chase Manhattan Corporation and the Chase
Manhattan Bank, N.A., Alcoa, Inc., Johnson and Johnson Corporation, Knoll Inc.
and the New York Times Company.
Donald K. Peterson will be our President and Chief Executive Officer and a
director following the distribution. Mr. Peterson has been Executive Vice
President and Chief Executive Officer of Lucent's Enterprise Networks Group
since March 1, 2000. Previously, he was Executive Vice President and Chief
Financial Officer for Lucent since February 1996. He joined AT&T in 1995 and
moved to Lucent following its spin-off in 1996. While at AT&T, Mr. Peterson held
the positions of Vice President and Chief Financial Officer of the AT&T
Communications Services Group from September 1995 until January 1996. Prior to
that time, Mr. Peterson held various senior executive positions at Northern
Telecom Inc., where he worked from 1976 through September 1995. His
responsibilities included President of Nortel Communications Systems, Inc., from
January 1993 to September 1995, Vice President of Finance of Northern Telecom
Inc., from January 1991 to January 1993, and Group Vice President of Northern
Telecom Inc., from September 1987 to January 1991.
Steve Aaronson will be our Vice President of Communications following the
distribution. Mr. Aaronson has been Vice President of Communications for
Lucent's Enterprise Networks Group since April 2000. Previously, he was Vice
President of Service Provider Networks Public Relations for Lucent and also
served as Vice President of Global Corporate Public Relations. He joined AT&T in
1978 and moved to Lucent following its spin-off in 1996. While at AT&T, Mr.
Aaronson held various positions including Public Relations Vice President in the
Asia/Pacific region.
Dana Becker Dunn will be our Vice President of Transition Operations
following the distribution. Ms. Becker Dunn has been the Vice President of
Transition Operations for Lucent's Enterprise Networks Group since March 2000.
She joined AT&T in 1972 and moved to Lucent following its spin-off in 1996. She
has held various positions at Lucent, including Vice President, Growing and
Emerging Markets Division, Vice President, Marketing and Strategic Business
Planning, and Vice President, Multi-Media Markets Organization. At AT&T, Ms.
Becker Dunn held various positions including Vice President of Consumer
Communications Services' Strategic Planning and New Business Development
Organization and Chief Technical Officer of the Call Servicing Organization.
Pamela F. Craven is presently a director, and will be our Vice President,
General Counsel and Secretary following the distribution. Mrs. Craven has been
Vice President, General Counsel and Secretary of Lucent's Enterprise Networks
Group since March 2000. Mrs. Craven served as Vice President, Law and Secretary
for Lucent from February 1, 1999 to April 2000. She joined AT&T in 1992 and
moved to Lucent following its spin-off in 1996. Mrs. Craven held the position of
Vice President, Law and Assistant Secretary for Lucent until January 1999. At
AT&T, Mrs. Craven served as a General Attorney responsible for mergers and
acquisitions.
Michael A. Dennis will be our Vice President of U.S. Services following the
distribution. Mr. Dennis has been Vice President of U.S. Services for Lucent's
Enterprise Networks Group since April 2000. He joined AT&T in July 1981 and
moved to Lucent following its spin-off in 1996. Mr. Dennis has held various
positions at Lucent including Sales Vice President and Field Services Vice
President. At AT&T, Mr. Dennis held various positions including General Manager
of Global Business Communications Systems.
Maryanne DiMarzo will be our Vice President of Human Resources following
the distribution. Ms. DiMarzo has been Vice President of Human Resources for
Lucent's Enterprise Networks Group since April 2000. She joined Lucent in August
1996 and served as Director of Human Resources from August 1996 to March 1997,
when she was named Human Resources Vice President Corporate Centers, until
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April 2000. Prior to working at Lucent, Ms. DiMarzo served as the Director of
Human Resources for AlliedSignal, now known as Honeywell.
David P. Johnson will be our Vice President of Worldwide Sales and
International Services following the distribution. Mr. Johnson has been Vice
President of Worldwide Sales for Lucent's Enterprise Networks Group since April
2000. He joined AT&T in 1982 and moved to Lucent following its spin-off in 1996.
Mr. Johnson has held various positions at Lucent, including International
President of Enterprise Networks and Regional President of Asia/Pacific Region.
At AT&T, Mr. Johnson served as Regional President of the Asia/Pacific Region and
as Strategic Marketing Director.
Karyn Mashima will be our Vice President of Global Strategy and Technology
following the distribution. Ms. Mashima has been Vice President of Strategy and
Technology for Lucent's Enterprise Networks Group since March 2000. She joined
AT&T in 1994 and moved to Lucent following its spin-off in 1996. Ms. Mashima has
held various positions at Lucent, including Vice President of Advanced Multi-
Media Communications Systems, Vice President of the Enterprise Systems Group and
Vice President and Chief Technical Officer.
Garry K. McGuire Sr., will be our Chief Financial Officer following the
distribution. Mr. McGuire has been Chief Financial Officer for Lucent's
Enterprise Network Group since May 2000. Mr. McGuire was a consultant to
Kleiner, Perkins, Caufield and Byers/Broadband Office from August 1999 to
December 1999. He was President and Chief Executive Officer of Williams
Communications Solutions, LLC, from April 1997 to July 1999, and was President
of Nortel Communications Systems, LLC, from September 1995 until April 1997.
Prior to that, Mr. McGuire served as President of Bell Atlantic Meridian Systems
from January 1995 to September 1995.
Ravi Sethi will be our Vice President of Research following the
distribution. Dr. Sethi has been Vice President of Research for Lucent's
Enterprise Networks Group since May 2000. Dr. Sethi had been Senior Vice
President of Communications Science Research for Lucent since December 1999. He
joined AT&T in 1976 and worked in Bell Laboratories in areas such as data
networks, software systems and network management. In 1997, Dr. Sethi took on
the additional role of Chief Technical Officer of Lucent's Communications
Software Group.
Jeffrey A. Harris will be a director following the consummation of the
equity investment in us by Warburg, Pincus Equity Partners, L.P. and related
investment funds as their designee. Mr. Harris has been a Member and Managing
Director of E.M. Warburg, Pincus & Company, LLC and a general partner of
Warburg, Pincus & Co. since 1988, where he has been employed since 1983. Mr.
Harris is a director of ECsoft Group PLC, Industri-Matematik International
Corp., Knoll Inc. and Spinnaker Exploration Inc., as well as of several
privately held companies.
Daniel C. Stanzione will be a director following the distribution. Dr.
Stanzione has served as Special Advisor to the Chairman of Lucent since October
1999. He served as Chief Operating Officer of Lucent from November 1997 to
October 1999 and as the President of Bell Laboratories at Lucent from March 1996
to October 1999. Dr. Stanzione previously served as President of Network Systems
at Lucent from March 1996 to October 1997, as President of Network Systems at
AT&T from January 1996 to March 1996, and as President of AT&T Bell Laboratories
from January 1995 to March 1996. Dr. Stanzione is currently a director of Quest
Diagnostics, Inc.
Franklin A. Thomas will be a director following the distribution. Mr.
Thomas has been a director of Lucent since January 1996. Mr. Thomas also
currently serves as a consultant to the TFF Study Group, a position he has held
since 1996. Mr. Thomas was President of the Ford Foundation between 1979 and
1996. Mr. Thomas is currently a director of Alcoa Inc., Citigroup, N.A., Conoco
Inc., Cummins Engine Company Inc., Lucent and PepsiCo Inc.
ANNUAL MEETING
Our first annual meeting of shareowners after the distribution is expected
to be held in February 2002. The annual meeting will be held at our principal
office or at such other place or by electronic means as
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permitted by Delaware law and on such date as may be fixed from time to time by
resolution of our board of directors.
COMMITTEES OF THE BOARD OF DIRECTORS
We will be managed under the direction of our board of directors. Our board
of directors has established two committees: an audit and finance committee and
a corporate governance and compensation committee.
AUDIT AND FINANCE COMMITTEE
The audit and finance committee will be comprised solely of directors that
are not our employees or employees of any of our subsidiaries. This committee
will meet with our management periodically to consider the adequacy of our
internal controls and the objectivity of our financial reporting. This committee
will also meet with the independent auditors and with our own appropriate
financial personnel and internal auditors regarding these matters. Both the
independent auditors and the internal auditors will regularly meet privately
with this committee and have unrestricted access to this committee. The audit
and finance committee will recommend to our board of directors the appointment
of the independent auditors. The audit and finance committee will review our
financing plans and reports recommendations to our full board for approval and
to authorize action.
CORPORATE GOVERNANCE AND COMPENSATION COMMITTEE
Our corporate governance and compensation committee will be comprised
solely of directors that are not our employees or employees of any of our
subsidiaries. The functions of this committee include:
- recommending to our full board of directors nominees for election as
directors;
- making recommendations to our board of directors from time to time as to
matters of corporate governance;
- administering management incentive compensation plans;
- establishing the compensation of officers; and
- reviewing the compensation of directors.
This committee will consider qualified candidates for director suggested by
shareowners in written submissions to our corporate secretary.
DIRECTOR COMPENSATION
Following the distribution date, commencing on or about March 1, 2001, all
non-employee directors will receive an annual retainer of $100,000. In addition,
on or about October 2, 2000, each non-employee director will receive an
inaugural grant of an option to purchase the largest whole number of shares of
our common stock obtained by employing the following formula:
$50,000
Number of shares = 3 x -----------------------------------------------
fair market value of our common stock on October 2,
2000
The chair of each committee will receive an additional annual retainer of
$10,000. Directors will not receive separate meeting fees. Directors must elect
to receive between 50% and 100% of their retainers in our common stock or an
option to purchase our common stock or a combination of common stock and an
option. Any remaining amount may be paid in cash, but shall not exceed 50% of
the retainer. If a director
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elects to receive an option, the number of shares purchaseable under the option
will be determined pursuant to the following formula:
Dollar value of retainer taken as an option
Number of shares = 3 x -----------------------------------------------
fair market value of our common stock on date of
grant
The exercise price per share under the option will be the fair market value
of a share on the date of grant. Options will generally become exercisable on
the six-month anniversary of the date of grant and have a 10-year term.
Directors may defer all or a portion of their retainers under our Deferred
Compensation Plan.
We will assume the rights and obligations of Lucent under the Lucent
Technologies Inc. Directors' Individual Life Insurance Program with respect to
an existing policy covering Henry B. Schacht, wherein we will pay one-half of
the annual premium for Mr. Schacht's policy and he will pay one-half of the
annual premium. Otherwise, we will not offer a life insurance program for
directors.
We also provide non-employee directors with travel accident insurance when
traveling on our business.
EXECUTIVE COMPENSATION
The compensation of our executive officers will be approved by our
corporate governance and compensation committee of our board of directors. Our
corporate governance and compensation committee will consist entirely of
non-employee directors. Our corporate governance and compensation committee has
not yet established the compensation of our executive officers. We expect,
however, that the compensation of the executive and other officers will consist
principally of base salary, annual cash bonus and long-term equity-based
incentive compensation.
Salaries of the executive officers will be based, among other factors, on
our corporate governance and compensation committee's assessment of the
executive's responsibilities, experience and performance, compensation data of
other companies, and the competitive environment for attracting and retaining
executives.
We expect that cash bonuses for executive officers will be determined each
year at or following the end of our fiscal year, in accordance with targets
established at or near the beginning of the fiscal year. Factors which may be
considered in determining the amount of cash bonuses paid to officers will be,
among others, the executive officer's individual performance, including the
quality of strategic plans, organizational and management development, special
project leadership and similar indicators of individual performance, and our
financial performance, which may be measured by earnings per share, return on
equity and total return to the shareholders in the form of stock price
appreciation and dividends, if paid.
Our equity-based awards will consist principally of stock options and
restricted stock unit awards which will be granted from time to time under our
2000 Long Term Incentive Plan. We anticipate that our corporate governance and
compensation committee will base grants of stock-based awards on various
factors, including the number of shares of common stock outstanding, the number
of shares of common stock authorized under the 2000 Long Term Incentive Plan,
the executive officer's ability to contribute to our future services and the
other elements of the executive's compensation.
We are a recently formed subsidiary of Lucent, formed on February 16, 2000.
We were not in existence on September 30, 1999, the end of Lucent's last fiscal
year. Although certain of the individuals who will be serving as our executive
officers were performing services in connection with our businesses during the
last fiscal year, those individuals were employed by Lucent during such period,
were not dedicated exclusively to our businesses, and, in fact, devoted
substantial time and effort to other Lucent businesses or to the Lucent
organization in general. Our businesses had no formalized executive management
structure prior to our formation, and certain of the individuals who would have
constituted the most highly compensated individuals providing services to our
businesses as of the end of the last fiscal year are not, in fact, our executive
officers. Accordingly, no information on the compensation of executive
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officers for periods prior to September 30, 1999 is reported. Our Annual Report
on Form 10-K for fiscal year 2001 will contain information on compensation paid
to our executive officers in fiscal year 2001.
We describe below the current compensation arrangements for our chief
executive officer and our four other most highly compensated executive officers,
as measured by their base salaries, calculated on an annualized basis, and
target bonus amounts. Although we expect that the compensation of our executive
officers will consist principally of base salary, annual cash bonus and
long-term equity-based incentive compensation, the compensation arrangements
established by our corporate governance and compensation committee may differ
from the compensation arrangements described below. Although certain of the
individuals who will be serving as our executive officers were performing
services in connection with our businesses during the fiscal year ending
September 30, 2000, those individuals were employed by Lucent during such
period, were not dedicated exclusively to our businesses and, in fact, devoted
time and effort to other Lucent businesses or to the Lucent organization in
general. In connection with the current compensation arrangements for our
executive officers described below:
- Base salary represents the executive officer's current base salary on an
annualized basis.
- Target bonus percentage represents the targeted percentage of annual base
salary payable in the form of a bonus for the fiscal year ending
September 30, 2000. Such percentage may be adjusted upward or downward
based on a combination of the financial performance of Lucent and the
organizations in which each individual was employed for the fiscal year
ending September 30, 2000 and the indicators of individual performance
described above for the same period.
- Option grants were made under Lucent's stock option plans and restricted
stock awards were granted under Lucent restricted stock plans. A portion
of the option grants for all executive officers, other than Mr. McGuire,
were performance based awards for the fiscal year ended September 30,
1999. The remaining option grants and restricted stock awards were
granted in connection with such executive officer's acceptance of
employment with Avaya. Such option grants and awards may not be
indicative of future grants and awards to our executive officers.
Outstanding vested options for Lucent common stock will remain as Lucent
stock options, subject to adjustment based on the same ratio. All
unvested options and unvested restricted stock units will be converted to
options for Avaya common stock and Avaya restricted stock units as
described in "Relationship Between Lucent and Our Company After the
Distribution -- Employee Benefits Agreement and Plans -- Lucent Stock
Options and Restricted Stock Units."
The current compensation for our chief executive officer and our four other
most highly compensated officers is as follows:
- Donald K. Peterson, who will serve as our President and Chief Executive
Officer following the distribution, currently receives a base salary
equal to $800,000 on an annualized basis. Mr. Peterson's targeted bonus
percentage is 125%. Since September 30, 1999, Mr. Peterson has received
options to purchase up to 1,100,000 shares of common stock of Lucent and
150,000 Lucent restricted stock units.
- Garry K. McGuire Sr., who will serve as our Chief Financial Officer
following the distribution, currently receives a base salary equal to
$370,000 on an annualized basis. Mr. McGuire's targeted bonus percentage
is 85%. Since September 30, 1999, Mr. McGuire has received options to
purchase up to 300,000 shares of common stock of Lucent and 25,000 Lucent
restricted stock units.
- David P. Johnson, who will serve as our Vice President of Worldwide Sales
and International Services following the distribution, currently receives
a base salary equal to $350,000 on an annualized basis. Mr. Johnson's
targeted bonus percentage is 75%. Since September 30, 1999, Mr. Johnson
has received options to purchase up to 355,000 shares of common stock of
Lucent and 30,000 Lucent restricted stock units.
- Karyn Mashima, who will serve as our Vice President of Global Strategy
and Technology following the distribution, currently receives a base
salary equal to $350,000 on an annualized basis.
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Ms. Mashima's targeted bonus percentage is 75%. Since September 30, 1999, Ms.
Mashima has received options to purchase up to 325,000 shares of common stock of
Lucent and 30,000 Lucent restricted stock units.
- Michael A. Dennis, who will serve as our Vice President, U.S. Services
following the distribution, currently receives a base salary of $325,000
on an annualized basis. Mr. Dennis' targeted bonus percentage is 70%.
Since September 30, 1999, Mr. Dennis has received options to purchase up
to 349,000 shares of common stock of Lucent and 30,000 Lucent restricted
stock units.
PENSION PLANS
Prior to the distribution, most of our U.S. management employees, including
executive officers, are participants in Lucent's retirement income plan.
Effective at the time of the distribution, we will adopt a retirement income
plan that will replicate, in all material respects, the Lucent retirement income
plan, and that will be a non-contributory pension plan which covers management
employees, including the executive officers. We also will adopt a
non-contributory supplemental pension plan that will replicate in all material
respects Lucent's supplemental pension plans. The following is a summary
description of the expected terms of our retirement income plan and our
supplemental pension plan.
Participants will be given full credit under our retirement income plan for
service and compensation accrued under the Lucent retirement income plan. Under
our retirement income plan, annual pensions will be computed on an adjusted
career average pay basis. A participant's adjusted career average pay will be
equal to 1.4% of the sum of the individual's:
- average annual pay for the five years ending December 31, 1998, excluding
the annual bonus award paid in December 1997, times the number of years
of service prior to January 1, 1999;
- pay subsequent to December 31, 1998; and
- annual bonus award paid in December 1997.
The normal retirement age under our retirement income plan will be 65.
However, employees who are at least age 50 with at least 15 years of service can
retire with reduced benefits. If an employee's age is at least 50 and, when
added to service, is equal to or greater than 75, the employee may retire with
unreduced pension benefits. A reduction equal to 3% is made for each year age
plus service is less than 75. Pension amounts under our retirement income plan
will not be subject to reductions for social security benefits or other offset
amounts.
Average annual pay includes base salary and annual bonus awards. However,
federal laws place limitations on compensation amounts that may be included
under this plan. In 2000, up to $170,000 in eligible base salary and annual
bonus could be included in the calculation under this plan.
Pension amounts based on our retirement income plan formula which exceed
the applicable limitations will be paid under our supplemental pension plan.
Compensation and benefit amounts which exceed the applicable federal limitations
will be taken into account, and pension amount related to annual bonus awards
payable to executive officers will be paid, under our supplemental pension plan.
This plan will be a non-contributory plan, and will use the same adjusted career
average pay formula and eligibility rules as our retirement income plan to
provide supplemental pension benefits to our management employees, including our
executive officers.
Our supplemental pension plan will provide executive officers and other of
our eligible employees with minimum pensions. Eligible retired executive
officers and surviving spouses may receive an annual minimum pension equal to
15% of the sum of final base salary plus annual bonus awards. This minimum
pension will be offset by amounts received by plan participants as pensions
under all our pension plans.
Pursuant to the terms of an arrangement provided by AT&T and assumed by
Lucent and, at the time of the distribution, by us, Mr. Peterson will also be
entitled to a supplemental pension benefit under our supplemental pension plan.
This benefit will be available to certain management employees who were hired
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generally at or over age 35 and who terminate with at least five years service
at such level. This plan will provide additional pension credits equal to the
difference between age 35 and the maximum possible years of service attainable
at age 65, but not to exceed actual net credited service, at one-half the rate
in our retirement income plan.
It is anticipated that some of our non-qualified executive benefit plans
will be supported by a benefits protection trust, the assets of which will be
subject to the claims of our creditors. In the event of a change in control or a
potential change in control of our company, certain additional funds might be
required to be contributed to such trust to support benefits under such plans.
2000 COMPANY LONG TERM INCENTIVE PLAN
We intend to adopt, with the approval of Lucent in its capacity as our sole
stockholder, the 2000 Long Term Incentive Plan, for the benefit of our executive
officers and some of our other employees. The plan is distinct from any other
broad-based plan that we may adopt for the grant of stock options to our
employees more generally. After the distribution, the 2000 Long Term Incentive
Plan will be administered by our corporate governance and compensation
committee. In order to ensure that compensation paid pursuant to the 2000 Long
Term Incentive Plan can qualify as "performance-based compensation" not subject
to the limitation on deductibility of executive compensation in excess of $1
million, we intend to seek shareowner approval of the 2000 Long Term Incentive
Plan at our 2001 annual meeting of shareowners.
The following description of the 2000 Long Term Incentive Plan is qualified
by reference to the full text thereof, a copy of which will be filed as an
exhibit to the registration statement.
