Avaya: How we arrived at Chapter 11

A letter from the Corporate Treasurer

John Sullivan, CFA, VP and Corporate Treasurer, Avaya Inc. Avaya

John Sullivan, CFA, VP and Corporate Treasurer, Avaya Inc.

I have been asked how a company that reports strong financial results can at the same time file for chapter 11 restructuring. How did we, Avaya – one of the top competitors in business communications – arrive at this juncture? After looking at the multiple options of how to deal with our debt, we decided it was a critical next step in our transformation from a hardware company to a software and services company and the best path forward for our customers, partners and employees.

Our business is healthy and performing well. We have successfully transformed from our hardware heritage, with 75% of revenue now generated by software and services. All of our recent products are virtualized and run on various hardware platforms. We continue to be number one or two in the key markets we serve, and are at the beginning of new product cycles across our business.

Our customer satisfaction scores are more than 20 points ahead of our key competitors. From a financial perspective, the company’s operating profitability metrics have improved in each of the past six years, and we generate positive cash flow.  At the end of fiscal year 2016 we had $3 billion of estimated future revenue under contract. Pretty impressive results during a transformation.

To understand how we arrived at this juncture, you need to start with Avaya’s capital structure, which was put in place 10 years ago to support a hardware-focused business model. During the past decade, our business model has evolved significantly – driven by changes in technology and customer expectations. The economic downturn that started in 2008 also had a dramatic impact on technology spending and the ways customers wanted to buy and deploy communications solutions.

When Avaya went private in 2007, customers were using a CapEx model to make up-front purchases of hardware and software. Over time, with the explosion of applications and software-as-a-service, together with growing customer demand for a more flexible OpEx/subscription model for technology purchases, we have evolved to a software and services-led business.

Although this business model generally produces a higher gross profit margin, the recognition of revenue over longer periods of time is a drag on top line revenue. In Avaya’s case, this was exacerbated by the slump in technology spending as well as the commoditization of traditional Unified Communications, where barriers to entry fell and competition from established vendors and start-ups surged. This made it difficult to retire debt and reduce interest payments.

We effectively faced two choices: refinance at ever-increasing interest rates, creating an unsustainable expense burden, or restructure our debt. Our restructuring reflects our financial leverage and the realities of the financial markets, not our operations or financial performance, which have been, and continue to be, strong. 

Restructuring through chapter 11 will reduce Avaya’s debt burden and corresponding interest expense, enhancing our financial flexibility and enabling further investment in innovation and growth. We continue to support mission-critical infrastructure and services in all sectors, including education, government, technology and healthcare. The restructuring will enable us to focus on our core mission and future success. It remains business as usual for our company and we are keenly focused on minimizing disruption to our customers, partners and employees. 

We are fortunate to operate in a legal system that allows companies to restructure their balance sheets and continue to operate as healthy businesses, providing jobs, technology innovation and value to customers. The ability to borrow on credit is a hallmark of a strong economy, with risk-sharing mechanisms that allow access to capital for borrowers and financial returns for investors.

The smooth functioning of that system is vital grease in the cogs of commerce. But there is inherently risk involved. Too much debt, debt taken on for the wrong reasons, debt that is too freely available, or business conditions that change significantly after substantial debt is undertaken, can rapidly create an unsustainable burden, as many individuals, companies and even sovereigns have discovered. It’s a cautionary tale we can all learn from.

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