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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
| | | | | |
| ☒ | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the quarterly period ended December 31, 2022
or | | | | | |
| ☐ | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the transition period from to
Commission File Number: 001-38289 AVAYA HOLDINGS CORP.
(Exact name of registrant as specified in its charter) | | | | | | | | | | | |
| Delaware | | 26-1119726 |
| (State or other jurisdiction of incorporation or organization) | | (I.R.S. Employer Identification No.) |
| | |
| 350 Mt. Kemble Avenue | | 07960 |
| Morristown, | New Jersey | |
| (Address of Principal executive offices) | | (Zip Code) |
(908) 953-6000
(Registrant's telephone number, including area code)
None
(Former name, former address and former fiscal year, if changed since last report) Securities registered pursuant to Section 12(b) of the Act | | | | | | | | |
| Title of Each Class | Trading Symbol(s) | Name of each exchange on which registered |
| Common Stock | AVYA | New York Stock Exchange |
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ☐ No ☒
Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes ☐ No ☒
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of "large accelerated filer," "accelerated filer," "smaller reporting company," and "emerging growth company" in Rule 12b-2 of the Exchange Act. | | | | | | | | | | | |
| Large accelerated filer | ☒ | Accelerated filer | ☐ |
| Non-accelerated filer | ☐ | Smaller Reporting Company | ☐ |
| | Emerging growth company | ☐ |
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ☐ No ☒
Indicate by check mark whether the registrant has filed all documents and reports required to be filed by Section 12, 13 or 15(d) of the Securities Exchange Act of 1934 subsequent to the distribution of securities under a plan confirmed by a court. Yes ☐ No ☒
As of April 30, 2023, 86,846,958 shares of common stock, $.01 par value, of the registrant were outstanding.
TABLE OF CONTENTS | | | | | | | | | | | |
| Item | | Description | Page |
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| 4. | | | |
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| 1. | | | |
| 1A. | | | |
| 2. | | | |
| 3. | | | |
| 4. | | | |
| 5. | | | |
| 6. | | | |
| 7. | | | |
When we use the terms "we," "us," "our," "Avaya" or the "Company," we mean Avaya Holdings Corp., a Delaware corporation, and its consolidated subsidiaries taken as a whole, unless the context otherwise indicates.
This Quarterly Report on Form 10-Q (this "Quarterly Report") contains the registered and unregistered trademarks or service marks of Avaya and are the property of Avaya Holdings Corp. and/or its affiliates. This Quarterly Report on Form 10-Q also contains additional trade names, trademarks or service marks belonging to us and to other companies. We do not intend our use or display of other parties' trademarks, trade names or service marks to imply, and such use or display should not be construed to imply, a relationship with, or endorsement or sponsorship of us by, these other parties.
Explanatory Note
As previously disclosed in the Company’s NT 10-Q (the "12b-25") filed with the U.S. Securities & Exchange Commission (the “SEC”) on February 10, 2023, the Company was not able to timely file its quarterly report on Form 10-Q because the audit committee (the “Audit Committee”) of the Company’s board of directors was conducting internal investigations to review, among other things, the circumstances surrounding the Company’s financial results for the quarter ended June 30, 2022 and items related to a whistleblower claim. The Audit Committee has completed its planned procedures with respect to its investigations and continues to cooperate with the SEC's ongoing investigation, which could require additional procedures to be performed. The results of the investigations are disclosed in Note 1, "Background and Basis of Presentation," to the Company's Condensed Consolidated Financial Statements. Additionally, the Company has completed its impairment assessment of its long lived assets, including its intangible assets. The Company has also determined that its internal control over financial reporting is not effective as of December 31, 2022 as a result of material weaknesses disclosed in Item 4.
Additionally, on February 14, 2023 (the “Petition Date”), Avaya Holdings Corp. (“Avaya Holdings”) and certain of its direct and indirect subsidiaries (the “Debtors”) commenced voluntary cases (the “Chapter 11 Cases”) under Chapter 11 of Title 11 of the United States Code (the “Bankruptcy Code”) in the United States Bankruptcy Court for the Southern District of Texas (the “Bankruptcy Court”). On the Petition Date, the Company entered into a Restructuring Support Agreement (the “RSA”) with certain of its creditors that contemplated a prepackaged joint plan of reorganization (the “Plan”). The implementation of the Plan pursuant to the RSA did not provide for any recovery for holders of the Company’s existing common stock, par value $0.01 per share (the “Common Stock”) or Series A Convertible Preferred Stock, par value $0.01 per share (the "Series A Preferred Stock").