AWARDS
The 2000 Long Term Incentive Plan for officers and executives provides for
the grant of incentive stock options that qualify under Section 422 of the Code
and non-statutory stock options, stock appreciation rights, restricted stock
awards, performance awards, and other stock unit awards, as such terms are
defined in the 2000 Long Term Incentive Plan. No determination has yet been made
as to the number of our employees who will be eligible to participate in such
2000 Long Term Incentive Plan. However, as described under "Relationship Between
Lucent and Our Company After the Distribution -- Employee Benefits Agreement and
Plans," our approximately 85 officers and executives who hold unvested Lucent
stock awards are expected to receive in substitution therefor, following
consummation of the distribution, awards under the 2000 Long Term Incentive
Plan.
SHARES AVAILABLE
The total number of shares of our common stock available for awards granted
under the 2000 Long Term Incentive Plan will be 25 million shares. During the
five-year term of the long term plan, no more than 2 million shares of our
common stock will be available for the grant of incentive stock options. No
individual may be granted awards with respect to more than 5 million shares of
our common stock over the five-year term of the long term plan.
Any shares issued by us through the assumption or substitution of
outstanding grants from Lucent or an acquired company will not reduce the number
of shares of our common stock available for grants under the 2000 Long Term
Incentive Plan. Any shares of our common stock issued under the 2000 Long Term
Incentive Plan, including in connection with substitute awards may consist, in
whole or in part, of authorized and unissued shares of our common stock or
treasury shares of our common stock or shares of our common stock purchased in
the open market. If any shares of our common stock subject to any award are
forfeited or such award otherwise terminates without the issuance of such shares
of our common stock or of other consideration in lieu of such shares, the shares
of our common stock subject to such award, to the extent of any such forfeiture
or termination, will again be available for grant under the 2000 Long Term
Incentive Plan. In the event of any merger, reorganization, consolidation,
recapitalization, stock dividend, or other change in corporate structure
affecting the shares of our common stock, such adjustment
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will be made in the aggregate number and class of shares of our common stock
which may be delivered under the 2000 Long Term Incentive Plan, in the
individual limit described above, in the number, class and option price of
shares of our common stock subject to outstanding options thereunder, and in the
value of, or number or class of shares of our common stock subject to, awards as
may be determined to be appropriate by the compensation committee, in its sole
discretion; provided that the number of shares of our common stock subject to
any award will always be a whole number.
PLAN ADMINISTRATION
The members of our corporate governance and compensation committee, will
administer the 2000 Long Term Incentive Plan.
OPTIONS; STOCK APPRECIATION RIGHTS
Options to purchase shares of our common stock may be granted under the
2000 Long Term Incentive Plan, either alone or in addition to other awards.
Except in the case of substitute awards, the purchase price per share of our
common stock purchasable under an option will be determined by our compensation
committee, in its sole discretion; provided that such purchase price will not be
less than the fair market value, as defined in the 2000 Long Term Incentive
Plan, of a share of our common stock on the date of the grant of the option. The
term of each option will be fixed by our corporate governance and compensation
committee in its sole discretion; provided that no incentive stock option will
be exercisable after the expiration of 10 years from the date the option is
granted. Options will be exercisable at such time or times as determined by our
corporate governance and compensation committee at or subsequent to grant.
Subject to the other provisions of the 2000 Long Term Incentive Plan and any
applicable award agreement, any option may be exercised by the participant in
such form or forms, including, without limitation, payment by delivery of cash,
shares of our common stock or other consideration including, where permitted by
law and our corporate governance and compensation committee, awards having a
fair market value on the exercise date equal to the total option price, or by
any combination of cash, shares of our common stock and other consideration as
our corporate governance and compensation committee may specify in the
applicable award agreement.
As of the time of the grant, the aggregate fair market value of the shares
of our common stock with respect to which incentive stock options held by any
participant become exercisable for the first time by such participant during any
calendar year under the 2000 Long Term Incentive Plan, including under any of
our other benefit plans or of any of our parent or subsidiary corporations, will
not exceed $100,000 or, if different, the maximum limitation in effect at the
time of grant under Section 422 of the Internal Revenue Code, or any successor
provision, and any regulations promulgated thereunder. In its sole discretion,
our corporate governance and compensation committee may provide, at the time of
grant, that the shares of common stock to be issued upon an option's exercise
will be in the form of restricted stock or other similar securities, or may
reserve the right so to provide after the time of grant. Upon termination of
employment, other than for death, disability or retirement, a participant
forfeits all unexercisable options and may exercise all exercisable options
within 90 days following such termination, except that, if such termination is
the result of a specified action by us, the participant may exercise a pro rata
portion of all options within such 90 day period.
Stock appreciation rights may be granted to participants either alone or in
addition to other awards and may, but need not, relate to a specific option. Any
stock appreciation rights related to an option other than an incentive stock
option may be granted at the same time such option is granted or at any time
thereafter before exercise or expiration of such option. Any stock appreciation
right related to an incentive stock option must be granted at the same time such
option is granted. In the case of any stock appreciation right related to any
option, the stock appreciation right or applicable portion thereof will
terminate and no longer be exercisable upon the termination or exercise of the
related option, except that any stock appreciation right granted with respect to
less than the full number of shares of our common stock covered by a related
option will not be reduced except to the extent that the number of shares of our
common stock affected by the exercise or termination of the related option
exceeds the number of shares
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of our common stock not covered by the stock appreciation right. Any option
related to any stock appreciation right will no longer be exercisable to the
extent the related stock appreciation right has been exercised. Our compensation
committee may impose such conditions or restrictions on the exercise of any
stock appreciation right as it may deem appropriate.
PERFORMANCE SHARES OF COMMON STOCK
Performance-based equity awards may be issued to participants, for no cash
consideration or for such minimum consideration as may be required by applicable
law, either alone or in addition to other awards granted under the 2000 Long
Term Incentive Plan. The performance criteria to be achieved during any
performance period under the 2000 Long Term Incentive Plan and the length of the
performance period will be determined by our corporate governance and
compensation committee upon the grant of each performance award. Performance
awards will generally be distributed only after the end of the relevant
performance period. Performance awards may be paid in cash, shares of our common
stock, other property or any combination thereof, in the sole discretion of our
corporate governance and compensation committee at the time of payment.
Performance awards may be paid in a lump sum or in installments following the
close of the performance period.
OTHER STOCK UNIT AWARDS
Other awards of shares of common stock and other awards that are valued in
whole or in part by reference to, or are otherwise based on, shares of our
common stock or other property may be granted to participants, either alone or
in addition to other awards. Other stock unit awards may be paid in shares of
our common stock, other securities, cash or any other form of property as the
corporate governance and compensation committee may determine. Our corporate
governance and compensation committee may impose these conditions or
restrictions on the exercise of any other stock award as the committee may deem
appropriate.
Shares of our common stock, including securities convertible into shares of
our common stock, subject to other stock unit awards may be issued for no cash
consideration or for such minimum consideration as may be required by applicable
law; shares of our common stock, including securities convertible into such
shares of our common stock purchased pursuant to such a purchase right will be
purchased for such consideration as our corporate governance and compensation
committee may, in its sole discretion, determine, which except in the case of
substitute awards will not be less than the fair market value of such shares of
our common stock or other securities as of the date such purchase right is
awarded.
RESTRICTED SHARES OF COMMON STOCK
Restricted stock awards may be issued to participants, for no cash
consideration or for such minimum consideration as may be required by applicable
law, either alone or in addition to other awards granted under the 2000 Long
Term Incentive Plan. Except as otherwise determined by our compensation
committee at the time of grant, upon termination of employment for any reason
during the restriction period, all restricted stock awards still subject to
restriction will be forfeited by the participant and reacquired by us.
CHANGE IN CONTROL
The 2000 Long Term Incentive Plan will generally provide that, unless our
corporate governance and compensation committee determines otherwise at the time
of grant with respect to a particular award, in the event of a change in
control,
- any options and stock appreciation rights outstanding as of the date the
change in control is determined to have occurred will become fully
exercisable and vested;
- the restrictions and deferral limitations applicable to any restricted
stock awards will lapse;
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- all performance awards will be considered to be earned and payable in
full, and any deferral or other restriction will lapse and such
performance awards will be immediately settled or distributed; and
- the restrictions and deferral limitations and other conditions applicable
to any other stock unit awards or any other awards will lapse, and such
other stock unit awards or other awards will become free of all
restrictions, limitations or conditions and become fully vested and
transferable.
The 2000 Long Term Incentive Plan defines change in control to mean,
generally:
- an acquisition by any individual, entity or group of beneficial ownership
of 20% or more of either the then outstanding shares of our common stock
or the combined voting power of our then outstanding voting securities
entitled to vote generally in the election of directors;
- a change in the composition of a majority of our board of directors which
is not supported by our current board of directors;
- the approval by the shareholders of a merger, reorganization or
consolidation or sale or other disposition of all or substantially all of
our assets of or, if consummation of such corporate transaction is
subject, at the time of such approval by shareholders, to the consent of
any government or governmental agency, the obtaining of such consent
either explicitly or implicitly by consummation; or
- the approval of the shareholders of our complete liquidation or
dissolution.
OTHER PROVISIONS
Our board of directors may amend, alter or discontinue the 2000 Long Term
Incentive Plan, but no amendment, alteration, or discontinuation may be made
that would impair rights under an award theretofore granted without the
participant's consent.
Our corporate governance and compensation committee will be authorized to
make adjustments in performance award criteria or in the terms and conditions of
other awards in recognition of limitations pursuant to section 162(m) of the
Internal Revenue Code, unusual or nonrecurring events affecting us or our
financial statements or changes in applicable laws, regulations or accounting
principles.
Subject to the provisions of the 2000 Long Term Incentive Plan and any
award agreement, the recipient of an award, including, without limitation, any
deferred award may, if so determined by our corporate governance and
compensation committee, be entitled to receive, currently or on a deferred
basis, interest or dividends, or interest or dividend equivalents, with respect
to the number of shares of our common stock covered by the award, and our
corporate governance and compensation committee may provide that such amounts,
if any, will be deemed to have been reinvested in additional shares of our
common stock or otherwise reinvested.
EMPLOYMENT AGREEMENTS
The employment agreement entered into by Mr. Peterson and AT&T,
subsequently assumed by Lucent, in 1995 required Lucent to establish a special
deferred compensation account in the amount of $190,000. In connection with the
distribution, we will assume Lucent's obligations under Mr. Peterson's
employment agreement. Interest is compounded as of the end of each calendar
quarter for as long as any sums remain in the account, and the quarterly rate of
interest applied at the end of any calendar quarter is one-quarter of the
average 30-year Treasury note rate for the previous quarter. The amounts
credited to the account vested in October 1999, and will be paid out following
Mr. Peterson's termination of employment with us.
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OWNERSHIP OF OUR COMMON STOCK
All of the outstanding shares of our common stock are and will be prior to
the distribution, held beneficially and of record by Lucent. The following
tables set forth information concerning shares of our common stock projected to
be beneficially owned immediately after the distribution date by:
- each person or entity known by us to own more than five percent of the
outstanding shares of our common stock;
- each person who we currently know will be our director at the time of the
distribution or upon consummation of the equity investment described
below; and
- all persons who we currently know will be our directors and executive
officers at the time of the distribution or upon consummation of the
equity investment described below as a group.
Upon completion of the distribution, there is not expected to be any person
that will own more than five percent of our outstanding common stock. However,
as described more fully under "Related Transactions and Equity Investment," we
have agreed to sell to Warburg, Pincus Equity Partners, L.P. and related
investment funds an aggregate of 4,000,000 shares of our Series B convertible
participating preferred stock and warrants to purchase shares of our common
stock. Based on the formula set forth under "Description of Capital Stock -- Our
Preferred Stock -- Series B Convertible Participating Preferred
Stock -- Conversion," these shares of Series B convertible participating
preferred stock are expected to be initially convertible into approximately 5.0%
of our fully diluted common stock. The warrants are expected to be exercisable
for 3.6% of a total number of shares of common stock calculated pursuant to the
formula set forth under "Description of Capital Stock -- Warrants". Subject to
the satisfaction of a number of conditions, these shares of Series B convertible
participating preferred stock and warrants will be issued, and this equity
investment will be consummated, immediately after consummation of the
distribution. By virtue of their ownership of these shares of Series B
convertible participating preferred stock and these warrants, as of the date of
this information statement, Warburg, Pincus Equity Partners, L.P. and the
related investment funds may be deemed, individually or collectively, to
beneficially own more than 5.0% of our common stock.
The share amounts in the table below reflect the distribution ratio of one
share of our common stock for every 12 shares of Lucent common stock currently
held by the listed individuals. The percentage ownership of our common stock of
each person named below immediately following the distribution will be
approximately the same as the percentage ownership of such person or entity
immediately prior to the distribution and is calculated based on the number of
shares of Lucent common stock outstanding as of June 30, 2000. No individual
director or officer identified above beneficially owns 1% or more of our
outstanding common stock, nor do our directors and executive officers as a
group. Unless otherwise indicated in the footnotes below, each person or entity
has sole voting and investment power with respect to the shares of common stock
set forth opposite such person's or entity's name. Beneficial ownership is
determined in accordance with the rules of the Commission and generally includes
voting or investment power with respect to securities. Shares of common stock
and options, warrants and convertible securities that are currently exercisable
or convertible within 60 days of September 1, 2000 into shares of our common
stock are deemed to be outstanding and to be beneficially owned by the person
holding the options or warrants for the purpose of computing the percentage
ownership of the person, but are not treated as outstanding for the purpose of
computing the percentage ownership of any other person.
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DIRECTORS AND EXECUTIVE OFFICERS AND FIVE PERCENT HOLDERS
<TABLE>
<CAPTION>
UNVESTED LUCENT STOCK
OPTIONS AND SHARES PERCENT OF SHARES
OUR COMMON STOCK HELD IN DEFERRED SHARE BENEFICIALLY OWNED
NAME BENEFICIALLY OWNED(1) ACCOUNTS(2) AFTER DISTRIBUTION
- ---- --------------------- ---------------------- ------------------
<S> <C> <C> <C>
Warburg, Pincus Equity Partners, L.P. 466
Lexington Ave., 10th Fl. New York, NY
10017-3147............................. 29,106,746(3) -- 9.5%
Henry B. Schacht(4)...................... 309 12,664(5) *
Donald K. Peterson....................... -- 5,904(6) *
Jeffrey A. Harris(7)..................... -- -- *
Daniel C. Stanzione...................... 2,181 -- *
Franklin A. Thomas....................... -- -- *
Directors and executive officers as a
group, including those named above (14
persons)............................... 4,888 58,450(8) *
</TABLE>
- ---------------
* Indicates less than 1%.
(1) The amounts included in this column represent the shares of our common stock
which will be beneficially owned by the listed individuals based on the
distribution ratio of one share of our common stock to be received for every
12 shares of Lucent common stock held by such individual.
(2) Represents stock options, shares held in deferred share accounts and shares
from Lucent's employee stock purchase plan that will be converted in amounts
and on terms as described in "Relationship Between Lucent and Our Company
After the Distribution -- Employee Benefits Agreement and Plans -- Lucent
Stock Options and Restricted Stock Units."
(3) Estimated based upon the conversion of the Series B convertible
participating preferred stock and the exercise of the warrants to be
purchased by Warburg, Pincus Equity Partners, L.P. and related investment
funds as of the distribution and using assumptions set forth in Note (B) to
the Unaudited Pro Forma Condensed Financial Statements. The actual amount of
shares of our common stock will not be known until 90 days after the
distribution. The formula for determining the actual number of shares of our
common stock into which the Series B convertible participating preferred
stock may be converted is set forth under "Description of Capital
Stock -- Our Preferred Stock -- Series B Convertible Participating Preferred
Stock -- Conversion" and the formula for determining the actual number of
shares of our common stock issuable on exercise of the warrants is set forth
under "Description of Capital Stock -- Warrants."
(4) Mr. Schacht is a managing director and a senior advisor of E.M. Warburg,
Pincus and Company, LLC, an affiliate of Warburg, Pincus Equity Partners,
L.P. The table excludes the shares of our common stock in which Mr. Schacht
has an indirect interest through Warburg, Pincus Equity Partners, L.P.'s
beneficial ownership of our common stock. Mr. Schacht disclaims beneficial
ownership of such shares, except to the extent of his pecuniary interest
therein.
(5) Represents 12,664 shares held in a deferred share account.
(6) Represents 5,904 shares held in a deferred share account.
(7) Mr. Harris will be Warburg, Pincus Equity Partners, L.P.'s initial designee
to our board of directors. Mr. Harris is the partner of Warburg, Pincus &
Co., the general partner of Warburg, Pincus Equity Partners, L.P. The table
excludes the shares of our common stock in which Mr. Harris has an indirect
interest through Warburg, Pincus Equity Partners, L.P.'s beneficial
ownership of our common stock. Mr. Harris disclaims beneficial ownership of
such shares, except to the extent of his pecuniary interest therein.
(8) Includes 50,688 shares held in deferred share accounts and 7,762 shares from
Lucent's employee stock purchase plan.
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DESCRIPTION OF CAPITAL STOCK
The following information reflects our certificate of incorporation and
by-laws as these documents will be in effect at the time of the distribution.
OUR AUTHORIZED CAPITAL STOCK
Immediately after the distribution, our authorized capital stock will
consist of 200,000,000 shares of preferred stock, par value $1.00 per share, and
1,500,000,000 shares of common stock, par value $0.01 per share. Immediately
following the distribution, approximately 278,292,661 shares of our common stock
will be outstanding based upon the shares of Lucent common stock outstanding on
June 30, 2000 and assuming no exercise of outstanding options. Thereafter, upon
consummation of the equity investment of Warburg, Pincus Equity Partners, L.P.
and related investment funds, these investors will own 4,000,000 shares of our
Series B convertible participating preferred stock and warrants to purchase
common stock. For a more detailed description of this equity investment, please
see "Management's Discussion and Analysis of Financial Condition and Results of
Operations -- Liquidity and Capital Resources" and "Related Transactions and
Equity Investment."
OUR COMMON STOCK
The holders of our common stock will be entitled to one vote for each share
on all matters voted on by shareowners, including elections of directors, and,
except as otherwise required by law or provided in any resolution adopted by our
board with respect to any series of preferred stock, the holders of such shares
will possess all voting power. Our certificate of incorporation does not provide
for cumulative voting in the election of directors. Subject to any preferential
rights of any outstanding series of our preferred stock created by our board
from time to time, the holders of common stock will be entitled to such
dividends as may be declared from time to time by our board from funds available
therefor, and upon liquidation will be entitled to receive pro rata all assets
available for distribution to such holders. For a more complete discussion of
our dividend policy, please see "Dividend Policy."
OUR PREFERRED STOCK
Our certificate of incorporation authorizes our board of directors to
establish one or more series of our preferred stock and to determine, with
respect to any series of our preferred stock, the terms and rights of such
series, including:
- the designation of the series,
- the number of shares of the series, which number our board may thereafter
except where otherwise provided in the applicable certificate of
designation, increase or decrease, but not below the number of shares
thereof then outstanding,
- whether dividends, if any, will be cumulative or noncumulative, and, in
the case of shares of any series having cumulative dividend rights, the
date or dates or method of determining the date or dates from which
dividends on the shares of such series shall be cumulative,
- the rate of any dividends or method of determining such dividends payable
to the holders of the shares of such series, any conditions upon which
such dividends will be paid and the date or dates or the method for
determining the date or dates upon which such dividends will be payable,
- the redemption rights and price or prices, if any, for shares of the
series,
- the terms and amounts of any sinking fund provided for the purchase or
redemption of shares of the series,
- the amounts payable on and the preferences, if any, of shares of the
series in the event of any voluntary or involuntary liquidation,
dissolution or winding up of our affairs,
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- whether the shares of the series will be convertible or exchangeable into
shares of any other class or series, or any other security, of us or any
other corporation, and, if so, the specification of such other class or
series or such other security, the conversion or exchange price or prices
or rate or rates, any adjustments thereof, the date or dates as of which
such shares will be convertible or exchangeable and all other terms and
conditions upon which such conversion or exchange may be made,
- restrictions on the issuance of shares of the same series or of any other
class or series,
- the voting rights, if any, of the holders of the shares of the series,
and
- any other relative rights, preferences and limitations of such series.
We believe that the ability of our board of directors to issue one or more
series of our preferred stock will provide us with flexibility in structuring
possible future financings and acquisitions, and in meeting other corporate
needs which might arise. The authorized shares of our preferred stock, as well
as shares of our common stock, will be available for issuance without further
action by our shareowners, unless such action is required by applicable law or
the rules of any stock exchange or automated quotation system on which our
securities may be listed or traded. The New York Stock Exchange currently
requires shareowner approval as a prerequisite to listing shares in several
instances, including where the present or potential issuance of shares could
result in an increase in the number of shares of common stock, or in the amount
of voting securities, outstanding of at least 20%. If the approval of our
shareowners is not required for the issuance of shares of our preferred stock or
our common stock, our board may determine not to seek shareowner approval.
Although our board of directors has no intention at the present time of
doing so, it could issue a series of our preferred stock that could, depending
on the terms of such series, impede the completion of a merger, tender offer or
other takeover attempt. Our board of directors will make any determination to
issue such shares based on its judgment as to the best interests of us and our
shareowners. Our board of directors, in so acting, could issue our preferred
stock having terms that could discourage an acquisition attempt through which an
acquiror may be able to change the composition of our board of directors,
including a tender offer or other transaction that some, or a majority, of our
shareowners might believe to be in their best interests or in which shareowners
might receive a premium for their stock over the then current market price of
such stock.
SERIES A JUNIOR PARTICIPATING PREFERRED STOCK
As of the distribution date, 7.5 million shares of our Series A junior
participating preferred stock will be reserved for issuance upon exercise of
rights under our rights agreement. For a more detailed discussion of our rights
agreement and our Series A junior participating preferred stock, please see
"-- Rights Agreement."
SERIES B CONVERTIBLE PARTICIPATING PREFERRED STOCK
After the distribution, we expect that 4,000,000 shares of our Series B
convertible participating preferred stock will be issued to Warburg, Pincus
Equity Partners, L.P. and several related investment funds. The terms of the
Series B convertible participating preferred stock are set forth in a
certificate of designation and are described below.
RANK. With respect to payments of dividends, redemption payments and
rights upon our liquidation, dissolution or the winding up of our affairs, our
Series B convertible participating preferred stock will rank senior to our
common stock. In the future, we may authorize and issue preferred stock which
ranks senior to, in parity with or junior to the Series B convertible
participating preferred stock. We may only issue parity securities in excess of
$400 million or senior securities with the consent of the holders of a majority
of the outstanding shares of Series B convertible participating preferred stock.
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DIVIDENDS. The holders of our Series B convertible participating preferred
shares are entitled to receive dividends when declared by our board of
directors, out of funds legally available for the payment of dividends as
described below.
- For so long as the Series B convertible participating preferred stock is
outstanding, holders of Series B convertible participating preferred
stock will receive dividends equally and ratably with the holders of our
common stock. Equal and ratable dividends are calculated on an as
converted basis, meaning we assume for the purposes of the calculation
that the shares of Series B convertible participating preferred stock
were converted into shares of our common stock on the record date for the
relevant common stock dividend.
- During the fourth and fifth years after issuance, we will have the option
to pay a quarterly cash dividend on each share of Series B convertible
participating preferred stock at an annual rate of 3.25%, compounded
quarterly, of the liquidation value of a share of Series B convertible
participating preferred stock.
- During the sixth through tenth years after issuance, we will have the
option to pay a quarterly cash dividend on each share of Series B
convertible participating preferred stock at an annual rate of 6.5%,
compounded quarterly, of the liquidation preference of the Series B
convertible participating preferred stock.
- After the tenth anniversary of issuance, we will be required to pay a
quarterly cash dividend on each share of Series B convertible
participating preferred stock at an annual rate of 12%, compounded
quarterly, of the liquidation preference of the Series B convertible
participating preferred stock.
LIQUIDATION PREFERENCE. The initial liquidation preference for each share
of Series B convertible participating preferred stock will be $100. From the
date on which these shares are issued, until the tenth anniversary of that date,
the liquidation preference for each share will increase at an annual rate of
6.5%, compounded quarterly. The increase in the liquidation preference for any
quarter will be reduced by the amount of any cash dividends we pay on the
Series B convertible participating preferred stock, other than dividends paid on
our common stock in which the Series B convertible participating preferred stock
participate.
Following a change-in-control of us during the first five years after the
investment, other than a change-in-control transaction that is a business
combination involving solely the issuance of common stock, some or all of the
liquidation value of the Series B convertible participating preferred stock that
would otherwise accrete through the fifth anniversary of the issue date, will be
accelerated, subject to our ability to pay a portion of the accelerated
accretion in cash in some instances.
A change-in-control includes any of the following:
- the acquisition of 50% or more of either our common stock or the combined
voting power of our then outstanding securities entitled to vote in an
election of our directors;
- changes in the composition of a majority of our board of directors which
are not supported by our current board of directors;
- a reorganization, consolidation, or merger or the sale or other
disposition of all or substantially all of our assets unless, following
the transaction, the holders of our common stock and voting securities
prior to the transaction own more than 50% of our common stock and voting
securities resulting from the transaction, such holders maintain their
proportionate ownership in us and no person or entity owns 50% or more of
our then-outstanding shares of our common stock or voting securities
resulting from this transaction; and
- approval by our shareowners of a complete liquidation or dissolution of
our company.
REDEMPTION. At any time after the fifth anniversary of the issuance, we
can force the holders of shares of Series B convertible participating preferred
stock to convert their shares into common stock. If
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we give a notice of mandatory conversion, the holders of our shares of Series B
convertible participating preferred stock have the right to require us to redeem
their shares for cash, in whole or in part, at their option, at a cash
redemption price equal to:
- the liquidation value in effect on the redemption date; plus
- except to the extent that a dividend has been declared for the applicable
quarter, an amount equal to the unrecognized accretion and dividends
accrued and unpaid on the Series B convertible participating preferred
stock up to but not including the redemption date.
For 60 days following the occurrence of a change-in-control transaction,
the holders of our shares of Series B convertible participating preferred stock
have the right to require us to redeem their shares for cash, in whole or in
part, at their option, at a cash redemption price equal to:
- 101% of the liquidation value, as increased pursuant to the provisions
described under "Liquidation Preference", in effect on the redemption
date; plus
- except to the extent that a dividend has been declared for the applicable
quarter, an amount equal to the unrecognized accretion and dividends
accrued and unpaid on the Series B convertible participating preferred
stock up to but not including the redemption date.
CONVERSION. Holders of shares of Series B convertible participating
preferred stock may convert their shares into shares of our common stock at any
time. The number of shares of our common stock into which each share of Series B
convertible participating preferred stock will be convertible is determined by
dividing the amount of the liquidation preference at the time of the conversion
of that share by the conversion price determined as described below.
From and after the fifth anniversary of the date of issuance of the
Series B convertible participating preferred stock, we will have the right to
require the holders of Series B convertible participating preferred stock, at
our option, to convert any or all of their shares, into shares of our common
stock at the conversion price determined as described below.
The initial conversion price is calculated as of 90 days after the issuance
by dividing $7.6 billion by the number of fully diluted shares outstanding,
calculated on a modified treasury stock basis. The number of fully diluted
shares calculated on a modified treasury stock basis is equal to the sum of:
- the number of shares of our common stock outstanding immediately after
the distribution; and
- all shares of common stock issuable upon exercise or conversion of all
options and convertible securities issued and outstanding immediately
following the distribution that are held by our employees, officers and
directors and with respect to which the exercise price is less than or
equal to the average trading price of our common stock over the last
20 trading days during the period ending on the 90th day after the issue
date; and
- all shares and restricted shares of common stock and all shares of common
stock issuable upon exercise or conversion of all options and convertible
securities issued, sold or granted during the 90 days following the
distribution to our employees, officers and directors and with respect to
which the exercise price, or in the case of shares or restricted shares,
the purchase price, is less than or equal to the average trading price of
our common stock over the last 20 trading days during the period ending
on the 90th day after the issue date.
The number of shares of our common stock in respect of the options and
other securities described in the previous two bullet points is adjusted to
reflect the assumed application by us of the aggregate exercise, conversion
or purchase price of all such options and securities to repurchase shares
of our common stock at a price equal to the average trading price of our
common stock over the last 20 trading days during the period ending on the
90th day after the issue date.
The conversion price is subject to customary anti-dilution adjustments.
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VOTING RIGHTS. The holders of our shares of Series B convertible
participating preferred stock:
- will be entitled to vote with the holders of our common stock on all
matters submitted for a vote of the holders of common stock, voting
together with the holders of our common stock as one class; and
- will be entitled to a number of votes equal to the number of votes to
which the shares of common stock issuable upon conversion of shares of
Series B convertible participating preferred stock would have been
entitled if such shares of common stock had been outstanding at the time
of the applicable vote and related record date.
Generally the holders of our shares of Series B convertible participating
preferred stock will be entitled to vote as a single class with respect to:
- the amendment, alteration or repeal of any provision of our certificate
of incorporation which adversely affects the preferences, rights or
powers of the Series B convertible participating preferred stock; and
- the authorization of any securities which would rank senior to the
Series B convertible participating preferred stock or parity securities
in excess of $400 million.
WARRANTS
As part of their investment, the investors will acquire warrants to
purchase our common stock. The warrants have an exercise price equal to 130% of
the initial conversion price for the Series B convertible participating
preferred stock. The warrants are exercisable for 3.6% of an agreed total number
of shares of our common stock. The agreed total number of shares of our common
stock will be determined as of the 90th day after the issuance of the warrants
and is the sum, adjusted to reflect the expected dilution resulting from the
issuance of shares of our common stock upon exercise of the warrants, of:
- our outstanding common stock on the day the warrants are issued; and
- the lesser of:
- 17.65% of our outstanding common stock on the day the warrants are
issued; and
- the sum of:
- all shares of common stock issuable upon exercise or conversion of
all options and convertible securities issued or granted to our
directors, officers or employees as of the day the warrants are
issued which at such date had exercise or conversion prices at or
below the exercise price of the warrants; and
- all shares of restricted common stock and shares of common stock
issuable upon exercise or conversion of all options and convertible
securities issued, granted or sold to our directors, officers or
employees during the 90 days following the issuance of the warrants
with exercise or purchase prices at or below the exercise price of
the warrants.
Of these warrants, warrants exercisable for 2.0% of such total number of
shares of common stock will have a four-year term and warrants exercisable for
1.6% of such total number of shares of common stock will have a five-year term.
During a period commencing on a date that we expect will be no later than June
30, 2001, until the second anniversary of their issuance, if the market price of
our common stock exceeds 200%, in the case of the four-year warrants, and 225%,
in the case of the five-year warrants, of the exercise price of the warrants for
20 consecutive trading days, we can force the exercise of up to 50% of the
four-year warrants and the five-year warrants, respectively. The warrants are
exercisable immediately upon issuance and will have customary antidilution
rights.
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ANTI-TAKEOVER EFFECTS OF PROVISIONS OF THE CERTIFICATE OF INCORPORATION AND
BY-LAWS
BOARD OF DIRECTORS
Our certificate of incorporation provides that, except as otherwise fixed
by or pursuant to the provisions of a certificate of designations setting forth
the rights of the holders of any class or series of our preferred stock, the
number of our directors will be fixed from time to time exclusively pursuant to
a resolution adopted by a majority of the total number of directors which we
would have if there were no vacancies, but shall not be less than three. Our
directors, other than those who may be elected by the holders of our preferred
stock, will be classified, with respect to the time for which they severally
hold office, into three classes, as nearly equal in number as possible, one
class to be originally elected for a term expiring at the annual meeting of
shareowners to be held in 2002, another class to be originally elected for a
term expiring at the annual meeting of shareowners to be held in 2003 and
another class to be originally elected for a term expiring at the annual meeting
of shareowners to be held in 2004, with each director to hold office until his
or her successor is duly elected and qualified. Commencing with the 2002 annual
meeting of shareowners, directors elected to succeed directors whose terms then
expire will be elected for a term of office to expire at the third succeeding
annual meeting of shareowners after their election, with each director to hold
office until such person's successor is duly elected and qualified.
Our certificate of incorporation provides that, except as otherwise
provided for or fixed by or pursuant to a certificate of designations setting
forth the rights of the holders of any class or series of our preferred stock,
newly created directorships resulting from any increase in the number of
directors and any vacancies on our board resulting from death, resignation,
disqualification, removal or other cause will be filled by the affirmative vote
of a majority of the remaining directors then in office, even though less than a
quorum of our board, and not by the shareowners. Any director elected in
accordance with the preceding sentence will hold office until the next annual
meeting of shareowners at which time the director will stand for election for
the remainder of the term and until such director's successor shall have been
duly elected and qualified. No decrease in the number of directors constituting
our board will shorten the term of any incumbent director. Subject to the rights
of holders of our preferred stock, any director may be removed from office only
for cause by the affirmative vote of the holders of at least a majority of the
voting power of all voting stock then outstanding, voting together as a single
class; provided, however, that any director or directors may be removed from
office by the affirmative vote of the holders of at least 80% of the voting
power of all our voting stock then outstanding, voting together as a single
class.
These provisions would preclude a third party from removing incumbent
directors and simultaneously gaining control of our board by filling the
vacancies created by removal with its own nominees. Under the classified board
provisions described above, it would take at least two elections of directors
for any individual or group to gain control of our board. Accordingly, these
provisions could discourage a third party from initiating a proxy contest,
making a tender offer or otherwise attempting to gain control of us.
NO SHAREOWNER ACTION BY WRITTEN CONSENT; SPECIAL MEETINGS
Our certificate of incorporation and by-laws provide that any action
required or permitted to be taken by our shareowners must be effected at a duly
called annual or special meeting of such holders and may not be effected by any
consent in writing by such holders. Except as otherwise required by law and
subject to the rights of the holders of any of our preferred stock, special
meetings of our shareowners for any purpose or purposes may be called only by
our board pursuant to a resolution stating the purpose or purposes thereof
approved by a majority of the whole board or by our chairman of the board and,
any power of shareowners to call a special meeting is specifically denied. No
business other than that stated in the notice shall be transacted at any special
meeting. These provisions may have the effect of delaying consideration of a
shareowner proposal until the next annual meeting unless a special meeting is
called by our board or the chairman of the board.
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ADVANCE NOTICE PROCEDURES
Our by-laws establish an advance notice procedure for shareowners to make
nominations of candidates for election as directors or to bring other business
before an annual meeting of our shareowners. Our shareowner notice procedure
provides that only persons who are nominated by, or at the direction of, our
chairman of the board, or by a shareowner who has given timely written notice to
our secretary prior to the meeting at which directors are to be elected, will be
eligible for election as our directors. Our shareowner notice procedure also
provides that at an annual meeting only such business may be conducted as has
been brought before the meeting by, or at the direction of, our chairman of the
board or our board, or by a shareowner who has given timely written notice to
our secretary of such shareowner's intention to bring such business before such
meeting. Under our shareowner notice procedure, for notice of shareowner
nominations to be made at an annual meeting to be timely, such notice must be
received by our secretary not later than the close of business on the 45th
calendar day nor earlier than the close of business on the 75th calendar day
prior to the first anniversary of the preceding year's annual meeting, except
that, in the event that the date of the annual meeting is more than 30 calendar
days before or more than 60 calendar days after such anniversary date, notice by
the shareowner to be timely must be so delivered not earlier than the close of
business on the 75th calendar day prior to such annual meeting and not later
than the close of business on the later of the 45th calendar day prior to such
annual meeting or the 10th calendar day following the day on which public
announcement of a meeting date is first made by us.
Notwithstanding the foregoing, in the event that the number of directors to
be elected to our board is increased and there is no public announcement by us
naming all of the nominees for director or specifying the size of our increased
board at least 55 calendar days prior to the first anniversary of the preceding
year's annual meeting, a shareowner's notice also will be considered timely, but
only with respect to nominees for any new positions created by such increase, if
it shall be delivered not later than the close of business on the 10th calendar
day following the day on which such public announcement is first made by us.
Under our shareowner notice procedure, for notice of a shareowner nomination to
be made at a special meeting at which directors are to be elected to be timely,
such notice must be received by us not earlier than the close of business on the
75th calendar day prior to such special meeting and not later than the close of
business on the later of the 45th calendar day prior to such special meeting or
the 10th calendar day following the day on which public announcement is first
made of the date of the special meeting and of the nominees proposed by our
board to be elected at such meeting.
In addition, under our shareowner notice procedure, a shareowner's notice
to us proposing to nominate a person for election as a director or relating to
the conduct of business other than the nomination of directors must contain the
information required by our certificate of incorporation. If the chairman of a
meeting determines that an individual was not nominated, or other business was
not brought before the meeting, in accordance with our shareowner notice
procedure, such individual will not be eligible for election as a director, or
such business will not be conducted at such meeting, as the case may be.
AMENDMENT
Our certificate of incorporation provides that the affirmative vote of the
holders of at least 80% of our voting stock then outstanding, voting together as
a single class, is required to amend provisions of the certificate relating to
the number, election and term of our directors; the nomination of director
candidates and the proposal of business by shareowners; the filling of
vacancies; and the removal of directors. Our certificate further provides that
the related by-laws described above, including the shareowner notice procedure,
may be amended only by our board or by the affirmative vote of the holders of at
least 80% of the voting power of the outstanding shares of voting stock, voting
together as a single class.
RIGHTS AGREEMENT
Our board of directors currently expects to adopt a rights agreement, with
The Bank of New York as rights agent, on or prior to the distribution date. The
Rights Agreement will be filed as an exhibit to the
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registration statement. For information on how to receive the Rights Agreement,
please see "Available Information."
ANTI-TAKEOVER EFFECTS
The rights are intended to have anti-takeover effects. If the rights become
exercisable, the rights will cause substantial dilution to a person or group
that attempts to acquire or merge with us in most cases. Accordingly, the
existence of the rights may deter a potential acquiror from making a takeover
proposal or tender offer. The rights should not interfere with any merger or
other business combination approved by our board of directors since we may
redeem the rights as described below and since a transaction approved by our
board of directors would not cause the rights to become exercisable.
EXERCISABILITY OF RIGHTS
Under the rights agreement, one right attaches to each share of our common
stock outstanding and, when exercisable, entitles the registered holder to
purchase from us one one-thousandth of a share of Series A Junior Participating
Preferred Stock, par value $1.00 per share, at an initial purchase price of
$125, subject to the customary antidilution adjustments. For a description of
the terms of our Series A Preferred Stock, see "-- Series A Junior Participating
Preferred Stock".
The rights will not become exercisable until the earliest of:
- 10 business days following a public announcement that a person or group
has become the beneficial owner of securities representing 10% or more of
our common shares then outstanding
- 10 business days after we first determine that a person or group has
become the beneficial owner of securities representing 10% or more of our
common shares then outstanding or
- such date, if any, as may be designated by the Board of Directors
following the commencement of, or the announcement of an intention to
commence, a tender offer or exchange offer that would result in a person
or group becoming the beneficial owner of securities representing 10% or
more of our common shares then outstanding (or such later date as our
board of directors may determine, but in no event later than the date
that any person or group actually becomes such an owner).
Additionally, at any time a person or a group has become the beneficial
owner of securities representing 10% or more of our common shares then
outstanding and we have registered the securities subject to the rights under
the Securities Act, the flip-in or flip-over features of the rights or, at the
discretion of our board of directors, the exchange features of the rights, may
be exercised by any holder, except for such person or group.
Our sale to Warburg, Pincus Equity Partners, L.P. and related investment
funds of 4,000,000 shares of Series B convertible participating preferred stock
and warrants to purchase our common stock will not trigger the exercisability of
the rights under our rights agreement. These investors shall not be deemed to be
the beneficial owners of any shares of common stock:
- that these investors acquire or can acquire by converting their shares of
Series B convertible participating preferred stock into shares of our
common stock;
- that these investors acquire or can acquire by exercising their warrants
to purchase shares of our common stock;
- that these investors acquire, directly or indirectly, by exercising their
preemptive rights granted in connection with their investment; or
- as a result of their ownership of the Series B convertible participating
preferred stock or warrants acquired pursuant to their initial
investment.
The various features of our rights agreement are described below.
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"FLIP IN" FEATURE
In the event a person or group becomes the beneficial owner of securities
representing 10% or more of our common shares then outstanding, each holder of a
right, except for such person or group, will have the right to acquire, upon
exercise of the right, instead of one one-thousandth of a share of our Series A
Preferred Stock, shares of our common stock having a value equal to twice the
exercise price of the right. For example, if we assume that the initial purchase
price of $125 is in effect on the date that the flip-in feature of the right is
exercised, any holder of a right, except for the person or group that has become
the beneficial owner of securities representing 10% or more of our common shares
then outstanding, can exercise his or her right by paying us $125 in order to
receive from us shares of common stock having a value equal to $250.
"EXCHANGE" FEATURE
At any time after a person or group becomes the beneficial owner of
securities representing 10% or more, but less than 50%, of our common shares
then outstanding, our board of directors may, at its option, exchange all or
some of the rights, except for those held by such person or group, for our
common stock at an exchange ratio of one share of common stock per right,
subject to adjustment, and cash instead of fractional shares, if any. Use of
this exchange feature means that eligible rights holders would not have to pay a
purchase price before receiving shares of our common stock.
"FLIP OVER" FEATURE
In the event we are acquired in a merger or other business combination
transaction or 50% or more of our assets or our earning power and our
subsidiaries, taken as a whole, are sold, each holder of a right, except for a
person or group that is the beneficial owner of securities representing 10% or
more of, will have the right to receive, upon exercise of the right, the number
of shares of the acquiring company's capital stock with the greatest voting
power having a value equal to twice the exercise price of the right.
REDEMPTION OF RIGHTS
At any time before the earlier to occur of:
- public disclosure that a person or group has become the beneficial owner
of securities representing 10% or more of our common shares then
outstanding or
- our determination that a person or group has become the beneficial owner
of securities representing 10% or more of our common shares then
outstanding
our board of directors may redeem all of the rights at a redemption price of
$0.01 per right, subject to adjustment. The right to exercise the rights, as
described under "-- Exercisability of Rights", will terminate upon redemption,
and at such time, the holders of the rights will have the right to receive only
the redemption price for each right held.