After the Petition Date, following the effectiveness of a Form 25-NSE and the filing of post-effective amendments to outstanding registration statements to remove unsold securities, the Company filed a Form 15 with the United States Securities and Exchange Commission (the "SEC") to deregister its Common Stock under the Securities Exchange Act of 1934 (the “Exchange Act”) and to suspend its reporting obligations pursuant to Section 15(d)(1) of the Exchange Act, because the Company had less than 300 holders of record of each class of securities to which Securities Act registration statements related at the beginning of its 2023 fiscal year. The Company is filing this report to comply with its obligations to file all reports required to be filed with the SEC not filed prior to the filing of the Form 15.
The Bankruptcy Court confirmed the Plan on March 22, 2023, and the Debtors satisfied all conditions required for Plan effectiveness and emerged from the Chapter 11 Cases as a non-reporting private company on May 1, 2023 (the "Emergence Date").
PART I—FINANCIAL INFORMATION
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| Item 1. | Financial Statements. |
Avaya Holdings Corp.
Condensed Consolidated Statements of Operations (Unaudited)
(In millions, except per share amounts)
| | | | | | | | | | | | | | |
| | Three months ended
December 31, |
| | 2022 | | 2021 |
| REVENUE | | | | |
| Products | | $ | 136 | | | $ | 231 | |
| Services | | 282 | | | 482 | |
| | 418 | | | 713 | |
| COSTS | | | | |
| Products: | | | | |
| Costs | | 70 | | | 111 | |
| Amortization of technology intangible assets | | 35 | | | 42 | |
| Services | | 165 | | | 191 | |
| | 270 | | | 344 | |
| GROSS PROFIT | | 148 | | | 369 | |
| OPERATING EXPENSES | | | | |
| Selling, general and administrative | | 221 | | | 262 | |
| Research and development | | 50 | | | 61 | |
| Amortization of intangible assets | | 39 | | | 40 | |
| Impairment charges | | 9 | | | — | |
| Restructuring charges, net | | 10 | | | 7 | |
| | 329 | | | 370 | |
| OPERATING LOSS | | (181) | | | (1) | |
| Interest expense | | (5) | | | (54) | |
| Other (expense) income, net | | (4) | | | 7 | |
| LOSS BEFORE INCOME TAXES | | (190) | | | (48) | |
| Benefit from (provision for) income taxes | | 26 | | | (18) | |
| NET LOSS | | $ | (164) | | | $ | (66) | |
| LOSS PER SHARE | | | | |
| Basic | | $ | (1.89) | | | $ | (0.79) | |
| Diluted | | $ | (1.89) | | | $ | (0.79) | |
| Weighted average shares outstanding | | | | |
| Basic | | 87.5 | | | 84.7 | |
| Diluted | | 87.5 | | | 84.7 | |
The accompanying Notes to Condensed Consolidated Financial Statements are an integral part of these statements.
Avaya Holdings Corp.
Condensed Consolidated Statements of Comprehensive Loss (Unaudited)
(In millions)
| | | | | | | | | | | | | | |
| | Three months ended
December 31, |
| | 2022 | | 2021 |
| Net loss | | $ | (164) | | | $ | (66) | |
| Other comprehensive (loss) income: | | | | |
Pension, post-retirement and post-employment benefit-related items, net of income taxes of $0 for both the three months ended December 31, 2022 and 2021, respectively | | (6) | | | (1) | |
| Cumulative translation adjustment | | (14) | | | 13 | |
Change in interest rate swaps, net of income taxes of $(18) and $0 for the three months ended December 31, 2022 and 2021, respectively | | (80) | | | 28 | |
| Other comprehensive (loss) income | | (100) | | | 40 | |
| Total comprehensive loss | | $ | (264) | | | $ | (26) | |
The accompanying Notes to Condensed Consolidated Financial Statements are an integral part of these statements.
Avaya Holdings Corp.