AMENDMENT OF RIGHTS
At any time before a person or group becomes the beneficial owner of
securities representing 10% or more of our common shares then outstanding, the
terms of the existing rights agreement may be amended by our board of directors
without the consent of the holders of the rights.
However, if at any time after a person or group beneficially owns
securities representing 10% or more, or such lower percentage as may be amended
in the existing rights agreement, of our common shares then outstanding, our
board of directors may not adopt amendments to the existing rights agreement
that adversely affect the interests of holders of the rights. Furthermore, once
the rights are no longer redeemable, our board of directors may not adopt any
amendment that would lengthen the time period during which the rights are
redeemable.
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TERMINATION OF RIGHTS
If not previously exercised, the rights will expire 10 years from the date
that the rights agreement commences, unless we earlier redeem or exchange the
rights or extend the final expiration date.
SERIES A JUNIOR PARTICIPATING PREFERRED STOCK
In connection with the creation of the rights, as described above, our
board of directors has authorized the issuance of 7.5 million shares of
Preferred Stock as Series A Junior Participating.
We have designed the dividend, liquidation, voting and redemption features
of our Series A Preferred Stock so that the value of one one-thousandth of a
share of our Series A Preferred Stock approximates the value of one share of our
common stock. Shares of our Series A Preferred Stock may only be purchased after
the rights have become exercisable, and each share of the Series A Preferred
Stock:
- is nonredeemable and junior to all other series of preferred stock,
unless otherwise provided in the terms of those series of preferred stock
- will have a preferential dividend in an amount equal to the greater of
$1.00 or 1,000 times any dividend declared on each share of common stock
- in the event of liquidation, will entitle its holder to receive a
preferred liquidation payment equal to 1,000 times the payment made per
share of common stock
- will have 1,000 votes, voting together with the common stock and any
other capital stock with general voting rights and
- in the event of any merger, consolidation or other transaction in which
shares of common stock are converted or exchanged, will be entitled to
receive 1,000 times the amount and type of consideration received per
share of common stock.
The rights of our Series A Preferred Stock as to dividends, liquidation and
voting, and in the event of mergers and consolidations, are protected by
customary antidilution provisions.
DELAWARE BUSINESS COMBINATION STATUTE
Section 203 of the Delaware General Corporation Law provides that, subject
to exceptions set forth therein, an interested stockholder of a Delaware
corporation shall not engage in any business combination, including mergers or
consolidations or acquisitions of additional shares of the corporation, with the
corporation for a three-year period following the date that such stockholder
becomes an interested stockholder unless:
- prior to such date, the board of directors of the corporation approved
either the business combination or the transaction which resulted in the
shareowner becoming an interested stockholder;
- upon consummation of the transaction which resulted in the shareowner
becoming an "interested stockholder," the interested stockholder owned at
least 85% of the voting stock of the corporation outstanding at the time
the transaction commenced, other than statutorily excluded shares; or
- on or subsequent to such date, the business combination is approved by
the board of directors of the corporation and authorized at an annual or
special meeting of stockholders by the affirmative vote of at least
66 2/3% of the outstanding voting stock which is not owned by the
interested stockholder. Except as otherwise set forth in Section 203, an
interested stockholder is defined to stockholder include:
- any person that is the owner of 15% or more of the outstanding voting
stock of the corporation, or is an affiliate or associate of the
corporation and was the owner of 15% or more of the outstanding voting
stock of the corporation at any time within three years immediately
prior to the date of determination and
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- the affiliates and associates of any such person.
Section 203 may make it more difficult for a person who would be an
interested stockholder to effect various business combinations with a
corporation for a three-year period. We have not elected to be exempt from the
restrictions imposed under Section 203. However, for a period of three years
following the distribution date, Lucent and its affiliates are excluded from the
definition of interested stockholder pursuant to the terms of Section 203. The
provisions of Section 203 may encourage persons interested in acquiring us to
negotiate in advance with our board, since the stockholder approval requirement
would be avoided if a majority of the directors then in office approves either
the business combination or the transaction which results in any such person
becoming an interested stockholder. Such provisions also may have the effect of
preventing changes in our management. It is possible that such provisions could
make it more difficult to accomplish transactions which our shareowners may
otherwise deem to be in their best interests.
TRANSFER AGENT AND REGISTRAR
The Bank of New York will be the transfer agent and registrar for our
common stock.
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RELATED TRANSACTIONS AND EQUITY INVESTMENT
EQUITY INVESTMENT
Warburg, Pincus Equity Partners, L.P. and related investment funds, which
we refer to collectively as the investors, have agreed to purchase 4,000,000
shares of our Series B convertible participating preferred stock and warrants to
purchase our common stock for an aggregate purchase price of $400 million. Based
on the formula set forth under "Description of Capital Stock -- Our Preferred
Stock -- Series B Convertible Participating Preferred Stock -- Conversion", the
Series B convertible participating preferred stock is expected to be initially
convertible into approximately 5.0% of our fully diluted common stock,
calculated using a modified treasury stock method as of the 90th day after
issuance. The warrants have an exercise price equal to 130% of the conversion
price for the Series B convertible participating preferred stock. The warrants
are exercisable for 3.6% of a total number of shares of common stock to be
calculated pursuant to the formula set forth under "Description of Capital
Stock -- Warrants" as of the 90th day after issuance. Of these warrants,
warrants exercisable for 2.0% of such total number of shares of common stock
will have a four-year term and warrants exercisable for 1.6% of such total
number of shares of common stock will have a five-year term. During a period
commencing on a date that we expect will be no later than June 30, 2001, until
the second anniversary of their issuance, if the market price of our common
stock exceeds 200%, in the case of the four-year warrants, and 225%, in the case
of the five-year warrants, of the exercise price of the warrants for 20
consecutive trading days, we can force the exercise of up to 50% of the
warrants. The warrants are exercisable immediately upon issuance. The Series B
convertible participating preferred stock and the warrants will have customary
antidilution rights.
The shares of Series B convertible participating preferred stock will have
an aggregate initial liquidation value of $400 million and will accrete for the
first ten years at an annual rate of 6.5%, compounded quarterly. After the third
anniversary of the issue date, 50% of the amount accreted for the year may be
paid in cash as a dividend, at our option, on a quarterly basis. From the fifth
anniversary of the issue date through the tenth anniversary, we may elect to pay
100% of the amount accreted for the year as a cash dividend on a quarterly
basis. Following the tenth anniversary of the issue date, we will pay quarterly
cash dividends at an annual rate of 12% of the then applicable liquidation value
of the Series B convertible participating preferred stock, compounded quarterly.
The Series B convertible participating preferred shares also will participate,
on an as-converted basis, in dividends paid on our common stock.
REDEMPTION. At any time after the fifth anniversary of their issuance, we
may force conversion of the shares of Series B convertible participating
preferred stock. If we give notice of a forced conversion, the investors will be
able to require us to redeem the Series B convertible participating preferred
shares at 100% of the then current liquidation value, plus accrued and unpaid
dividends. Following a change-in-control of us during the first five years after
the investment, other than a change of control transaction that is solely a
business combination involving the issuance of common stock, some or all of the
liquidation value of the Series B convertible participating preferred stock that
would otherwise accrete through the fifth anniversary of the issue date will be
accelerated, subject to our ability to pay a portion of the accelerated
accretion in cash in some instances. In addition, for 60 days following the
occurrence of any change-in-control of us during the first five years after the
investment, the investors will be able to require us to redeem the Series B
convertible participating preferred stock at 101% of the liquidation value,
including any accelerated accretion of the liquidation value, plus accrued and
unpaid dividends.
VOTING RIGHTS AND BOARD SEAT. The shares of Series B convertible
participating preferred stock will be entitled to vote, on an as-converted
basis, with our common stock on any matters submitted to holders of our common
stock. The shares of Series B convertible participating preferred stock also
have limited rights to vote as a separate class. So long as the investors and
their permitted transferees maintain ownership of a combination of shares of
Series B convertible participating preferred stock and common stock that, in the
aggregate, on an as-converted basis, represents at least 50% of the shares of
our common stock initially issuable on conversion of all the shares of Series B
convertible participating preferred stock purchased, they will be permitted to
designate for election one individual to our board of directors, and our board
of directors will use reasonable efforts to cause such person to be elected.
Permitted transferees are
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defined as investment funds affiliated with Warburg, Pincus Equity Partners,
L.P. While this ownership level is maintained, the investors and their permitted
transferees also will be permitted to designate one observer to attend meetings
of our board of directors.
PREEMPTIVE RIGHTS. As long as the investors maintain the minimum ownership
interest necessary to designate a director for election to our board of
directors, they will be entitled to preemptive rights to purchase a percentage
of any new shares of common stock and common stock equivalents sold by us for
cash in capital-raising transactions.
OTHER MATTERS. The investors also have agreed to limited transfer
restrictions for the securities acquired and a set of restrictions for a period
of five years that prohibits them from acquiring additional shares of our common
stock in an amount that, when taken together with the number of shares of our
common stock beneficially owned by the investors and their controlled affiliates
(excluding any shares issuable with respect to any then unexercised warrants)
and the number of shares of our common stock issuable upon conversion of the
shares of Series B convertible participating preferred stock beneficially owned
by the investors and their controlled affiliates (assuming the liquidation value
of such shares of Series B convertible participating preferred stock had
accreted until the fifth anniversary of their date of issuance), would not
exceed 9.9% of our then outstanding common stock and prohibits them from taking
actions that could result in a change-in-control of our company. We have agreed
to file a shelf registration statement for the registered sale of the Series B
convertible participating preferred shares, the warrants and the shares of our
common stock issuable in respect of the Series B convertible participating
preferred shares and the warrants.
CONDITIONS TO THE INVESTMENT. This investment is subject to the
satisfaction of several conditions, including the following:
- the consummation of the distribution;
- the reasonable satisfaction of Warburg, Pincus Equity Partners, L.P.
that our consolidated indebtedness at the time of the distribution
will not exceed the sum of (1) $700 million, (2) an amount equal to
the aggregate restructuring and separation costs and expenses for us
incurred by Lucent, to the extent such costs and expenses exceed
$50 million, all calculated on a pre-tax basis, and (3) increases in
working capital received by us from Lucent in excess of our current
business plan;
- no termination of, or material reduction in the responsibilities of,
the executive officers named in this information statement; and
- receipt of all necessary governmental approvals.
TERMINATION RIGHTS. The agreement between us and the investors generally
may be terminated as follows:
- if the equity investment has not been consummated by November 15,
2000;
- if a governmental authority prohibits the contribution by Lucent of
assets to us, the distribution or the equity investment;
- if the material agreements between Lucent and us are materially
modified in an adverse manner;
- if there is any amendment to the employee benefits agreement that
would result in a material decrease in the amount of net pension
assets being transferred to us;
- if the initial conditions to the equity investment, including
representations and warranties being true and correct, are not
satisfied on or prior to the third business day after the effective
date of the registration statement of which this information statement
forms a part; or
- if the distribution is not consummated on or prior to the second
business day after the investors fund into escrow the amount of their
investment.
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OTHER RELATIONSHIPS AND RELATED PARTY TRANSACTIONS
Henry Schacht, who will be the chairman of our board of directors following
the distribution, is a managing director and senior advisor of E.M. Warburg,
Pincus and Company, LLC. E.M. Warburg, Pincus and Company, LLC is an affiliate
of Warburg, Pincus Equity Partners, L.P., the party making the equity investment
in us, as described above.
During fiscal year 2000, a privately held business, of which Mr. Schacht
holds 80% of the equity interest and of which his son is the controlling
shareholder, purchased and paid for call center equipment and consulting
services from us for a total of approximately $800,000. This business continues
to purchase routine services from us on a time and materials basis.
Some of our directors and executive officers own substantial amounts of
Lucent common stock and vested Lucent options. Ownership of Lucent common stock
and Lucent options by our directors and officers after our separation from
Lucent could create, or appear to create, potential conflicts of interest when
faced with decisions that could have disparate implications for Lucent and us.
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SHARES ELIGIBLE FOR FUTURE SALE
Sales, or the availability for sale, of substantial amounts of our common
stock in the public market could adversely affect our common stock's prevailing
market price. Upon completion of the distribution, we will have outstanding an
aggregate of 278,292,661 shares of our common stock, based upon the shares of
Lucent common stock outstanding as of June 30, 2000 and assuming no exercise of
outstanding options. All of the shares will be freely tradeable without
restriction or further registration under the Securities Act, unless the shares
are owned by our "affiliates" as that term is defined in Rule 405 under the
Securities Act. Shares held by "affiliates" may be sold in the public market
only if registered or if they qualify for an exemption from registration under
Rule 144 which is summarized below. Further, as described below, we plan to file
a registration statement to cover the shares issued under our option plans.
RULE 144
In general, under Rule 144 as currently in effect, beginning December 21,
2000, an affiliate would be entitled to sell within any three-month period a
number of shares that does not exceed the greater of:
- 1% of the number of shares of our common stock then outstanding, which
will equal approximately 2,789,230 shares of common stock immediately
after the distribution; or
- the average weekly trading volume of our common stock on the New York
Stock Exchange during the four calendar weeks preceding the filing of a
notice of Form 144 with respect to such sale.
Sales under Rule 144 are also subject to manner of sale provisions and
notice requirements and to the availability of current public information about
us.
EMPLOYEE STOCK OPTIONS
As of August 4, 2000 unvested options to purchase approximately 33,300,000
shares of Lucent common stock were outstanding and held by Lucent employees as
of the distribution. It is estimated that as a result of the distribution these
options would represent options to purchase approximately 56,000,000 of our
shares of common stock, or approximately 20.1% of our outstanding common stock;
however, the actual number will not be determined until after the distribution.
From time to time, we will issue additional options to our employees under our
existing plans and under new plans we may adopt. Also as of August 4, 2000,
approximately 500,000 restricted stock units were held by Lucent employees who
are expected to become our employees as of the distribution, and it is estimated
that these restricted stock units will convert into approximately 840,000
restricted stock units of our company. As soon as practicable after the
effective date of the registration statement of which this information statement
is a part, we intend to file registration statements on Form S-8 under the
Securities Act covering the shares of common stock reserved for issuance under
our stock option plans. The registration statements are expected to
automatically become effective upon filing. Accordingly, shares registered under
these registration statements will, subject to vesting provisions and Rule 144
volume limitations applicable to our affiliates, be available for sale in the
open market shortly after the distribution.
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INDEMNIFICATION
OF DIRECTORS AND OFFICERS
Section 145 of the Delaware General Corporation Law provides that a
corporation may indemnify directors and officers as well as other employees and
individuals against expenses including attorneys' fees, judgments, fines and
amounts paid in settlement in connection with various actions, suits or
proceedings, whether civil, criminal, administrative or investigative other than
an action by or in the right of the corporation, a derivative action, if they
acted in good faith and in a manner they reasonably believed to be in or not
opposed to the best interests of the corporation, and, with respect to any
criminal action or proceeding, if they had no reasonable cause to believe their
conduct was unlawful. A similar standard is applicable in the case of derivative
actions, except that indemnification only extends to expenses including
attorneys' fees incurred in connection with the defense or settlement of such
actions, and the statute requires court approval before there can be any
indemnification where the person seeking indemnification has been found liable
to the corporation. The statute provides that it is not exclusive of other
indemnification that may be granted by a corporation's by-laws, disinterested
director vote, stockholder vote, agreement or otherwise.
Our certificate of incorporation provides that each person who was or is
made a party or is threatened to be made a party to or is involved in any
action, suit or proceeding, whether civil, criminal, administrative or
investigative, by reason of the fact that such person, or a person of whom such
person is the legal representative, is or was a director or officer of us or,
while a director or officer of us, is or was serving at our request as a
director, officer, employee or agent of another corporation or of a partnership,
joint venture, trust or other enterprise, including service with respect to
employee benefit plans, whether the basis of such proceeding is the alleged
action of such person in an official capacity as a director, officer, employee
or agent or in any other capacity while serving as a director, officer, employee
or agent, will be indemnified and held harmless by us to the fullest extent
authorized by the Delaware General Corporation Law, as the same exists or may
hereafter be amended, against all expense, liability and loss reasonably
incurred or suffered by such person in connection therewith. Our certificate of
incorporation also provides that we shall pay the expenses incurred in defending
any such proceeding in advance of its final disposition, subject to the
provisions of the Delaware General Corporation Law. Such rights are not
exclusive of any other right which any person may have or thereafter acquire
under any statute, provision of the certificate, by-law, agreement, vote of
shareowners or disinterested directors or otherwise. No repeal or modification
of such provision will in any way diminish or adversely affect the rights of any
director, officer, employee or agent of us thereunder in respect of any
occurrence or matter arising prior to any such repeal or modification. Our
certificate of incorporation also specifically authorizes us to maintain
insurance and to grant similar indemnification rights to our employees or
agents.
The Delaware General Corporation Law permits a corporation to provide in
its certificate of incorporation that a director of the corporation shall not be
personally liable to the corporation or its stockholders for monetary damages
for breach of fiduciary duty as a director, except for liability for:
- any breach of the director's duty of loyalty to the corporation or its
stockholders,
- acts or omissions not in good faith or which involve intentional
misconduct or a knowing violation of law,
- payments of unlawful dividends or unlawful stock repurchases or
redemptions, or
- any transaction from which the director derived an improper personal
benefit.
Our certificate of incorporation provides that none of our directors will
be personally liable to us or our shareowners for monetary damages for breach of
fiduciary duty as a director, except, if required by the Delaware General
Corporation Law as amended from time to time, for liability
- for any breach of the director's duty of loyalty to us or our
shareowners,
- for acts or omissions not in good faith or which involve intentional
misconduct or a knowing violation of law,
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- under Section 174 of the Delaware General Corporation Law, which concerns
unlawful payments of dividends, stock purchases or redemptions, or
- for any transaction from which the director derived an improper personal
benefit. Neither the amendment nor repeal of such provision will
eliminate or reduce the effect of such provision in respect of any matter
occurring, or any cause of action, suit or claim that, but for such
provision, would accrue or arise prior to such amendment or repeal.
The Contribution and Distribution Agreement by and among us and Lucent
dated as of September 30, 2000, provides for indemnification by us of Lucent and
its directors, officers and employees for some liabilities, including
liabilities under the Securities Act.
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AVAILABLE INFORMATION
We have filed with the Securities and Exchange Commission a registration
statement under the Exchange Act of 1934, as amended, with respect to the shares
of our common stock and the associated rights being issued in the distribution.
This information statement does not contain all of the information set forth in
the registration statement and the exhibits thereto, to which reference is
hereby made. With respect to each contract, agreement or other document filed as
an exhibit to the registration statement, reference is made to such exhibit for
a more complete description of the matter involved. The registration statement
and the exhibits thereto filed by us with the Securities and Exchange Commission
may be inspected at the public reference facilities of the Securities and
Exchange Commission listed below.
After the distribution, we will be subject to the informational
requirements of the Exchange Act, and in accordance therewith will file reports,
proxy statements and other information with the Securities and Exchange
Commission. Such reports, proxy statements and other information can be
inspected and copied at the public reference facilities maintained by the
Securities and Exchange Commission at its principal offices at Room 1024, 450
Fifth Street, N.W., Washington, D.C. 20549. Copies of such information may be
obtained from the Public Reference Section of the Securities and Exchange
Commission at 450 Fifth Street, N.W., Washington, D.C. 20549 at prescribed
rates. The Commission also maintains a World Wide Web site (http://www.sec.gov)
that contains reports, proxy and information statements and other information
regarding registrants that file electronically with the Securities and Exchange
Commission.
We intend to furnish holders of our common stock with annual reports
containing combined financial statements audited by independent accountants,
beginning with the fiscal year ending September 30, 2001.
No person is authorized to give any information or to make any
representations other than those contained in this information statement, and,
if given or made, such information or representations must not be relied upon as
having been authorized. Neither the delivery of this information statement nor
any distribution of securities made hereunder shall imply that there has been no
change in the information set forth herein or in our affairs since the date
hereof.
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INDEX TO COMBINED FINANCIAL STATEMENTS
<TABLE>
<S> <C>
Combined Financial Statements:
Report of Independent Accountants......................... F-2
Combined Statements of Income for the three fiscal years
ended September 30, 1999 and the nine months ended June
30, 2000 and 1999 (unaudited).......................... F-3
Combined Balance Sheets as of September 30, 1998 and 1999
and June 30, 2000 (unaudited).......................... F-4
Combined Statements of Changes in Invested Equity for the
three fiscal years ended September 30, 1999 and the
nine months ended June 30, 2000 and 1999 (unaudited)... F-5
Combined Statements of Cash Flows for the three fiscal
years ended September 30, 1999 and the nine months
ended June 30, 2000 and 1999 (unaudited)............... F-6
Notes to Combined Financial Statements.................... F-7
Financial Statement Schedule:
Schedule II -- Valuation and Qualifying Accounts for
the three fiscal years ended September 30, 1999....... S-1
</TABLE>
F-1
130
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors and
Shareowner of Avaya Inc.:
In our opinion, the combined financial statements listed in the
accompanying index present fairly, in all material respects, the financial
position of Avaya Inc. and its subsidiaries (formerly Lucent EN Corp.), (the
"Company") at September 30, 1999 and 1998, and the combined results of their
operations and their combined cash flows for each of the three years in the
period ended September 30, 1999, in conformity with accounting principles
generally accepted in the United States of America. In addition, in our opinion,
the financial statement schedule listed in the accompanying index presents
fairly, in all material respects, the information set forth therein when read in
conjunction with the related combined financial statements. These financial
statements and the financial statement schedule are the responsibility of the
Company's management; our responsibility is to express an opinion on these
financial statements and the financial statement schedule based on our audits.
We conducted our audits of these statements in accordance with auditing
standards generally accepted in the United States of America, which require that
we plan and perform the audit to obtain reasonable assurance about whether the
financial statements are free of material misstatement. An audit includes
examining, on a test basis, evidence supporting the amounts and disclosures in
the financial statements, assessing the accounting principles used and
significant estimates made by management, and evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis
for our opinion.
The Company is a fully integrated business of Lucent Technologies Inc.
("Lucent"); consequently, as indicated in Note 1, these combined financial
statements have been derived from the consolidated financial statements and
accounting records of Lucent, and reflect significant assumptions and
allocations. Moreover, as indicated in Note 1, the Company relies on Lucent and
its other businesses for administrative, management and other services.
Accordingly, these combined financial statements do not necessarily reflect the
financial position, results of operations, changes in invested equity and cash
flows of the Company had it been a separate stand-alone entity, independent of
Lucent.
As discussed in Note 8 to the combined financial statements, the Company
changed its method for calculating annual pension and postretirement benefit
costs in 1999.
/s/ PRICEWATERHOUSECOOPERS LLP
PricewaterhouseCoopers LLP
New York, New York
June 15, 2000
F-2
131
AVAYA INC. AND SUBSIDIARIES
COMBINED STATEMENTS OF INCOME
(DOLLARS IN MILLIONS)
<TABLE>
<CAPTION>
NINE MONTHS ENDED YEAR ENDED
JUNE 30, SEPTEMBER 30,
------------------ --------------------------
2000 1999 1999 1998 1997
------- ------- ------ ------ ------
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
REVENUE
Products.................................... $4,212 $4,474 $6,368 $6,004 $4,890
Services.................................... 1,452 1,396 1,900 1,750 1,523
------ ------ ------ ------ ------
5,664 5,870 8,268 7,754 6,413
------ ------ ------ ------ ------
COSTS
Products.................................... 2,418 2,516 3,579 3,253 2,567
Services.................................... 734 734 985 854 718
------ ------ ------ ------ ------
3,152 3,250 4,564 4,107 3,285
------ ------ ------ ------ ------
GROSS MARGIN.................................. 2,512 2,620 3,704 3,647 3,128
------ ------ ------ ------ ------
OPERATING EXPENSES
Selling, general and administrative......... 1,880 2,088 2,795 2,609 2,186
Research and development.................... 350 397 540 423 346
Purchased in-process research and
development.............................. -- -- -- 306 472
------ ------ ------ ------ ------
TOTAL OPERATING EXPENSES...................... 2,230 2,485 3,335 3,338 3,004
------ ------ ------ ------ ------
OPERATING INCOME (LOSS)....................... 282 135 369 309 124
Other income -- net........................... 54 26 28 25 17
Interest expense.............................. 59 66 90 94 59
------ ------ ------ ------ ------
INCOME (LOSS) BEFORE INCOME TAXES............. 277 95 307 240 82
Provision (benefit) for income taxes.......... 109 38 121 197 230
------ ------ ------ ------ ------
INCOME (LOSS) BEFORE CUMULATIVE EFFECT OF
ACCOUNTING CHANGE........................... 168 57 186 43 (148)
Cumulative effect of accounting change (net of
income taxes of $62 for the nine months
ended June 30, 1999 and for the year ended
September 30, 1999)......................... -- 96 96 -- --
------ ------ ------ ------ ------
NET INCOME (LOSS)............................. $ 168 $ 153 $ 282 $ 43 $ (148)
====== ====== ====== ====== ======
</TABLE>
See Notes to Combined Financial Statements.
F-3
132
AVAYA INC. AND SUBSIDIARIES
COMBINED BALANCE SHEETS
(DOLLARS IN MILLIONS)
<TABLE>
<CAPTION>
SEPTEMBER 30,
JUNE 30, ----------------
2000 1999 1998
-------- ------ ------
(UNAUDITED)
<S> <C> <C> <C>
ASSETS
Current Assets:
Cash and cash equivalents................................... $ 217 $ 194 $ 107
Receivables less allowances of $72 in 2000, $58 in 1999 and
$82 in 1998............................................... 1,588 1,765 1,783
Inventories................................................. 736 824 907
Deferred income taxes -- net................................ 96 137 197
Other current assets........................................ 126 123 71
------ ------ ------
TOTAL CURRENT ASSETS........................................ 2,763 3,043 3,065
Property, plant and equipment -- net........................ 727 676 613
Deferred income taxes -- net................................ 213 171 99
Capitalized software development costs -- net............... 41 34 17
Goodwill -- net............................................. 226 261 344
Other assets................................................ 106 54 39
------ ------ ------
TOTAL ASSETS................................................ $4,076 $4,239 $4,177
====== ====== ======
LIABILITIES AND INVESTED EQUITY
Current Liabilities:
Accounts payable............................................ $ 383 $ 364 $ 411
Payroll and benefit liabilities............................. 498 663 652
Advance billings and deposits............................... 197 198 140
Other current liabilities................................... 455 372 337
------ ------ ------
TOTAL CURRENT LIABILITIES................................... 1,533 1,597 1,540
Benefit obligations......................................... 270 354 367
Deferred revenue............................................ 95 88 76
Other liabilities........................................... 382 383 399
------ ------ ------
TOTAL LIABILITIES........................................... 2,280 2,422 2,382
------ ------ ------
Commitments and contingencies
INVESTED EQUITY
Owner's net investment...................................... 1,844 1,871 1,854
Accumulated other comprehensive income (loss)............... (48) (54) (59)
------ ------ ------
TOTAL INVESTED EQUITY....................................... 1,796 1,817 1,795
------ ------ ------
TOTAL LIABILITIES AND INVESTED EQUITY....................... $4,076 $4,239 $4,177
====== ====== ======
</TABLE>
See Notes to Combined Financial Statements.
F-4
133
AVAYA INC. AND SUBSIDIARIES
COMBINED STATEMENTS OF
CHANGES IN INVESTED EQUITY
(DOLLARS IN MILLIONS)
<TABLE>
<CAPTION>
NINE MONTHS ENDED YEAR ENDED
JUNE 30, SEPTEMBER 30,
------------------ --------------------------
2000 1999 1999 1998 1997
------- ------- ------ ------ ------
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
OWNER'S NET INVESTMENT
Beginning balance............................. $1,871 $1,854 $1,854 $1,290 $ 620
Net income (loss)............................. 168 153 282 43 (148)
Transfer to Lucent............................ (5,914) (5,852) (8,488) (7,313) (6,147)
Transfer from Lucent.......................... 5,719 6,040 8,223 7,834 6,965
------ ------ ------ ------ ------
Ending balance................................ $1,844 $2,195 $1,871 $1,854 $1,290
====== ====== ====== ====== ======
ACCUMULATED OTHER COMPREHENSIVE INCOME (LOSS):
Beginning balance............................. $ (54) $ (59) $ (59) $ (30) $ (4)
Foreign currency translations................. 6 (7) 5 (29) (26)
------ ------ ------ ------ ------
Ending balance................................ (48) (66) (54) (59) (30)
------ ------ ------ ------ ------
TOTAL INVESTED EQUITY......................... $1,796 $2,129 $1,817 $1,795 $1,260
====== ====== ====== ====== ======
TOTAL COMPREHENSIVE INCOME (LOSS):
Net income (loss)............................. $ 168 $ 153 $ 282 $ 43 $ (148)
Other comprehensive income (loss)............. 6 (7) 5 (29) (26)
------ ------ ------ ------ ------
Total comprehensive income (loss)............. $ 174 $ 146 $ 287 $ 14 $ (174)
====== ====== ====== ====== ======
</TABLE>
See Notes to Combined Financial Statements.
F-5
134
AVAYA INC. AND SUBSIDIARIES
COMBINED STATEMENTS OF CASH FLOWS
(DOLLARS IN MILLIONS)
<TABLE>
<CAPTION>
NINE MONTHS
ENDED YEAR ENDED
JUNE 30, SEPTEMBER 30,
-------------- -------------------------
2000 1999 1999 1998 1997
----- ----- ----- ----- -------
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
OPERATING ACTIVITIES:
Net income (loss).............................. $ 168 $ 153 $ 282 $ 43 $ (148)
Adjustments to reconcile net income (loss) to
net cash provided by (used in) operating
activities, net of effects from acquisitions
of businesses:
Cumulative effect of accounting change.... -- (96) (96) -- --
Business restructuring reversal........... -- (10) (33) (23) --
Asset impairment and other charges........ -- 26 26 -- --
Depreciation and amortization............. 160 159 212 193 158
Provision for uncollectibles.............. 43 16 25 33 25
Deferred income taxes..................... (5) (2) (7) (84) 15
Purchased in-process research and
development............................. -- -- -- 306 472
(Increase) decrease in
receivables -- net...................... 144 (174) 5 (424) (270)
(Increase) decrease in inventories........ 83 (42) 81 (204) (35)
Increase(decrease) in accounts payable.... 19 (58) (47) 142 (2)
Changes in other operating assets and
liabilities............................. (225) (92) 7 155 144
Other adjustments for non-cash
items -- net............................ (40) (16) (24) (8) --
----- ----- ----- ----- -------
NET CASH PROVIDED BY (USED IN) OPERATING
ACTIVITIES................................... 347 (136) 431 129 359
----- ----- ----- ----- -------
INVESTING ACTIVITIES:
Capital expenditures........................... (204) (139) (202) (197) (187)
Proceeds from the sale or disposal of property,
plant and equipment.......................... 9 9 17 13 --
Dispositions of businesses..................... 64 29 29 -- --
Acquisitions of businesses -- net of cash
acquired..................................... -- -- -- (248) (834)
Cash from mergers.............................. -- -- 60 -- --
Other investing activities -- net.............. (3) (13) 10 (27) (35)
----- ----- ----- ----- -------
NET CASH USED IN INVESTING ACTIVITIES.......... (134) (114) (86) (459) (1,056)
----- ----- ----- ----- -------
FINANCING ACTIVITIES:
Transfers (to) from Lucent..................... (184) 290 (253) 311 818
Increase (decrease) in short-term borrowings... (1) (5) (4) (37) 6
Other.......................................... (5) 3 -- (9) 9
----- ----- ----- ----- -------
NET CASH (USED IN) PROVIDED BY FINANCING
ACTIVITIES................................... (190) 288 (257) 265 833
----- ----- ----- ----- -------
Effect of exchange rate changes on cash and
cash equivalents............................. -- (2) (1) 6 3
Net increase (decrease) in cash and cash
equivalents.................................. 23 36 87 (59) 139
Cash and cash equivalents at beginning of
year......................................... 194 107 107 166 27
----- ----- ----- ----- -------
Cash and cash equivalents at end of year....... $ 217 $ 143 $ 194 $ 107 $ 166
===== ===== ===== ===== =======
</TABLE>
See Notes to Combined Financial Statements.
F-6
135
NOTES TO COMBINED FINANCIAL STATEMENTS
(DOLLARS IN MILLIONS)
1. BACKGROUND AND BASIS OF PRESENTATION
Background
Lucent Technologies Inc. ("Lucent") announced its intention to spin-off its
enterprise communications businesses to its shareowners. Avaya Inc. (formerly
Lucent EN Corp.), (the "Company"), which will own these businesses, will provide
communication systems and software for enterprises, including businesses,
government agencies and other organizations. The Company offers a broad range of
voice, converged voice and data, customer relationship management, messaging,
Internet-based network and structured cabling products and services.
The combined financial statements include the Company and its subsidiaries
as well as certain assets, liabilities, and related operations not currently
owned by the Company which will be transferred to the Company (the
"Contribution") from Lucent. The combined financial statements include the
historical operations to be transferred to the Company by Lucent (the "Company's
Businesses"). Because no direct ownership relationship existed among all the
various units comprising the Company, Lucent's and its subsidiaries' net
investment in the Company is shown in lieu of stockholders equity in the
combined financial statements.
On February 16, 2000, the Company was incorporated in Delaware as a wholly
owned subsidiary of Lucent. On this date, 1,000 shares of the Company's common
stock, par value $0.01 per share, were issued authorized and outstanding. The
Contribution is expected to be substantially complete by September 30, 2000 and
will result in a recapitalization of the Company.
Lucent has announced its intention to distribute to its shareowners by
September 30, 2000, subject to certain conditions, all of its interest in the
Company (the "Distribution"). On the date of Distribution, Lucent will
distribute the stock of the Company to shareowners of Lucent based on a
distribution ratio which will be determined prior to the Distribution. At the
Distribution, the Company's authorized capital stock will consist of 200 million
shares of preferred stock, par value $1.00 per share, and 1.5 billion shares of
common stock, par value $0.01 per share.
Rights Agreement
The Company expects to adopt a rights agreement on or prior to the
Distribution date. A delivery of a share of the Company's common stock in
connection with the Distribution also will constitute the delivery of the
preferred stock purchase right associated with such share. These rights are
intended to have anti-takeover effects in that the existence of the rights may
deter a potential acquiror from making a takeover proposal or a tender offer.
Basis of Presentation
The combined financial statements have been derived from the financial
statements and accounting records of Lucent using the historical results of
operations and historical basis of the assets and liabilities of the Company's
Businesses. Management believes the assumptions underlying the combined
financial statements are reasonable. However, the combined financial statements
included herein may not necessarily reflect the Company's results of operations,
financial position and cash flows in the future or what its results of
operations, financial position and cash flows would have been had the Company
been a stand-alone company during the periods presented.
The combined financial statements include allocations of certain Lucent
corporate headquarters' assets, liabilities, and expenses relating to the
Company's Businesses that will be transferred to the Company from Lucent.
General corporate overhead has been allocated either based on the ratio of the
Company's costs and expenses to Lucent's costs and expenses or based on the
Company's revenue as a percentage of Lucent's total revenue. General corporate
overhead primarily includes cash management,
F-7
136
NOTES TO COMBINED FINANCIAL STATEMENTS -- (CONTINUED)
(DOLLARS IN MILLIONS)
legal, accounting, tax, insurance, public relations, advertising and data
services and amounted to $449, $425 and $335 in 1999, 1998 and 1997,
respectively. Management believes the costs of these services charged to the
Company are a reasonable representation of the costs that would have been
incurred if the Company had performed these functions as a stand-alone company.
Following the Contribution, the Company will perform these functions using its
own resources or purchased services.
The combined financial statements also include an allocation from Lucent to
fund a portion of the costs of basic research conducted by Lucent's Bell
Laboratories. This allocation was based on the Company's revenue as a percentage
of Lucent's total revenue. This allocation amounted to $78, $66, and $59 for
fiscal 1999, 1998 and 1997, respectively. Management believes the costs of this
research charge to the Company are a reasonable representation of the costs that
would have been incurred if the Company had performed these functions as a
stand-alone company. Following the Distribution, the Company will satisfy its
basic research requirements using its own resources or through purchased
services.
Lucent uses a centralized approach to cash management and the financing of
its operations. Cash deposits from the Company's Businesses are transferred to
Lucent on a regular basis and are netted against the owner's net investment
account. As a result, none of Lucent's cash, cash equivalents or debt at the
corporate level have been allocated to the Company in the combined financial
statements. Cash and cash equivalents in the combined financial statements
represents amounts held by the Company's foreign operations. Changes in invested
equity represent any funding required from Lucent for working capital,
acquisition or capital expenditure requirements after giving effect to the
Company's transfers to or from Lucent of its cash flows from operations.
INTEREST EXPENSE
The Company's combined financial statements include interest expense
totaling $90, $94 and $59 in 1999, 1998 and 1997, respectively. The interest
rates used equate to an estimate of what the Company believes it would obtain
with a "BBB" rating, the assumed credit rating of the Company subsequent to the
Distribution. The associated weighted average interest rate for each of the
respective years was 6.8%, 6.5% and 7.1%. Average debt balances utilized for the
interest expense calculation were $1,320, $1,439 and $825 in 1999, 1998 and
1997, respectively, and were determined based upon the cash flows for each of
the periods. In determining the debt balances it was assumed that the September
1997 purchase of Octel was entirely funded by debt. The debt balances utilized
to calculate interest expense do not necessarily reflect the level of debt the
Company will assume at the Distribution or incur as a stand-alone company. It is
anticipated that, upon the Distribution, the Company will assume public debt in
an amount appropriate for an investment grade company.
The Company believes these are reasonable estimates of the cost of
financing the Company's assets and operations in the past. However, the Company
may not be able to obtain financing at interest rates similar to those used for
the interest expense calculation. Accordingly, the Company's interest expense as
a stand-alone company may be higher than that reflected in the combined
financial statements.
PENSION AND POSTRETIREMENT COSTS
At the Distribution, the Company will assume responsibility for pension and
postretirement benefits for the active employees of the Company. Obligations
related to retired and terminated vested employees as of September 30, 2000 will
remain the responsibility of Lucent. Until the Distribution, the Company's
employees are participants in the Lucent employee benefit plans and, upon
retirement, will be participants in Lucent's postretirement benefit plans.
Lucent has managed its employee benefit plans on a consolidated basis and
separate Company information is not readily available. Therefore, the Company's
share of the Lucent plans' assets and liabilities is not included in the
Company's combined financial statements. For purposes of the financial
statements the pension and postretirement costs were based on estimated plan
F-8
137
NOTES TO COMBINED FINANCIAL STATEMENTS -- (CONTINUED)
(DOLLARS IN MILLIONS)
assets being equal to a proportional share of plan obligations incurred by
Lucent for employees who performed services for the Company.
INCOME TAXES
The Company's income taxes are calculated on a separate tax return basis.
However, Lucent was managing its tax position for the benefit of its entire
portfolio of businesses, and its tax strategies are not necessarily reflective
of the tax strategies that the Company would have followed or will follow as a
stand-alone entity.
INTERIM FINANCIAL INFORMATION (UNAUDITED)
The financial information as of June 30, 2000 and for the nine month
periods ending June 30, 2000 and 1999 is unaudited, but includes all
adjustments, consisting only of normal and recurring accruals, that management
considers necessary for a fair presentation of its combined results of
operations, financial position and cash flows. Results for the nine month period
ended June 30, 2000 are not necessarily indicative of results to be expected for
the full fiscal year 2000 or any other future period.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Principles of Combination
The combined financial statements include certain majority-owned
subsidiaries to be transferred in which the Company exercises control and in
some cases, assets, liabilities and operations not currently owned by the
Company that will be transferred from Lucent, including entities for which no
direct ownership relationship existed. Investments in which the Company
exercises significant influence, but which it does not control (generally a
20% - 50% ownership interest), are accounted for under the equity method of
accounting. All material intercompany transactions and balances between and
among the Company Businesses have been eliminated. Transactions between any of
the Company Businesses and Lucent are included in these financial statements.
Use of Estimates
The preparation of financial statements and related disclosures in
conformity with accounting principles generally accepted in the United States
("U.S.") requires management to make estimates and assumptions that affect the
reported amounts of assets and liabilities, the disclosure of contingent assets
and liabilities at the date of the financial statements and revenue and expenses
during the period reported. These estimates include an allocation of costs by
Lucent, assessing the collectability of accounts receivable, the use and
recoverability of inventory, the realization of deferred tax assets and useful
lives for amortization periods of tangible and intangible assets, among others.
The markets for the Company's products are characterized by intense competition,
rapid technological development and frequent new product introduction, all of
which could impact the future realizability of the Company's assets. Actual
results could differ from those estimates.
Foreign Currency Translation
Balance sheet accounts of the Company's foreign operations are translated
from foreign currencies into U.S. dollars at period-end exchange rates while
income and expenses are translated at average exchange rates during the period.
Translation gains or losses related to net assets located outside the U.S. are
shown as a component of accumulated other comprehensive income (loss) in
invested equity. Gains and losses resulting from foreign currency transactions
(transactions denominated in a currency other than the entity's functional
currency) are included in the combined statements of income.