Condensed Consolidated Balance Sheets (Unaudited)
(In millions, except per share and share amounts) | | | | | | | | | | | | | | |
| | December 31, 2022 | | September 30, 2022 |
| ASSETS | | | | |
| Current assets: | | | | |
| Cash and cash equivalents | | $ | 225 | | | $ | 253 | |
| Restricted cash | | 223 | | | 222 | |
| Accounts receivable, net | | 302 | | | 322 | |
| Inventory | | 81 | | | 74 | |
| Contract assets, net | | 505 | | | 543 | |
| Contract costs | | 104 | | | 110 | |
| Other current assets | | 113 | | | 116 | |
| TOTAL CURRENT ASSETS | | 1,553 | | | 1,640 | |
| Property, plant and equipment, net | | 280 | | | 281 | |
| Intangible assets, net | | 1,695 | | | 1,776 | |
| | | | |
| Operating lease right-of-use assets | | 90 | | | 97 | |
| Other assets | | 229 | | | 279 | |
| TOTAL ASSETS | | $ | 3,847 | | | $ | 4,073 | |
| LIABILITIES | | | | |
| Current liabilities: | | | | |
| Debt maturing within one year | | $ | 3,358 | | | $ | 210 | |
| Accounts payable | | 263 | | | 263 | |
| Payroll and benefit obligations | | 105 | | | 108 | |
| Contract liabilities | | 255 | | | 245 | |
| Operating lease liabilities | | 40 | | | 40 | |
| Business restructuring reserves | | 19 | | | 26 | |
| Other current liabilities | | 137 | | | 137 | |
| TOTAL CURRENT LIABILITIES | | 4,177 | | | 1,029 | |
| Non-current liabilities: | | | | |
| Long-term debt | | — | | | 3,032 | |
| Pension obligations | | 434 | | | 410 | |
| Other post-retirement obligations | | 111 | | | 109 | |
| Deferred income taxes, net | | 42 | | | 43 | |
| Contract liabilities | | 287 | | | 300 | |
| Operating lease liabilities | | 66 | | | 72 | |
| Business restructuring reserves | | 26 | | | 23 | |
| Other liabilities | | 207 | | | 224 | |
| TOTAL NON-CURRENT LIABILITIES | | 1,173 | | | 4,213 | |
| TOTAL LIABILITIES | | 5,350 | | | 5,242 | |
| Commitments and contingencies (Note 18) | | | | |
Preferred stock, $0.01 par value; 55,000,000 shares authorized at December 31, 2022 and September 30, 2022 | | | | |
Convertible series A preferred stock; 125,000 shares issued and outstanding at December 31, 2022 and September 30, 2022 | | 134 | | | 133 | |
| STOCKHOLDERS' DEFICIT | | | | |
Common stock, $0.01 par value; 550,000,000 shares authorized; 86,846,958 shares issued and outstanding at December 31, 2022 and September 30, 2022 | | 1 | | | 1 | |
| Additional paid-in capital | | 1,428 | | | 1,546 | |
| Accumulated deficit | | (3,198) | | | (3,081) | |
| Accumulated other comprehensive income | | 132 | | | 232 | |
| TOTAL STOCKHOLDERS' DEFICIT | | (1,637) | | | (1,302) | |
| TOTAL LIABILITIES, PREFERRED STOCK AND STOCKHOLDERS' DEFICIT | | $ | 3,847 | | | $ | 4,073 | |
The accompanying Notes to Condensed Consolidated Financial Statements are an integral part of these statements.
Avaya Holdings Corp.