F-9
138
NOTES TO COMBINED FINANCIAL STATEMENTS -- (CONTINUED)
(DOLLARS IN MILLIONS)
Revenue Recognition
Revenue from sales of communications systems and software is recognized
when contractual obligations have been satisfied, title and risk of loss has
been transferred to the customer and collection of the resulting receivable is
reasonably assured. Revenue from the direct sales of products with installation
services is recognized at the time the products are installed, after
satisfaction of all the terms and conditions of the underlying customer
contract. The Company's indirect sales to distribution partners are recognized
at the time of shipment if all contractual obligations have been satisfied. For
the Company's value-added services, professional services and services performed
under maintenance contracts, the Company recognizes revenue ratably over the
term of the underlying customer contract or at the end of the contract, when
obligations have been satisfied. For services performed on a time and materials
basis, revenue is recognized upon performance. The Company accrues a provision
for estimated sales returns and other allowances as a reduction of revenue at
the time of revenue recognition, as required.
Research and Development Costs and Software Development Costs
Research and development costs are charged to expense as incurred. This
line item includes an allocation from Lucent for the costs of basic research
conducted by Bell Laboratories (see note 1). The costs incurred for the
development of computer software that will be sold, leased or otherwise
marketed, however, are capitalized when technological feasibility has been
established. These capitalized costs are subject to an ongoing assessment of
recoverability based on anticipated future revenues and changes in hardware and
software technologies. Costs that are capitalized include direct labor and
related overhead.
Amortization of capitalized software development costs begins when the
product is available for general release. Amortization is recognized on a
product-by-product basis on the greater of either the sales ratio method or the
straight-line method over the products' estimated useful lives. Unamortized
capitalized software development costs determined to be in excess of net
realizable value of the product are expensed immediately.
Cash and Cash Equivalents
Cash and cash equivalents represent amounts held by the Company's foreign
operations (see Note 1). All highly liquid investments with original maturities
of three months or less are considered to be cash equivalents.
Inventories
Inventories are stated at the lower of cost, determined on a first-in,
first-out basis, or market.
Property, Plant and Equipment
Property, plant and equipment are stated at cost less accumulated
depreciation. Depreciation is determined using a straight-line method on either
the unit or group method over the estimated useful lives of the various asset
classes. The unit method is used for manufacturing and laboratory equipment and
large computer systems. The group method is used for other depreciable assets.
Estimated lives range from three to ten years for machinery, electronic and
other equipment, and thirty years for buildings.
Major renewals and improvements are capitalized and minor replacements,
maintenance and repairs are charged to current operations as incurred. Upon
retirement or disposal of assets, the cost and related accumulated depreciation
are removed from the combined balance sheets and any gain or loss is reflected
in the combined statements of income.
F-10
139
NOTES TO COMBINED FINANCIAL STATEMENTS -- (CONTINUED)
(DOLLARS IN MILLIONS)
Internal Use Software
The Company adopted Statement of Position 98-1, "Accounting for the Costs
of Computer Software Developed or Obtained for Internal Use" on October 1, 1999.
Certain costs of computer software developed or obtained for internal use, that
were previously expensed as incurred, are capitalized and amortized on a
straight-line basis over three years. Costs for general and administrative,
overhead, maintenance and training, as well as the cost of software that does
not add functionality to the existing system, are expensed as incurred. As of
June 30, 2000, the Company has unamortized internal use software costs of $42.
Goodwill and Long-Lived Assets
Goodwill is the excess of the purchase price over the fair value of
identifiable net assets acquired in business combinations accounted for as
purchases. Goodwill is amortized on a straight-line basis over the periods
benefited. Long-lived assets and goodwill are reviewed for impairment whenever
events such as asset impairments, product discontinuance, plant closures,
product dispositions or other changes in circumstances indicate that the
carrying amount may not be recoverable. In reviewing for impairment, the Company
compares the carrying value of such assets to the estimated undiscounted future
cash flows expected from the use of the asset and its eventual disposition. An
impairment loss, equal to the difference between the assets fair value and its
carrying value, is recognized when the estimated future cash flows are less than
its carrying amount.
Financial Instruments
The Company uses various financial instruments, including foreign currency
exchange contracts, to manage and reduce risk to the Company by generating cash
flows which offset the cash flows of certain transactions in foreign currencies
or underlying financial instruments in relation to their amount and timing. The
Company's derivative financial instruments are used as risk management tools and
are not for trading purposes. The Company's non-derivative financial instruments
include letters of credit and commitments to extend credit.
Income Taxes
Historically, the Company's operations have been included in Lucent's
consolidated income tax returns. Income tax expense in the Company's combined
financial statements has been calculated on a separate tax return basis. The
asset and liability approach is used to recognize deferred tax assets and
liabilities for the expected future tax consequences of temporary differences
between the carrying amounts and the tax bases of assets and liabilities.
Other Comprehensive Income
Comprehensive income includes, in addition to net income, unrealized gains
and losses excluded from the combined statements of income and are recorded
directly into a separate section of invested equity on the combined balance
sheet. These unrealized gains and losses are referred to as other comprehensive
income items. The Company's accumulated other comprehensive income (loss) shown
on the combined balance sheet consists solely of foreign currency translation
adjustments which are not adjusted for income taxes since they relate to
indefinite investments in non-U.S. subsidiaries.
F-11
140
NOTES TO COMBINED FINANCIAL STATEMENTS -- (CONTINUED)
(DOLLARS IN MILLIONS)
3. ACQUISITIONS, DIVESTITURES AND OTHER TRANSACTIONS
Acquisitions
PURCHASE METHOD
The following table presents information about certain acquisitions by the
Company in the fiscal years ended September 30, 1998, and 1997. There were no
material acquisitions accounted for under the purchase method in the fiscal year
1999. These acquisitions were accounted for under the purchase method of
accounting, and the acquired technology valuation included both existing
technology and purchased in-process research and development. The combined
financial statements include the results of operations and the estimated fair
values of the assets and liabilities assumed from the respective dates of
acquisition. All charges related to the write-off of purchased in-process
research and development were recorded in the quarter in which the transaction
was completed.
<TABLE>
<CAPTION>
AMORTIZATION AMORTIZATION
PURCHASED PERIOD PERIOD
ACQUISITION PURCHASE EXISTING IPR&D GOODWILL EXISTING TECH.
DATE PRICE GOODWILL TECHNOLOGY (NONDEDUCTIBLE) (IN YEARS) (IN YEARS)
----------- -------- -------- ---------- --------------- ------------ --------------
<S> <C> <C> <C> <C> <C> <C> <C>
1998
Lannet(1)............ 8/98 $115 $ 2 $15 $ 67 7 5
SDX(2)............... 7/98 $207 $96 $16 $ 82 10 5
Prominet(3).......... 1/98 $199 $35 $23 $157 5 6
1997
Octel(4)............. 9/97 $724 $74 $57 $393 7 5
Agile(5)............. 10/96 $135 $52 $ 2 $ 79 5 2
</TABLE>
- ---------------
(1) Acquisition of Lannet Ltd., an Israeli-based producer of multi-service
networking products. The purchase price of $115 was in cash.
(2) Acquisition of SDX Business Systems PLC, a United Kingdom-based provider of
multi-service networking products. The purchase price of $207 was in cash.
(3) Acquisition of Prominet Corporation, a producer of multi-service networking
products. The purchase price was $199 of Lucent common stock. In addition,
under the terms of the acquisition agreement, Lucent had a contingent
obligation to pay former Prominet shareowners $35 in Lucent stock. The $35
of Lucent stock was paid in July 1998 and was recorded primarily as
goodwill.
(4) Acquisition of Octel Communications Corporation, a provider of voice, fax
and electronic messaging technologies to service providers and enterprises.
The total purchase price was $1,819, in cash, and the enterprise portion of
that business, along with $724 of the purchase price was allocated to the
Company.
(5) Acquisition of Agile Networks, Inc., a provider of multi-service networking
products. The purchase price of $135 was in cash. In 1999, the net goodwill
of $26 was deemed impaired and written off.
Included in the purchase price for each of the above acquisitions was
purchased in-process research and development. As some of the technology had not
reached technological feasibility and had no future alternative use, it was
written off as a non-tax-deductible charge to earnings immediately upon
consummation of the respective acquisition. The remaining purchase price was
allocated to tangible assets and intangible assets, including goodwill and
existing technology, less liabilities assumed.
The value allocated to purchased in-process research and development was
determined utilizing an income approach that included an excess earnings
analysis reflecting the appropriate cost of capital for the investment.
Estimates of future cash flows related to the purchased in-process research and
development were made for each project based on the Company's estimates of
revenue, operating expenses and income
F-12
141
NOTES TO COMBINED FINANCIAL STATEMENTS -- (CONTINUED)
(DOLLARS IN MILLIONS)
taxes from the project. These estimates were consistent with historical pricing,
margins and expense levels for similar products.
Revenue was estimated based on relevant market size and growth factors,
expected industry trends, individual product sales cycles and the estimated life
of each product's underlying technology. Estimated operating expenses, income
taxes, and charges for the use of contributory assets were deducted from
estimated revenue to determine estimated after-tax cash flows for each project.
Estimated operating expenses include cost of goods sold; selling, general and
administrative expenses; and research and development expenses. The research and
development expenses include estimated costs to maintain the products once they
have been introduced into the market and generate revenue and costs to complete
the purchased in-process research and development.
The rates utilized to discount the projected cash flows were based on
consideration of Lucent's weighted average cost of capital, as well as other
factors including the useful life of each project, the anticipated profitability
of each project, the uncertainty of technology advances that were known at the
time and the stage of completion of each project.
Lucent's management was primarily responsible for estimating the fair value
of the assets and liabilities acquired, and conducted due diligence in
determining the fair value. Lucent made estimates and assumptions that affect
the reported amounts of assets, liabilities and expenses resulting from such
acquisitions. The Company believes these estimates and allocations are
reasonable.
POOLING OF INTERESTS MERGER
On July 15, 1999, the Company completed its merger with Mosaix, a provider
of software that manages an enterprise's various office functions and helps them
deliver more responsive and efficient customer service. Under the terms of the
agreement, the outstanding common stock of Mosaix was converted into
approximately 2.6 million shares of Lucent common stock with a value of $145.
The financial position and results of operations of Mosaix were immaterial to
the Company and as such the combined financial statements include the results of
operations and the historical basis of the assets acquired and liabilities
assumed from the date of acquisition.
Divestitures
On March 31, 2000, the Company completed the sale of its U.S. sales
division that served small and mid-sized businesses to Expanets, Inc.
("Expanets"). Under the agreement, approximately 1,800 of the Company's sales
and sales support employees were transferred to Expanets. Expanets became a
distributor of the Company's product to this market and a significant customer
of the Company. A gain of $45 was recognized to the extent of cash proceeds
received related to the sale of this business.
Other Transactions
In 1999, the Company sold equipment, which was previously rented to
customers, for $97. The equipment had a net book value of approximately $2 and
consisted predominantly of discontinued product lines. The rental income
generated by this equipment for the fiscal year 1999, 1998 and 1997 was $79, $91
and $116, respectively.
4. RECENT PRONOUNCEMENTS
SFAS 133
In June 1998, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards ("SFAS") No. 133, "Accounting for
Derivative Instruments and Hedging
F-13
142
NOTES TO COMBINED FINANCIAL STATEMENTS -- (CONTINUED)
(DOLLARS IN MILLIONS)
Activities" ("SFAS 133"). SFAS 133 establishes new accounting and reporting
standards for derivative financial instruments and for hedging activities. SFAS
133 requires the Company to measure all derivatives at fair value and to
recognize them in the balance sheet as an asset or liability, depending on the
Company's rights or obligations under the applicable derivative contract.
Subsequent to the issuance of SFAS 133, the FASB has received many requests to
clarify certain issues causing difficulties in implementation. In June 2000, the
FASB issued SFAS 138 which responds to those requests by amending certain
provisions of SFAS 133. These amendments include allowing foreign-currency
denominated assets and liabilities to qualify for hedge accounting, permitting
the offsetting of selected inter-entity foreign currency exposures that reduce
the need for third party derivatives and redefining the nature of interest rate
risk to avoid sources of ineffectiveness. The Company expects to adopt SFAS 133
and the corresponding amendments of SFAS 138 in the first quarter of fiscal year
2001. SFAS 133, as amended by SFAS 138, is not expected to have a material
impact on the Company's combined results of operations, financial position and
cash flows.
SAB 101
In December 1999, the Securities and Exchange Commission issued Staff
Accounting Bulletin 101, "Revenue Recognition in Financial Statements" ("SAB
101"). SAB 101 provides guidance on the recognition, presentation and disclosure
of revenue in financial statements and requires adoption no later than the
fourth quarter of the Company's fiscal 2001. The Company is currently evaluating
the impact of SAB 101 to determine what effect, if any, it may have on the
Company's combined financial position and results of operations.
5. SUPPLEMENTARY FINANCIAL INFORMATION
SUPPLEMENTARY INCOME STATEMENT INFORMATION
<TABLE>
<CAPTION>
YEAR ENDED
SEPTEMBER 30,
----------------------------
1999 1998 1997
---- ---- ----
<S> <C> <C> <C>
INCLUDED IN COSTS
Amortization of software development costs.......... $ 14 $ 24 $51
INCLUDED IN SELLING, GENERAL AND ADMINISTRATIVE
EXPENSES
Amortization of goodwill and existing technology.... $ 59 $ 45 $13
INCLUDED IN COSTS AND OPERATING EXPENSES
Depreciation and amortization of property, plant and
equipment......................................... $139 $124 $94
OTHER INCOME -- NET
Gain on foreign currency transactions............... $ -- $ 7 $--
Gain on sale or disposal of property, plant and
equipment......................................... -- 4 5
Gain on businesses sold............................. 24 -- --
Miscellaneous -- net................................ 4 14 12
---- ---- ---
Total other income -- net........................... $ 28 $ 25 $17
==== ==== ===
</TABLE>
F-14
143
NOTES TO COMBINED FINANCIAL STATEMENTS -- (CONTINUED)
(DOLLARS IN MILLIONS)
SUPPLEMENTARY BALANCE SHEET INFORMATION
<TABLE>
<CAPTION>
SEPTEMBER 30,
JUNE 30, ----------------
2000 1999 1998
----------- ------ ------
(UNAUDITED)
<S> <C> <C> <C>
INVENTORIES
Completed goods....................................... $ 504 $ 577 $ 625
Work in process and raw materials..................... 232 247 282
------ ------ ------
Inventories........................................... $ 736 $ 824 $ 907
====== ====== ======
PROPERTY, PLANT AND EQUIPMENT -- NET
Land and improvements................................. $ 47 $ 35 $ 37
Buildings and improvements............................ 419 366 302
Machinery, electronic and other equipment............. 1,015 979 904
------ ------ ------
Total property, plant and equipment................... 1,481 1,380 1,243
Less: Accumulated depreciation and amortization....... (754) (704) (630)
------ ------ ------
Property, plant and equipment -- net.................. $ 727 $ 676 $ 613
====== ====== ======
</TABLE>
SUPPLEMENTARY CASH FLOW INFORMATION
Payments for interest and income taxes historically have been paid by
Lucent on behalf of the Company and do not necessarily reflect what the Company
would have paid had it been a stand-alone company. The interest and income tax
expense amounts shown in the combined statements of income have been calculated
based on management's estimate of what the Company may have incurred had it been
a separate company.
Net transfers (to) from Lucent include the following noncash transactions:
(1) a $96 decrease in owner's net investment for a change in accounting related
to pension and postretirement benefit costs reflected in the nine months ended
June 30, 1999 and fiscal year ended September 30, 1999, (2) an $82 increase in
owner's net investment attributed to the Mosaix pooling of interests merger in
the fiscal year ended September 30, 1999, and (3) a $199 increase in owner's net
investment to reflect the Prominet acquisition that was purchased with Lucent
common stock in the fiscal year ended September 30, 1998.
ACQUISITIONS OF BUSINESSES
Shown below is the impact on cash flows related to the acquisition of
businesses (excluding Prominet which was a non-cash transaction in 1998):
<TABLE>
<CAPTION>
YEAR ENDED
SEPTEMBER 30,
-------------
1998 1997
----- -----
<S> <C> <C>
Fair value of assets acquired, net of cash acquired..... $ 353 $ 966
Less: Fair value of liabilities assumed................. (105) (132)
----- -----
Acquisitions of businesses, net of cash acquired........ $ 248 $ 834
===== =====
</TABLE>
6. BUSINESS RESTRUCTURING
In December 1995, a pre-tax charge of $146 was recorded to cover
restructuring costs. The restructuring plans included the exit of certain
businesses as well as consolidating business unit operations.
F-15
144
NOTES TO COMBINED FINANCIAL STATEMENTS -- (CONTINUED)
(DOLLARS IN MILLIONS)
Total deductions to the Company's business restructuring reserves were $49
and $37 for the years ended September 30, 1999 and 1998, respectively, and
related to employee separation costs. Included in these deductions were cash
payments of $16 and $14 for the years ended September 30, 1999 and 1998,
respectively. In addition, the Company reversed $33 and $23 of business
restructuring reserves primarily related to favorable experience in employee
separations for the years ended September 30, 1999 and 1998, respectively. As of
September 30, 1999, all restructuring plans were complete and no reserves
remain.
7. INCOME TAXES
Income tax expense in the Company's combined financial statements has been
calculated on a separate tax return basis. The following table presents the
principal reasons for the difference between the effective tax rate and the U.S.
federal statutory income tax rate:
<TABLE>
<CAPTION>
YEAR ENDED
SEPTEMBER 30,
---------------------
1999 1998 1997
---- ---- -----
<S> <C> <C> <C>
U.S. federal statutory income tax rate...................... 35.0% 35.0% 35.0%
State and local income taxes, net of federal income tax
effect.................................................... 4.2 3.5 4.2
Foreign earnings and dividends taxed at different rates..... 5.0 (1.1) 2.0
Research credits............................................ (3.7) (2.1) (1.0)
Purchased in-process research and development............... -- 45.9 239.2
Other differences -- net.................................... (1.1) 0.9 1.1
---- ---- -----
Effective income tax rate................................... 39.4% 82.1% 280.5%
==== ==== =====
Effective income tax rate excluding purchased in-process
research and development.................................. 39.4% 36.2% 41.3%
</TABLE>
The following table presents the U.S. and foreign components of income
before income taxes and the provision for income taxes:
<TABLE>
<CAPTION>
YEAR ENDED
SEPTEMBER 30,
--------------------
1999 1998 1997
---- ---- ----
<S> <C> <C> <C>
INCOME BEFORE INCOME TAXES
U.S......................................................... $173 $102 $ 39
Foreign..................................................... 134 138 43
---- ---- ----
Income before income taxes.................................. $307 $240 $ 82
==== ==== ====
PROVISION FOR INCOME TAXES
CURRENT
Federal..................................................... $ 45 $117 $127
State and local............................................. 19 31 39
Foreign..................................................... 59 30 25
---- ---- ----
Sub-total................................................... 123 178 191
---- ---- ----
DEFERRED
Federal..................................................... (3) 20 42
State and local............................................. 1 (1) (3)
---- ---- ----
Sub-total................................................... (2) 19 39
---- ---- ----
Provision for income taxes.................................. $121 $197 $230
==== ==== ====
</TABLE>
F-16
145
NOTES TO COMBINED FINANCIAL STATEMENTS -- (CONTINUED)
(DOLLARS IN MILLIONS)
The asset and liability approach is used to recognize deferred tax assets
and liabilities for the expected future tax consequences of temporary
differences between the carrying amounts and the tax bases of assets and
liabilities. The components of deferred tax assets and liabilities at September
30, 1999 and 1998 are as follows:
<TABLE>
<CAPTION>
SEPTEMBER 30,
--------------
1999 1998
----- -----
<S> <C> <C>
DEFERRED INCOME TAX ASSETS
Benefit obligations......................................... $214 $122
Accrued liabilities......................................... 176 229
Net operating loss/credit carryforwards..................... 77 61
Valuation allowance......................................... (73) (48)
Other....................................................... 4 --
---- ----
Total deferred tax assets................................... $398 $364
==== ====
DEFERRED INCOME TAX LIABILITIES
Property, plant and equipment............................... $ 41 $ 23
Other....................................................... 49 45
---- ----
Total deferred tax liabilities.............................. $ 90 $ 68
==== ====
</TABLE>
As of September 30, 1999, the Company had tax credit carryforwards of $18
and federal, state and local foreign net operating loss carryforwards (tax
effected) of $59. Tax credit carryforwards begin to expire in the year 2003.
Federal and state net operating losses begin to expire in the year 2005 while
the majority of foreign net operating losses can be carried forward
indefinitely.
The valuation allowance has been established for deferred tax assets
primarily related to state tax credit carryforwards and foreign net operating
loss carryforwards for which management believes it is more likely than not such
deferred tax assets will not be realized.
The Company has not provided for U.S. deferred income taxes or foreign
withholding taxes on $221 of undistributed earnings of its operations outside
the U.S. as of September 30, 1999, since these earnings are intended to be
reinvested indefinitely.
8. BENEFIT OBLIGATIONS
Pension and Postretirement Benefits
At the Distribution, the Company will assume responsibility for pension and
postretirement benefit obligations for the active employees of the Company.