Condensed Consolidated Statements of Changes in Stockholders' (Deficit) Equity (Unaudited)
(In millions) | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | Common Stock | | Additional
Paid-In
Capital | | Accumulated Deficit | | Accumulated
Other
Comprehensive
Income (Loss) | | Total
Stockholders'
(Deficit) Equity |
| | Shares | | Par Value | | | | |
| Balance as of September 30, 2022 | | 86.8 | | | $ | 1 | | | $ | 1,546 | | | $ | (3,081) | | | $ | 232 | | | $ | (1,302) | |
| Share-based compensation expense | | | | | | 1 | | | | | | | 1 | |
| Preferred stock dividends accrued | | | | | | (1) | | | | | | | (1) | |
| Adoption of ASU 2020-06 (Note 2) | | | | | | (118) | | | 47 | | | | | (71) | |
| Net loss | | | | | | | | (164) | | | | | (164) | |
| Other comprehensive loss | | | | | | | | | | (100) | | | (100) | |
| Balance as of December 31, 2022 | | 86.8 | | | $ | 1 | | | $ | 1,428 | | | $ | (3,198) | | | $ | 132 | | | $ | (1,637) | |
| | | | | | | | | | | | |
| Balance as of September 30, 2021 | | 84.1 | | | $ | 1 | | | $ | 1,467 | | | $ | (985) | | | $ | (91) | | | $ | 392 | |
| Issuance of common stock under the equity incentive plan and the Stock Bonus Program | | 0.9 | | | | | 5 | | | | | | | 5 | |
| Issuance of common stock under the employee stock purchase plan | | 0.2 | | | | | 3 | | | | | | | 3 | |
| Shares repurchased and retired for tax withholding on vesting of restricted stock units and Stock Bonus Program shares | | (0.3) | | | | | (7) | | | | | | | (7) | |
| Share-based compensation expense | | | | | | 14 | | | | | | | 14 | |
| Preferred stock dividends paid | | | | | | (1) | | | | | | | (1) | |
| Net loss | | | | | | | | (66) | | | | | (66) | |
| Other comprehensive income | | | | | | | | | | 40 | | | 40 | |
| Balance as of December 31, 2021 | | 84.9 | | | $ | 1 | | | $ | 1,481 | | | $ | (1,051) | | | $ | (51) | | | $ | 380 | |
The accompanying Notes to Condensed Consolidated Financial Statements are an integral part of these statements.
Avaya Holdings Corp.
Condensed Consolidated Statements of Cash Flows (Unaudited)
(In millions) | | | | | | | | | | | | | | |
| | Three months ended
December 31, |
| | 2022 | | 2021 |
| OPERATING ACTIVITIES: | | | | |
| Net loss | | $ | (164) | | | $ | (66) | |
| Adjustments to reconcile net loss to net cash used for operating activities: | | | | |
| Depreciation and amortization | | 99 | | | 104 | |
| Share-based compensation | | 1 | | | 14 | |
| Amortization of debt discount and issuance costs | | 5 | | | 7 | |
| Deferred income taxes, net | | (19) | | | (4) | |
| Impairment charges | | 9 | | | — | |
| Change in fair value of emergence date warrants | | — | | | (1) | |
| Change in fair value of interest rate swap agreements | | 13 | | | — | |
| Change in fair value of debt-related embedded derivatives | | (16) | | | — | |
| Reclassification of AOCI associated with interest rate swaps | | (62) | | | — | |
| Unrealized gain on foreign currency transactions | | 10 | | | (2) | |
| Other non-cash charges, net | | 1 | | | 2 | |
| Changes in operating assets and liabilities: | | | | |
| Accounts receivable | | 22 | | | (44) | |
| Inventory | | (9) | | | 1 | |
| | | | |
| Contract assets | | 48 | | | (57) | |
| Contract costs | | 13 | | | (1) | |
| Accounts payable | | (4) | | | 46 | |
| Payroll and benefit obligations | | (12) | | | (70) | |
| Business restructuring reserves | | (8) | | | (3) | |
| Contract liabilities | | (9) | | | (28) | |
| Other assets and liabilities | | 17 | | | (9) | |
| NET CASH USED FOR OPERATING ACTIVITIES | | (65) | | | (111) | |
| INVESTING ACTIVITIES: | | | | |
| Capital expenditures | | (17) | | | (27) | |
| NET CASH USED FOR INVESTING ACTIVITIES | | (17) | | | (27) | |
| FINANCING ACTIVITIES: | | | | |
| | | | |
| | | | |
| | | | |
| | | | |
| | | | |
| Borrowings under ABL Credit Agreement | | 90 | | | — | |
| Repayments of ABL Credit Agreement | | (34) | | | — | |
| | | | |
| Principal payments for financing leases | | (2) | | | (2) | |
| | | | |
| | | | |
| Proceeds from Employee Stock Purchase Plan | | — | | | 4 | |
| Proceeds from exercises of stock options | | — | | | 1 | |
| Preferred stock dividends paid | | — | | | (1) | |
| Shares repurchased for tax withholdings on vesting of restricted stock units and Stock Bonus Program shares | | — | | | (7) | |
| NET CASH PROVIDED BY (USED FOR) FINANCING ACTIVITIES | | 54 | | | (5) | |
| Effect of exchange rate changes on cash, cash equivalents, and restricted cash | | 2 | | | (1) | |
| NET DECREASE IN CASH, CASH EQUIVALENTS, AND RESTRICTED CASH | | (26) | | | (144) | |
| Cash, cash equivalents, and restricted cash at beginning of period | | 478 | | | 502 | |
| Cash, cash equivalents, and restricted cash at end of period | | $ | 452 | | | $ | 358 | |
The accompanying Notes to Condensed Consolidated Financial Statements are an integral part of these statements.