Obligations related to retired and terminated vested employees as of September
30, 2000 will remain the responsibility of Lucent. Until the Distribution, the
Company's employees will be participants in the Lucent pension plans and, upon
retirement, will be participants in Lucent's postretirement benefit plans.
Lucent has managed its employee benefit plans on a consolidated basis,
therefore, the Lucent plans' assets and liabilities are not included in the
Company's combined financial statements.
The pension and postretirement costs incurred by Lucent for employees who
performed services for the Company were based on estimated plan assets being
equal to a proportional share of plan obligations incurred by Lucent for
employees who performed services for the Company. In relation to the Lucent
plans, the Company recorded pension expense of $97, $70 and $84, and
postretirement benefit expense of $62, $49 and $49 in 1999, 1998 and 1997,
respectively. In connection with the Distribution, the Company will receive the
assets and liabilities of various existing Lucent pension and other employee
benefit plans related to the employees for whom the Company is assuming
responsibility.
F-17
146
NOTES TO COMBINED FINANCIAL STATEMENTS -- (CONTINUED)
(DOLLARS IN MILLIONS)
Effective October 1, 1998, Lucent changed its method for calculating the
market-related value of plan assets used in determining the expected
return-on-asset component of annual net pension and postretirement benefit
costs. Under the previous accounting method, the calculation of the
market-related value of plan assets included only interest and dividends
immediately, while all other realized and unrealized gains and losses were
amortized on a straight-line basis over a five-year period. The new method used
to calculate market-related value includes recognizing immediately an amount
based on Lucent's historical asset returns and amortizes the difference between
that amount and the actual return on a straight-line basis over a five-year
period. The new method is preferable under SFAS No. 87 because it results in
calculated plan asset values that are closer to current fair value, thereby
lessening the accumulation of unrecognized gains and losses while still
mitigating the effects of annual market value fluctuations.
The cumulative effect of this accounting change for the Company related to
periods prior to fiscal year 1999 of $158 ($96 after-tax) is a one-time,
non-cash credit to fiscal 1999 earnings. This accounting change also resulted in
a reduction in benefit costs in the fiscal year ended September 30, 1999 that
increased income by $30 ($18 after-tax) as compared with the previous accounting
method. The pro forma estimated effect if the accounting change were applied
retroactively would be an increase to pre-tax income of $28 and $25 for 1998 and
1997, respectively.
The information that follows relates to Lucent's employee benefit plans.
The following table shows the funded status of Lucent's defined benefit and
postretirement plans:
<TABLE>
<CAPTION>
PENSION POSTRETIREMENT
BENEFITS BENEFITS
SEPTEMBER 30, SEPTEMBER 30,
------------------ ------------------
1999 1998 1999 1998
------- ------- ------- -------
<S> <C> <C> <C> <C>
CHANGE IN BENEFIT OBLIGATION
Benefit obligation at October 1............. $27,846 $23,187 $ 9,193 $ 7,939
Service cost................................ 509 331 80 63
Interest cost............................... 1,671 1,631 537 540
Actuarial (losses) gains.................... (2,182) 3,811 (240) 919
Amendments.................................. 1,534 626 (359) 324
Benefits paid............................... (1,977) (1,740) (607) (592)
------- ------- ------- -------
Benefit obligation at September 30.......... $27,401 $27,846 $ 8,604 $ 9,193
------- ------- ------- -------
CHANGE IN PLAN ASSETS
Fair value of plan assets at October 1...... $36,191 $36,204 $ 3,959 $ 4,152
Actual return on plan assets................ 7,114 1,914 776 349
Lucent contributions........................ 14 12 29 53
Benefits paid............................... (1,977) (1,740) (607) (592)
Other (including transfer of assets from
pension to postretirement plans).......... (275) (199) 310 (3)
------- ------- ------- -------
Fair value of plan assets at September 30... $41,067 $36,191 $ 4,467 $ 3,959
------- ------- ------- -------
FUNDED (UNFUNDED) STATUS OF THE PLAN........ $13,666 $ 8,345 $(4,137) $(5,234)
Unrecognized prior service cost............. 2,583 1,509 121 533
Unrecognized transition asset............... (645) (944) -- --
Unrecognized net gain....................... (9,466) (5,175) (1,014) (408)
------- ------- ------- -------
NET AMOUNT RECOGNIZED....................... $ 6,138 $ 3,735 $(5,030) $(5,109)
</TABLE>
F-18
147
NOTES TO COMBINED FINANCIAL STATEMENTS -- (CONTINUED)
(DOLLARS IN MILLIONS)
<TABLE>
<CAPTION>
PENSION POSTRETIREMENT
BENEFITS BENEFITS
SEPTEMBER 30, SEPTEMBER 30,
------------------ ------------------
1999 1998 1999 1998
------- ------- ------- -------
<S> <C> <C> <C> <C>
======= ======= ======= =======
Amounts recognized in the Lucent
consolidated balance sheets consist of:
Prepaid pension costs....................... $ 6,175 $ 3,754 $ -- $ --
Accrued benefit liability................... (63) (44) (5,030) (5,109)
Intangible asset............................ 9 4 -- --
Accumulated other comprehensive income...... 17 21 -- --
------- ------- ------- -------
Net amount recognized....................... $ 6,138 $ 3,735 $(5,030) $(5,109)
======= ======= ======= =======
</TABLE>
Pension plan assets include $287 and $159 of Lucent common stock at
September 30, 1999 and 1998, respectively. Postretirement plan assets include
$20 and $11 of Lucent common stock at September 30, 1999 and 1998, respectively.
<TABLE>
<CAPTION>
AS OF SEPTEMBER 30,
------------------------
1999 1998 1997
---- ---- ----
<S> <C> <C> <C>
PENSION AND POSTRETIREMENT BENEFITS WEIGHTED-AVERAGE
ASSUMPTIONS
Discount rate.............................................. 7.25% 6.0% 7.25%
Expected return on plan assets............................. 9.0% 9.0% 9.0%
Rate of compensation increase.............................. 4.5% 4.5% 4.5%
</TABLE>
Lucent has several non-pension postretirement benefit plans. For
postretirement health care benefit plans, Lucent assumed a 9.2% annual health
care cost trend rate for 2000, gradually declining to 3.9% by the year 2005,
after which the trend rate would remain at that level. The assumed health care
cost trend rate has a significant effect on the amounts reported. A
one-percentage-point change in the assumed Lucent health care cost trend rate
would have the following effects:
<TABLE>
<CAPTION>
1 PERCENTAGE POINT
--------------------
INCREASE DECREASE
-------- --------
<S> <C> <C>
Effect on total of service and interest cost components... $ 23 $ 20
Effect on postretirement benefit obligation............... $371 $344
</TABLE>
Savings Plans
The majority of the Company's employees are eligible to participate in
savings plans sponsored by Lucent. The plans allow employees to contribute a
portion of their compensation on a pre-tax and/or after-tax basis in accordance
with specified guidelines. Lucent matches a percentage of employee contributions
up to certain limits. The Company's expense related to the Lucent savings plans
was $68, $64, and $35 in 1999, 1998 and 1997, respectively. The Company expects
to establish similar plans following the Distribution.
9. STOCK COMPENSATION PLANS
During 1999, 1998 and in prior years, certain employees of the Company were
granted stock options and other equity-based awards under Lucent's stock-based
compensation plans. During 1999, 1998 and 1997, the Company's employees were
also eligible to participate in the Lucent Employee Stock Purchase Plan
("ESPP"). At the time of the Distribution, unvested awards outstanding under
Lucent's stock plans that are held by Lucent employees who transfer to the
Company will be converted to awards to acquire stock of the Company. Vested
Lucent stock options will remain options to acquire Lucent common stock,
F-19
148
NOTES TO COMBINED FINANCIAL STATEMENTS -- (CONTINUED)
(DOLLARS IN MILLIONS)
subject to adjustments as described below. The Company will initiate its own
employee stock purchase plan at the time of the Distribution.
The stock options and other awards as converted or adjusted will have the
same vesting provisions, option periods, and other terms and conditions as the
Lucent options and awards they replaced. The number of shares and exercise price
of each stock option will be adjusted so that each option, whether a Lucent
option or a Company option, will have the same ratio of the exercise price per
share to the market value per share, and the same aggregate difference between
market value and exercise price (intrinsic value), as the Lucent stock options
prior to the Distribution. No new measurement date is expected to occur upon
conversion of the stock options.
Stock options generally are granted with an exercise price equal to 100% of
the market value of a share of common stock on the date of grant, have a
ten-year term and vest within four years from the date of grant.
In connection with certain of the Company's acquisitions, outstanding stock
options held by employees of acquired companies became exercisable, according to
their terms, for Lucent's common stock effective at the acquisition date. For
acquisitions accounted for as purchases, the fair value of these options was
included as part of the purchase price.
Under the terms of Lucent's ESPP, eligible employees may have up to 10% of
eligible compensation deducted from their pay to purchase common stock through
June 30, 2001. The per share purchase price is 85% of the average high and low
per share trading price of Lucent common stock on the New York Stock Exchange on
the last trading day of each month. In 1999, 1998 and 1997, 1.2 million, 1.6
million and 2.1 million Lucent shares, respectively, were purchased under the
ESPP, at a weighted average price of $47.02, $24.49 and $12.65, respectively.
Lucent has adopted the disclosure requirements of SFAS No. 123, "Accounting
for Stock-Based Compensation" and, as permitted under SFAS No. 123, applies
Accounting Principles Board Opinion ("APB") No. 25 and related interpretations
in accounting for its plans. Compensation expense recorded under APB No. 25,
which uses the intrinsic value method, was $14, $4 and $2 for the years ended
September 30, 1999, 1998 and 1997, respectively. If Lucent had elected to adopt
the optional recognition provisions of SFAS No. 123, which uses the fair
value-based method, for its stock option plans and employee stock purchase plan,
net income for the Company would have been changed to the pro forma amounts
indicated below:
<TABLE>
<CAPTION>
YEAR ENDED SEPTEMBER 30,
------------------------
1999 1998 1997
----- ----- ------
<S> <C> <C> <C>
NET INCOME
As reported................................................. $282 $43 $(148)
Pro forma................................................... $231 $16 $(162)
</TABLE>
The fair value of stock options used to compute pro forma net income
disclosures is the estimated fair value at grant date using the Black-Scholes
option-pricing model with the following assumptions:
<TABLE>
<CAPTION>
YEAR ENDED SEPTEMBER 30,
--------------------------
1999 1998 1997
------ ------ ------
<S> <C> <C> <C>
WEIGHTED AVERAGE ASSUMPTIONS
Dividend yield.............................................. 0.13% 0.23% 0.65%
Expected volatility......................................... 34.1% 29.3% 22.4%
Risk free interest rate..................................... 5.3% 5.2% 6.4%
Expected holding period (in years).......................... 3.8 5.0 5.0
</TABLE>
F-20
149
NOTES TO COMBINED FINANCIAL STATEMENTS -- (CONTINUED)
(DOLLARS IN MILLIONS)
Presented below is a summary of the status of the Lucent stock options held
by employees for whom the Company estimates it will assume responsibility, and
the related transactions for the years ended September 30, 1999, 1998 and 1997.
The stock option activity is not necessarily indicative of what the activity
would have been had the Company been a separate stand-alone entity during the
periods presented or what the activity may be in the future.
<TABLE>
<CAPTION>
SHARES WEIGHTED AVERAGE
(000'S) EXERCISE PRICE
------- ----------------
<S> <C> <C>
OPTIONS OUTSTANDING AT OCTOBER 1, 1996...................... 2,197 $10.92
Granted/Assumed*(1)......................................... 13,709 11.30
Exercised................................................... (124) 7.60
Forfeited/Expired........................................... (8) 11.17
------
OPTIONS OUTSTANDING AT SEPTEMBER 30, 1997................... 15,774 11.27
Granted/Assumed*(2)......................................... 12,665 31.65
Exercised................................................... (1,278) 7.73
Forfeited/Expired........................................... (95) 6.10
------
OPTIONS OUTSTANDING AT SEPTEMBER 30, 1998................... 27,066 20.99
Granted/Assumed............................................. 6,814 49.81
Exercised................................................... (2,246) 11.44
Forfeited/Expired........................................... (33) 36.86
------
OPTIONS OUTSTANDING AT SEPTEMBER 30, 1999................... 31,601 27.87
======
</TABLE>
- ---------------
* Includes options converted in acquisitions.
(1) Includes options covering 7,713 shares of common stock granted under a
broad-based employee plan at a weighted average exercise price of $11.15.
(2) Includes options covering 5,843 shares of common stock granted under a
broad-based employee plan at a weighted average exercise price of $37.34.
The weighted average fair value of the Company's stock options, calculated
using the Black-Scholes option-pricing model, granted during the years ended
September 30, 1999, 1998 and 1997 is $19.21, $12.35 and $3.56 per share,
respectively.
F-21
150
NOTES TO COMBINED FINANCIAL STATEMENTS -- (CONTINUED)
(DOLLARS IN MILLIONS)
The following table summarizes the status of stock options outstanding and
exercisable at September 30, 1999:
<TABLE>
<CAPTION>
STOCK OPTIONS STOCK OPTIONS
OUTSTANDING EXERCISABLE
---------------------------------- -------------------
WEIGHTED
AVERAGE
REMAINING WEIGHTED WEIGHTED
CONTRACTUAL AVERAGE AVERAGE
SHARES LIFE EXERCISE SHARES EXERCISE
RANGE OF EXERCISE PRICES (000'S) (YEARS) PRICE (000'S) PRICE
- ------------------------ ------- ----------- -------- ------- --------
<S> <C> <C> <C> <C> <C>
$ 0.01 to $ 11.14................. 10,352 6.6 $10.53 2,146 $ 9.28
$11.15 to $ 23.07................. 5,528 7.2 17.14 934 14.60
$23.08 to $ 29.09................. 269 8.4 27.26 22 27.22
$29.10 to $ 40.87................. 9,068 9.0 35.88 211 35.34
$40.88 to $ 61.78................. 4,357 9.1 48.83 141 46.69
$61.79 to $102.48................. 2,027 9.8 64.92 19 72.47
------ -----
Total............................. 31,601 27.87 3,473 14.27
====== =====
</TABLE>
Other stock unit awards are granted under certain award plans. The
following table presents the total number of shares of common stock represented
by awards granted to Company employees:
<TABLE>
<CAPTION>
YEAR ENDED SEPTEMBER 30,
--------------------------
1999 1998 1997
------ ------ ------
<S> <C> <C> <C>
Other stock unit awards granted (000's).................. 10 164 711
Weighted average market value of shares granted during
the period............................................. $47.73 $24.98 $11.19
</TABLE>
10. OPERATING SEGMENTS
The Company reports its operations in three segments: Communications
Solutions, Services and Connectivity Solutions. The Communications Solutions
segment represents the Company's core business, comprised of enterprise voice
communications systems and software, communications applications, professional
services for customer and enterprise relationship management, multi-service
networking products and product installation services. The purchase prices of
the Company's products typically include installation costs. The Connectivity
Solutions segment represents structured cabling systems and electronic cabinets.
The Services segment represents maintenance and value-added services.
Each segment is managed separately as each operation requires different
technologies and marketing strategies. Intersegment transactions that occur are
based on current market prices and all intersegment profit is eliminated in
consolidation. Disclosure of segment information is on the same basis used
internally for evaluating segment performance and for deciding how to allocate
resources.
The Company has centralized corporate functions and uses shared service
arrangements to realize economies of scale and efficient use of resources. The
costs of shared services, and other corporate center operations managed on a
common basis, are allocated to the segments based on usage, where possible, or
other factors based on the nature of the activity. The accounting policies of
the reportable operating segments are the same as those described in the Summary
of Significant Accounting Policies (see Note 2).
Performance measurement and resource allocation for the reportable
operating segments are based on many factors. The primary financial measure used
is operating income, exclusive of corporate operations including goodwill and
existing technology amortization, and of purchased in-process research and
development and other costs from business acquisitions (acquisition or
integration-related costs).
F-22
151
NOTES TO COMBINED FINANCIAL STATEMENTS -- (CONTINUED)
(DOLLARS IN MILLIONS)
Reportable Segments
<TABLE>
<CAPTION>
NINE MONTHS ENDED YEAR ENDED
JUNE 30, SEPTEMBER 30,
------------------ --------------------------
2000 1999 1999 1998 1997
------- ------- ------ ------ ------
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
Communications Solutions:
External revenue............................ $3,255 $3,529 $5,088 $4,583 $3,721
Intersegment revenue........................ 9 24 24 -- 2
Total Revenue....................... 3,264 3,553 5,112 4,583 3,723
Operating income (loss)..................... 54 (72) 81 115 166
Assets...................................... 1,829 2,181 2,204 2,274 1,964
Capital expenditures........................ 70 49 64 86 77
Depreciation and amortization............... 59 64 85 88 91
Services:
External revenue............................ $1,452 $1,396 $1,900 $1,750 $1,523
Intersegment revenue........................ -- -- -- -- --
Total Revenue....................... 1,452 1,396 1,900 1,750 1,523
Operating income............................ 178 137 199 300 330
Assets...................................... 585 664 599 695 491
Capital expenditures........................ 30 16 20 21 32
Depreciation and amortization............... 18 17 23 19 17
Connectivity Solutions:
External revenue............................ $ 955 $ 940 $1,274 $1,408 $1,158
Intersegment revenue........................ 1 8 8 -- --
Total Revenue....................... 956 948 1,282 1,408 1,158
Operating income............................ 93 103 111 224 113
Assets...................................... 782 793 707 677 509
Capital expenditures........................ 16 37 51 70 66
Depreciation and amortization............... 30 31 37 30 26
</TABLE>
F-23
152
NOTES TO COMBINED FINANCIAL STATEMENTS -- (CONTINUED)
(DOLLARS IN MILLIONS)
Reconciling Items
A reconciliation of the totals reported for the operating segments to the
significant line items in the combined financial statements is as follows:
<TABLE>
<CAPTION>
NINE MONTHS ENDED YEAR ENDED
JUNE 30, SEPTEMBER 30,
------------------ --------------------------
2000 1999 1999 1998 1997
------- ------- ------ ------ ------
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
EXTERNAL REVENUE
Total reportable segments........... $5,662 $5,865 $8,262 $7,741 $6,402
Corporate and other................. 2 5 6 13 11
------ ------ ------ ------ ------
Total External Revenue.............. $5,664 $5,870 $8,268 $7,754 $6,413
====== ====== ====== ====== ======
OPERATING INCOME
Total reportable segments........... $ 325 $ 168 $ 391 $ 639 $ 609
Goodwill and existing technology
amortization..................... (43) (46) (59) (45) (13)
Purchased in-process research and
development...................... -- -- -- (306) (472)
Corporate and other................. -- 13 37 21 --
------ ------ ------ ------ ------
Total operating income (loss)....... $ 282 $ 135 $ 369 $ 309 $ 124
====== ====== ====== ====== ======
</TABLE>
The results of other smaller units and corporate operations are reported in
corporate and other. Assets included in corporate and other consist primarily of
items not specifically identifiable to the operating segments and principally
includes cash, deferred taxes and property, plant and equipment.
Geographic Information
<TABLE>
<CAPTION>
EXTERNAL REVENUE(1) LONG-LIVED ASSETS(2)
YEAR ENDED SEPTEMBER 30, SEPTEMBER 30,
-------------------------- --------------------
1999 1998 1997 1999 1998 1997
------ ------ ------ ---- ---- ----
<S> <C> <C> <C> <C> <C> <C>
U.S.............................. $6,683 $6,376 $5,343 $583 $532 $461
Foreign countries................ 1,585 1,378 1,070 93 81 74
------ ------ ------ ---- ---- ----
Totals......................... $8,268 $7,754 $6,413 $676 $613 $535
====== ====== ====== ==== ==== ====
</TABLE>
- ---------------
(1) Revenue is attributed to geographic areas based on the location of
customers.
(2) Represents property, plant and equipment (net).
Concentrations
For any period presented, no single customer accounts for more than 10% of
the Company's combined revenue. The Company is not aware of any significant
concentration of business transacted with a particular supplier that could, if
suddenly eliminated have a material adverse affect on the Company's operations.
While the Company believes that alternative sources would be available,
disruption of its primary source could create a temporary, adverse effect on
product shipments.
F-24
153
NOTES TO COMBINED FINANCIAL STATEMENTS -- (CONTINUED)
(DOLLARS IN MILLIONS)
11. FINANCIAL INSTRUMENTS
Fair Value
The net carrying amounts and estimated fair values of the Company's foreign
currency forward exchange contracts and options were immaterial in 1999 and were
liabilities in 1998 of $8 and $6, respectively. Market quotes were used to
estimate the fair value of foreign currency forward exchange contracts/options.
The carrying amounts of cash and cash equivalents, investments and receivables
contained in the combined balance sheets approximate fair value.