Avaya Holdings Corp.
Notes to Condensed Consolidated Financial Statements (Unaudited)
1. Background and Basis of Presentation
Background
Avaya Holdings Corp. (the "Parent" or "Avaya Holdings"), together with its consolidated subsidiaries (collectively, the "Company" or "Avaya"), is a global leader in digital communications products, solutions and services for businesses of all sizes delivering its technology predominantly through software and services. Avaya builds innovative open, converged software solutions to enhance and simplify communications and collaboration in the cloud, on-premise or a hybrid of both. The Company's global team of professionals delivers services from initial planning and design, to implementation and integration, to ongoing managed operations, optimization, training and support. The Company manages its business operations in two segments: Products & Solutions and Services. The Company sells directly to customers through its worldwide sales force and indirectly through its global network of channel partners, including distributors, service providers, dealers, value-added resellers, system integrators and business partners that provide sales and services support.
Basis of Presentation
Avaya Holdings has no material assets or standalone operations other than its ownership of its direct wholly-owned subsidiary Avaya Inc. and its subsidiaries. The accompanying unaudited interim Condensed Consolidated Financial Statements reflect the operating results of Avaya Holdings and its consolidated subsidiaries and have been prepared in accordance with accounting principles generally accepted in the United States of America ("GAAP") and the rules and regulations of the U.S. Securities and Exchange Commission ("SEC") for interim financial statements. The unaudited interim Condensed Consolidated Financial Statements should be read in conjunction with the audited Consolidated Financial Statements and other financial information for the fiscal year ended September 30, 2022, included in the Company's Annual Report on Form 10-K filed with the SEC on September 8, 2023. In management's opinion, these unaudited interim Condensed Consolidated Financial Statements reflect all adjustments, consisting of normal and recurring adjustments, necessary to fairly state the results of operations, financial position and cash flows for the periods indicated. The unaudited condensed consolidated results of operations for the interim periods reported are not necessarily indicative of the results for the entire fiscal year.
Management is required 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 periods reported. The Company uses estimates to assess expected credit losses on its financial assets, sales returns and allowances, the use and recoverability of inventory, the realization of deferred tax assets, annual effective tax rate, the recoverability of long-lived assets, useful lives and impairment of tangible and intangible assets including goodwill, business restructuring reserves, pension and post-retirement benefit costs, the fair value of assets and liabilities in business combinations and the amount of exposure from potential loss contingencies, among others. Estimates and assumptions are reviewed periodically, and the effects of revisions are reflected in the Condensed Consolidated Financial Statements in the period they are determined to be necessary. Actual results could differ from these estimates. The ongoing military conflict between Russia and Ukraine, including the sanctions and export controls that have been imposed by the U.S. and other countries in response to the conflict, severely limits commercial activities in Russia and impacts other markets where we do business. This global issue, among others, have resulted in elevated levels of inflation throughout the world, increased raw material costs and other supply chain issues all of which may affect management's estimates and assumptions, in particular those that require a projection of our financial results, our cash flows or broader economic conditions.
Board and Audit Committee Investigations
In February 2023, the Company announced a delay in the filing of its Quarterly Report on Form 10-Q (this "Quarterly Report") for the quarter ended December 31, 2022, due to, among other things, the commencement of an investigation by the audit committee (the "Audit Committee", and such investigation, the "Financial Results Investigation") of the Company's board of directors (the "Board") related to the circumstances surrounding the Company's financial results for the third quarter of fiscal 2022, which were significantly lower than the Company's expectations and previously issued guidance. This investigation also addressed the information provided by the Company to the lenders of the Tranche B-3 Term Loans and the 8.00% Exchangeable Senior Secured Notes due 2027 which was funded in July 2022 as discussed in Note 7, "Financing Arrangements."
The Company also announced the Audit Committee had commenced a separate internal investigation to review matters related to a whistleblower letter (the "Whistleblower Letter Investigation"). The Company engaged outside counsel, which reported to the Audit Committee, to assist in these investigations and notified the SEC and the Company's external auditor, PricewaterhouseCoopers LLP, about the investigations at that time.
The Company also announced in August 2022 that it was reviewing matters related to the maintenance of its whistleblower log and the proper dissemination of related information and materials. The review related to an email received by a Board member prior to the filing of the Company's Annual Report on Form 10-K for fiscal year ended September 30, 2021 (the "2021 Form 10-K"). Upon receipt of the email, the Board determined to undertake an investigation, assisted by outside counsel (the “Whistleblower Email Investigation” and together with the Financial Results Investigation and the Whistleblower Letter Investigation, the "Investigations"). Upon conclusion of the Whistleblower Email Investigation, it was determined that the claims included were unsubstantiated (see Note 18, "Commitments and Contingencies").
Avaya notified the SEC of the Investigations and the SEC initiated an investigation to review, among other things, the circumstances surrounding Avaya's financial results for the quarter ended June 30, 2022.
On February 10, 2023, the Company filed a Form 12b-25 announcing a delay in the filing of its Quarterly Report on Form 10-Q for the three months ended December 31, 2022. As a result of the activities noted above, the Company required additional time to complete its review of its financial statements and other disclosures as of December 31, 2022, and to complete its quarterly closing processes and controls, and was unable to file its Quarterly Report on Form 10-Q on or prior to the prescribed due date of February 9, 2023.
The Audit Committee has completed its planned procedures with respect to its Investigations and continues to cooperate with the SEC's on-going investigation, which could require additional procedures to be performed. The Audit Committee identified several contributing factors for the significant differences between the Company's forecasts and actual financial results for the third quarter of fiscal 2022, including:
•Inappropriate tone at the top among certain members of senior management, which resulted in a corporate culture characterized by significant pressure to meet aggressive sales projections and a failure to foster an environment of appropriate and open communication of significant matters throughout the organization and with others outside of the organization;
•A declining pipeline of existing legacy customers (with expiring maintenance contracts) eligible for migration to the Company's subscription model;
•A business model in which a significant portion of quarterly revenue is generated at the end of each quarter, making it difficult to accurately forecast revenue;
•Adverse market conditions, as well as concerns that arose during the third quarter about the Company's financial health, which negatively influenced customer sentiment; and
•The ineffective control environment with respect to tone at the top noted above contributed to additional material weaknesses, that the Company did not design and maintain effective controls over the information and communication component of the Committee of Sponsoring Organizations of the Treadway Commission ("COSO") framework which led to an additional material weakness with respect to the ethics and compliance program. The Company did not maintain a complete and accurate whistleblower log and did not inform certain members of senior management and its external auditor about an investigation undertaken by a committee of the Board of Directors.
In addition, the investigation identified revenue of $3 million that was recognized for product shipments during the three months ended March 31, 2022 that had rights of return and, accordingly, should not have been recognized as revenue. The Company corrected this error during the three months ended June 30, 2022. This out-of-period correction was not material to any interim period and had no impact on the financial results for the year ended September 30, 2022.
The SEC is investigating the matters underlying the Audit Committee's investigation and may be subject to additional regulatory or legal proceedings. These investigations and legal proceedings may result in adverse findings, damages, the imposition of fines or other penalties, increased costs and expenses as well as the diversion of management's time and resources.
Chapter 11 Filing
On February 14, 2023 (the "Petition Date"), Avaya Holdings and certain of its direct and indirect subsidiaries (collectively, the "Debtors") commenced voluntary cases (the "Chapter 11 Cases") under Chapter 11 of Title 11 of the United States Code (the "Bankruptcy Code") in the United States Bankruptcy Court for the Southern District of Texas. The Chapter 11 Cases were jointly administered under the caption In re Avaya Inc., et al., case number 23-90088.