Derivative Financial Instruments
The Company conducts its business on a multinational basis in a wide
variety of foreign currencies. Consequently, the Company enters into various
foreign exchange forward and option contracts to manage its exposure against
adverse changes in those foreign exchange rates. The notional amounts for
foreign exchange forward and option contracts represent the U.S. dollar
equivalent of an amount exchanged. Generally, foreign currency exchange
contracts are designated for firmly committed or forecasted sales and purchases
that are expected to occur in less than one year. Gains and losses on all hedged
contracts for firmly committed transactions and option contracts for anticipated
transactions are deferred in Other current assets and liabilities, are
recognized in income when the transactions occur, and are not material to the
combined financial statements at September 30, 1999, and 1998. All other gains
and losses on foreign currency exchange contracts are recognized in other
income-net as the exchange rates change.
The Company engages in foreign currency hedging activities to reduce the
risk that changes in exchange rates will adversely affect the eventual net cash
flows resulting from the sale of products to foreign customers and purchases
from foreign suppliers. The Company believes that it has achieved risk reduction
and hedge effectiveness, because the gains and losses on its derivative
instruments substantially offset the gains on the assets, liabilities and
transactions being hedged. Hedge effectiveness is periodically measured by
comparing the change in fair value of each hedged foreign currency exposure at
the applicable market rate with the change in market value of the corresponding
derivative instrument.
The notional amounts at September 30, 1999 and 1998 of the Company's
foreign exchange forward contracts were $93 and $211, respectively, and foreign
exchange option contracts were $52 and $21, respectively. In 1999, these
notional amounts principally represent contracts in Canadian dollars, British
pounds and Dutch guilders. Notional amounts represent the face amount of the
contractual arrangements and the basis on which U.S. dollars are to be exchanged
and are not a measure of market or credit exposure.
Non-Derivative and Off-Balance-Sheet Instruments
Requests for providing commitments to extend credit and financial
guarantees are reviewed and approved by senior management. Management regularly
reviews all outstanding commitments, letters of credit and financial guarantees,
and the results of these reviews are considered in assessing the adequacy of the
Company's reserve for possible credit and guarantee losses.
At September 30, 1999 and 1998, in management's opinion, there was no
significant risk of loss in the event of non-performance of the counterparties
to these financial instruments.
Letters of Credit
Letters of credit are purchased guarantees that ensure the Company's
performance or payment to third parties in accordance with specified terms and
conditions which amounted to approximately $20 as of September 30, 1999 and
1998.
F-25
154
NOTES TO COMBINED FINANCIAL STATEMENTS -- (CONTINUED)
(DOLLARS IN MILLIONS)
12. TRANSACTIONS WITH LUCENT
For the years 1999, 1998 and 1997, the Company had $108, $90 and $97,
respectively, of revenue for products sold to Lucent. For the years 1999, 1998
and 1997, the Company had $189, $244 and $205, respectively, of products
purchased from Lucent.
In connection with the Contribution and Distribution, the Company and
Lucent are expected to execute and deliver the Contribution and Distribution
Agreement (the "Contribution and Distribution Agreement"), and certain related
agreements which are summarized below. This summary is qualified in all respects
by the terms of the Contribution and Distribution Agreement and such related
agreements.
Contribution and Distribution Agreement
Pursuant to the Contribution and Distribution Agreement, Lucent expects to
transfer to the Company substantially all of the assets, liabilities and
operations associated with the Company's Businesses. The Contribution and
Distribution Agreement, among other things, provides that the Company will
indemnify Lucent for all liabilities relating to the Company's Businesses and
for all contingent liabilities primarily relating to the Company's Businesses or
otherwise assigned to the Company. In addition, the Contribution and
Distribution Agreement provides that certain contingent liabilities not
allocated to one of the parties will be shared by Lucent and the Company in
proportion to the respective book value of their assets. The Contribution and
Distribution Agreement also provides that each party will share specified
portions of contingent liabilities based upon agreed percentages related to the
business of the other party that exceed $50 million.
Employee Benefits Agreement and Plans
The Company and Lucent are expected to enter into an Employee Benefits
Agreement, pursuant to which the Company will create independent pension and
other employee benefit plans that are substantially similar to Lucent's existing
pension and other employee benefit plans. This agreement will provide for the
transfer of assets and liabilities of various existing Lucent pension and other
employee benefit plans related to Lucent employees who are transferring to the
Company. Generally, following the Distribution, Lucent will cease to have any
liability or obligation to the Company's current employees and their
beneficiaries under any of Lucent's benefit plans, programs or practices. Under
the agreement, the Company will receive assets and liabilities of various
existing Lucent pension and other employee benefit plans related to the
employees for which the Company is assuming responsibility.
Federal, State and Local Tax Allocation Agreements
The Company and Lucent are expected to continue the existing State and
Local Income Tax Allocation Agreement and the existing Federal Tax Allocation
Agreement by and among Lucent and its subsidiaries. These tax agreements govern
the allocation of state, local and federal income taxes for periods prior to and
including the date of the Distribution.
Tax Sharing Agreement
The Company and Lucent are expected to enter into a Tax Sharing Agreement,
which will govern the Company's and Lucent's respective rights, responsibilities
and obligations after the Distribution with respect to taxes for the periods
ending on or before the Distribution. Generally, pre-Distribution taxes that are
clearly attributable to the business of one party will be borne solely by that
party, and other pre-Distribution taxes will be shared by the parties based on a
formula set forth in the Tax Sharing Agreement. In addition, the Tax Sharing
Agreement will address the allocation of liability for taxes that are incurred
as a result of restructuring activities undertaken to implement the
distribution. If the distribution fails to qualify as a tax-free distribution
under Section 355 of the Internal Revenue Code
F-26
155
NOTES TO COMBINED FINANCIAL STATEMENTS -- (CONTINUED)
(DOLLARS IN MILLIONS)
because of an acquisition of our stock or assets, or some other actions of ours,
then we will be solely liable for any resulting corporate taxes.
Global Purchase and Service Agreement
The Company and Lucent are expected to enter into a Global Purchase and
Service Agreement under which the Company will provide to Lucent products for
internal use. These products include the Company's enterprise voice
communications products as well as multi-service networking products. The
agreement neither grants to the Company an exclusive right to provide Lucent any
or all of these products or services, nor does it require the procurement of
products or services from the Company by Lucent. The pricing terms of goods and
services covered by the Global Purchase and Service Agreement will reflect
negotiated prices.
General Sales Agreement and Microelectronics Product Purchase Agreement
The Company and Lucent are expected to enter into a General Sales Agreement
and a Microelectronic Product Purchase Agreement, which will govern transactions
pursuant to which Lucent will provide its products and services that are not
part of the business not being transferred to the Company. These agreements
neither grant to Lucent an exclusive right to provide the Company with any or
all products or services, nor require the procurement of products or services
from Lucent by the Company. The pricing terms of goods and services covered by
the General Sales Agreement and Microelectronics Product Purchase Agreement will
reflect negotiated prices.
Other Commercial Agreements
In addition to the above listed agreements, the Company and Lucent are
expected to enter into a number of other commercial agreements to govern resale,
subcontracting and original equipment manufacturing arrangements between Lucent
and the Company. The pricing terms of the products, and services covered by the
other commercial agreements will reflect negotiated prices.
Interim Services and Systems Replication Agreement
The Company and Lucent are expected to enter into an Interim Services and
Systems Replication Agreement to provide each other, on an interim, transitional
basis, with various data processing services, telecommunications services and
corporate support services, including: accounting, financial management,
information systems management, tax, payroll, legal, human resources
administration, procurement and other general support. Furthermore, under the
terms of this agreement, Lucent will provide the Company with technical support
for the Company's converged voice and data products for a specified period of
time. Specific charges for such services are generally intended to allow the
company providing services to recover direct costs plus expenses, without
profit.
The Interim Services and Systems Replication Agreement will also provide
for the replication and transfer of specified computer systems used for
administrative support or used in the Company's Businesses or Lucent's retained
businesses. The systems include specified hardware, software, data storage or
maintenance and support components. Costs and expenses of purchasing hardware or
obtaining software will be borne by the party purchasing the hardware or
licensing the software.
Real Estate Agreements
Lucent and the Company are expected to also enter into various leases and
sublease arrangements for the sharing of certain facilities for a transitional
period on commercial terms. In the case of owned real estate to be leased, the
lease terms will be either two or three years, except that a limited number of
leases may be terminated on 90 days' notice by the tenant. In the case of
subleases or sub-subleases of
F-27
156
NOTES TO COMBINED FINANCIAL STATEMENTS -- (CONTINUED)
(DOLLARS IN MILLIONS)
property, the lease term will generally coincide with the remaining term of the
primary lease or sublease, respectively.
Trademark License Agreement
The Company and Lucent are expected to enter into a Trademark License
Agreement, pursuant to which the Company will have rights, on a royalty-free
basis, to continue to use the Lucent brand for specified transition periods
following the Distribution.
Patent Assignment
Pursuant to the Patent Assignment, Lucent and its subsidiary, Lucent
Technologies Guardian Corp., are expected to transfer to a subsidiary of the
Company certain patents and patent applications held by Lucent and Lucent
Technologies Guardian Corp. that relate principally to the Company's Businesses.
Lucent will retain ownership of all other patents and patent applications
currently owned by Lucent.
Technology Assignment and Joint Ownership Agreement
The Company and Lucent are expected to execute and deliver assignments and
other agreements, including the technology assignment, related to technology
currently owned or controlled by Lucent and its subsidiaries. Technology will
include copyrights, mask works and other intellectual property other than
trademarks, trade names, service marks and patent rights. The technology
assignment will divide ownership of technology between the Company and Lucent,
with each owning technology that was developed by or for, or purchased by, each
company for their respective businesses. Certain specified technology will be
owned jointly by the Company and Lucent.
Patent and Technology License Agreement
The Company and Lucent are expected to enter into a Patent and Technology
License Agreement under which Lucent and the Company will grant to each other
under certain patents and technology, a nonexclusive, personal, nontransferable
license to make, have made, use, lease, import, offer to sell, and sell any and
all products and services of the businesses in which the licensed company,
including specified related companies, is now or hereafter engaged. The
cross-licenses also permit each company, subject to specified limitations, to
have third parties make items under the other company's patents, as well as to
pass through to customers certain rights under the other company's patents with
respect to products and services furnished to customers by the licensed company.
Development Project Agreement
Lucent and the Company are expected to enter into a Development Project
Agreement governing their future commercial relationship under which Lucent's
Bell Labs will perform certain development activities for the Company, and the
Company will perform certain development activities for Lucent. Under this
agreement, Bell Labs will perform specific research and development projects on
a contract basis for the Company.
13. COMMITMENTS AND CONTINGENCIES
In the normal course of business, the Company is subject to proceedings,
lawsuits and other claims, including proceedings under laws and government
regulations related to environmental and other matters. The telecommunications
industry is characterized by substantial litigation regarding patents and other
intellectual property rights. From time to time, the Company may be party to
various inquiries or claims in connection with these rights. Such matters are
subject to many uncertainties, and outcomes are not predictable with assurance.
Consequently, the ultimate aggregate amount of monetary liability or financial
F-28
157
NOTES TO COMBINED FINANCIAL STATEMENTS -- (CONTINUED)
(DOLLARS IN MILLIONS)
impact with respect to these matters at March 31, 2000 cannot be ascertained.
While these matters could affect the operating results of any one quarter when
resolved in future periods and while there can be no assurance with respect
thereto, management believes that after final disposition, any monetary
liability or financial impact to the Company beyond that provided for at March
31, 2000, would not be material to the annual combined financial statements.
Risks and Uncertainties
The Company has no history operating as an independent company, and it may
be unable to make the changes necessary to operate as a stand-alone business, or
it may incur greater costs as a stand-alone company that may cause its
profitability to decline. Prior to the Distribution, the Company's business was
operated by Lucent as a segment of its broader corporate organization rather
than as a separate stand-alone company. Lucent assisted the Company by providing
financing, particularly of acquisitions, as well as providing corporate
functions such as identifying and negotiating acquisitions, and legal and tax
functions. Following the Distribution, Lucent will have no obligation to provide
assistance to the Company other than the interim and transitional services,
which will be provided by Lucent. Because the Company's businesses have never
been operated as an independent company, it cannot provide assurance that it
will be able to successfully implement the changes necessary to operate
independently or that the Company will not incur additional costs operating
independently that will cause its profitability to decline.
Legal Proceedings
From time to time the Company is involved in legal proceedings arising in
the ordinary course of business. The Company believes there is no litigation
pending that should have, individually or in the aggregate, a material adverse
effect on its financial position or results of operations. The Company is
involved in three purported class action lawsuits related to Y2K issues.
Although the Company believes that the outcome of these actions will not
adversely affect our business prospects, if these cases progress, they will
require expenditure of significant legal costs related to their defense.
Legal Proceedings Update (Unaudited)
In September 2000, one of the three purported class action lawsuits
relating to Y2K issues was dismissed.
Environmental Matters
The Company is subject to a wide range of governmental requirements
relating to employee safety and health and to the handling and emission into the
environment of various substances used in its operations. The Company is subject
to certain provisions of environmental laws, particularly in the U.S., governing
the cleanup of soil and groundwater contamination. Such provisions impose
liability for the costs of investigating and remediating releases of hazardous
materials at currently or formerly owned or operated sites of the Company. In
certain circumstances, this liability may also include the cost of cleaning up
historical contamination, whether or not caused by the Company. The Company is
currently conducting investigation and/or cleanup of known contamination at
approximately five of the Company's facilities either voluntarily or pursuant to
government directives.
It is often difficult to estimate the future impact of environmental
matters, including potential liabilities. The Company has established financial
reserves to cover environmental liabilities where they are probable and
reasonably estimable. Reserves for estimated losses from environmental matters
are, depending on the site, based primarily upon internal or third-party
environmental studies and the extent of contamination and the type of required
cleanup. Although the Company believes that its reserves are adequate to cover
known environmental liabilities, there can be no assurance that the actual
amount of
F-29
158
NOTES TO COMBINED FINANCIAL STATEMENTS -- (CONTINUED)
(DOLLARS IN MILLIONS)
environmental liabilities will not exceed the amount of reserves for such
matters or will not have a material adverse effect on the Company's combined
financial position, results of operations or cash flows.
Leases
The Company leases land, buildings and equipment under agreements that
expire in various years through 2019. Rental expense under operating leases was
$146, $94 and $67 for the years ended September 30, 1999, 1998 and 1997,
respectively. The table below shows the future minimum lease payments due under
non-cancelable operating leases at September 30, 1999. Such payments total $284.
<TABLE>
<CAPTION>
YEAR ENDED SEPTEMBER 30,
- ----------------------------------------
LATER
2000 2001 2002 2003 2004 YEARS
- ---- ---- ---- ---- ---- -----
<S> <C> <C> <C> <C> <C>
$85 $66 $41 $30 $22 $40
</TABLE>
The Company also has sales-type and direct financing leases for certain
products. Lease payment receivables under such agreements were $43 and $50 as of
September 30, 1999 and 1998, respectively. The table below shows the future
minimum lease payments to be received under sales-type and direct financing
leases at September 30, 1999. Such payments to be received total $43.
<TABLE>
<CAPTION>
YEAR ENDED SEPTEMBER 30,
- ----------------------------------------
LATER
2000 2001 2002 2003 2004 YEARS
- ---- ---- ---- ---- ---- -----
<S> <C> <C> <C> <C> <C>
$13 $10 $8 $6 $4 $2
</TABLE>
14. QUARTERLY INFORMATION (UNAUDITED)
<TABLE>
<CAPTION>
FISCAL YEAR QUARTERS
-----------------------------------------------
FIRST SECOND THIRD FOURTH TOTAL
------ ------ ------ ------ ------
<S> <C> <C> <C> <C> <C>
YEAR ENDED SEPTEMBER 30, 1999
Revenue................................ $1,894 $1,938 $2,038 $2,398(2) $8,268
Gross margin........................... 840 841 939 1,084 3,704
Net income (loss) before cumulative
effect of accounting change.......... 4 (34) 87 129 186
Cumulative effect of accounting
change(1)............................ 96 -- -- -- 96
Net income (loss)...................... 100 (34) 87 129 282
YEAR ENDED SEPTEMBER 30, 1998
Revenue................................ $1,865 $1,690 $1,918 $2,281 $7,754
Gross margin........................... 919 776 850 1,102 3,647
Net income (loss)...................... 105 (97) 59 (24) 43
</TABLE>
- ---------------
(1) Effective October 1, 1998, the Company changed its method for calculating
the market-related value of plan assets used in determining the expected
return-on-asset component of annual net pension and postretirement benefit
costs (see Note 8 to the combined financial statements).
(2) In 1999, the Company sold equipment, which was previously rented to
customers for $97. The equipment had a net book value of approximately $2
and consisted predominantly of discontinued product lines.
F-30
159
NOTES TO COMBINED FINANCIAL STATEMENTS -- (CONTINUED)
(DOLLARS IN MILLIONS)
15. SUBSEQUENT EVENTS AND OTHER RELATED PARTY TRANSACTIONS (UNAUDITED)
Subsequent Events
On August 8, 2000, the Company entered into an agreement with Warburg,
Pincus Equity Partners, L.P. and related investment funds, collectively referred
to as the investors, to sell to them 4,000,000 shares of the Company's Series B
convertible participating preferred stock and warrants to purchase the Company's
common stock for an aggregate purchase price of $400. The consummation of this
equity investment is subject to a number of conditions, including consummation
of the Distribution. Based on an agreed formula, the Series B convertible
participating preferred stock is expected to be initially convertible into
approximately 5.0% of the Company's fully diluted common stock, calculated using
a modified treasury stock method as of the 90th day after issuance. The warrants
have an exercise price equal to 130% of the conversion price for the Series B
convertible participating preferred stock. The warrants are exercisable for 3.6%
of a total number of shares of common stock to be calculated pursuant to an
agreed upon formula as of the 90th day after issuance. Of these warrants,
warrants exercisable for 2.0% of such total number of shares of common stock
will have a four-year term and warrants exercisable for 1.6% of such total
number of shares of common stock will have a five-year term. During a period
commencing no later than June 30, 2001, until the second anniversary of their
issuance, if the market price of the Company's common stock exceeds agreed upon
trading price levels, the Company can force conversion of up to 50% of the
warrants.
The shares of Series B convertible participating preferred stock will have
an aggregate initial liquidation value of $400 and will accrete for the first
ten years at an annual rate of 6.5%, compounded quarterly. After the third
anniversary of the issue date, 50% of the amount accreted for the year may be
paid in cash as a dividend on a quarterly basis, at the Company's option. From
the fifth anniversary of the issue date through the tenth anniversary, the
Company may elect to pay 100% of the amount accreted for the year as a cash
dividend on a quarterly basis. Following the tenth anniversary of the issue
date, the Company will pay quarterly cash dividends at an annual rate of 12% of
the then accreted liquidation value of the Series B convertible participating
preferred stock, compounded quarterly. The Series B convertible participating
preferred shares also participate, on an as-converted basis, in dividends paid
on the Company's common stock.
Once the conversion rate is known at Distribution, it may be determined
that a beneficial conversion feature exists which would serve as a further
dilution to earnings per share.
In August 2000, the Company was advised by Region 6 of the National Labor
Relations Board that it has been authorized to file a complaint alleging that
Lucent has refused to bargain over the outsourcing of certain of its
manufacturing activities. Because the complaint will relate to some of the
manufacturing facilities that will be transferred to the Company as part of the
distribution, the Company expects to become a party to this action. If the
Company is unsuccessful in resolving these charges, as they relate to the
Company, the Company's operations may be disrupted, the Company's initiative to
outsource substantially all of its manufacturing may be delayed or prohibited or
the Company may incur additional costs that may decrease its profitability.
Other Related Party Transactions
Henry Schacht, who will be chairman of the Company's board of directors
following the Distribution, is a managing director and senior advisor of an
affiliate of an investor.
During fiscal 2000, a privately held business, of which Mr. Schacht holds
an 80% equity interest and of which his son is the controlling shareholder,
purchased and paid for call center equipment and consulting services from the
Company for a total of approximately $800 thousand. This business continues to
purchase routine services from the Company on a time and materials basis.
F-31
160
AVAYA INC. AND SUBSIDIARIES
SCHEDULE II -- VALUATION AND QUALIFYING ACCOUNTS
(DOLLARS IN MILLIONS)
<TABLE>
<CAPTION>
COLUMN A COLUMN B COLUMN C COLUMN D COLUMN E
- ------------------------------------------ ------------ --------------------- ---------- -------------
ADDITIONS
---------------------
BALANCE AT CHARGED CHARGED
BEGINNING OF TO COSTS & TO OTHER BALANCE AT
PERIOD EXPENSES ACCOUNTS DEDUCTIONS END OF PERIOD
------------ ---------- -------- ---------- -------------
<S> <C> <C> <C> <C> <C>
YEAR 1999
Allowance for doubtful accounts........... $82 $25 $1 $50 $58
YEAR 1998
Allowance for doubtful accounts........... 57 33 17 25 82
YEAR 1997
Allowance for doubtful accounts........... 42 25 8 18 57
</TABLE>
S-1