On the Petition Date, the Company entered into a Restructuring Support Agreement (the "RSA") with certain of its creditors (the "Consenting Stakeholders") and RingCentral, Inc. ("RingCentral"). The RSA contemplated a prepackaged joint plan of reorganization (the "Plan"). The Plan provided for (i) the commencement of the Chapter 11 Cases, (ii) debtor-in-possession financing facilities in the aggregate amount of approximately $628 million that were subsequently converted into exit financing facilities upon the Company's Emergence (as defined below), (iii) a fully backstopped $150 million rights offering, (iv) payment in full of all trade liabilities, (v) the repayment of approximately $225 million escrowed cash to certain senior lenders
and (vi) entry into amended and restated agreements with RingCentral (the "Amended and Restated RingCentral Agreements") that collectively govern the Company's commercial relationship with RingCentral upon Emergence (which agreements were entered into immediately prior to, and in connection with, the execution of the RSA).
The RSA and the Plan did not contemplate any recovery for holders of the Company's existing common stock, par value $0.01 per share (the "Common Stock") or Series A Convertible Preferred Stock, par value $0.01 per share (the "Series A Preferred Stock").
On February 15, 2023, trading in the Company's Common Stock on the New York Stock Exchange ("NYSE") was permanently suspended and the Common Stock was delisted from the NYSE effective February 25, 2023.
To ensure their ability to continue operating in the ordinary course of business, the Debtors filed a variety of motions seeking "first day" relief, including the authority to continue using their cash management system, pay employee wages and benefits and pay vendors in the ordinary course of business. As of March 22, 2023, all "first day" relief had been granted by the Bankruptcy Court on a final basis.
The commencement of the Chapter 11 Cases constituted an event of default that accelerated and, as applicable, increased certain obligations under each of the Term Loan and ABL Credit Agreements and the indentures governing the Senior Notes, the Convertible Notes and the Exchangeable Notes (each as defined below) (collectively the "Pre-Petition Debt Instruments") and agreements described in Note 7, "Financing Arrangements," other than the DIP Term Loan (as defined below) and the DIP ABL Loan (as defined below). At December 31, 2022, all debt was classified as a current liability based on the Company's violation of certain covenants in December 2022.
The Pre-Petition Debt Instruments provided that, as a result of the Chapter 11 Cases, the principal and interest and certain other amounts (to the extent applicable) due thereunder were immediately due and payable. Any efforts to enforce such payment obligations under the Pre-Petition Debt Instruments against the Debtors were automatically stayed as a result of the Chapter 11 Cases, and the creditors' rights of enforcement in respect of the Pre-Petition Debt Instruments were subject to the applicable provisions of the Bankruptcy Code.
Under the Plan, holders of pre-petition claims were not required to file proofs of claim and all filed proofs of claim were automatically considered objected and disputed, and all other claims (other than cure disputes/rejection claims) were deemed withdrawn and expunged as of May 1, 2023 (the "Emergence Date"). On the Emergence Date, the Company reviewed claims that had been filed and updated the claims register to reflect whether claims had been withdrawn, expunged or satisfied, as applicable, as of the Emergence Date and did not identify any adjustments to its consolidated financial statements.
Subject to certain specific exceptions under the Bankruptcy Code, the Chapter 11 Cases automatically stayed most judicial or administrative actions against the Debtors and efforts by creditors to collect on or otherwise exercise rights or remedies with respect to pre-petition claims.
The Debtors operated as debtors-in-possession in accordance with the applicable provisions of the Bankruptcy Code and entered into (a) a $500 million priming superpriority senior secured debtors-in-possession term loan facility (the "DIP Term Loan," and such facility, the "DIP Term Loan Facility") and (b) an approximately $128 million priming superpriority senior secured debtors-in-possession asset-based loan facility (the "DIP ABL Loan," and such facility, the "DIP ABL Facility"). The DIP Term Loan and DIP ABL Loan converted into exit financing upon Avaya's Emergence. See Note 7, "Financing Arrangements".
Emergence from Voluntary Reorganization under Chapter 11 of the Bankruptcy Code
The Bankruptcy Court confirmed the Plan on March 22, 2023, and the Debtors satisfied all conditions required for Plan effectiveness and emerged from the Chapter 11 Cases ("Emergence") on May 1, 2023.
On or following the Emergence Date and pursuant to the terms of the Plan, the following occurred or became effective:
▪Debtors' Equity and Indebtedness. All of the Debtors' pre-petition equity and debt facilities as well as the Debtors' securities were canceled.
▪Reorganized Company Equity. The Company's certificate of incorporation was amended and restated to authorize the issuance of 80 million shares of the Company's common stock, par value $0.01 per share (the "New Common Stock"), of which 36 million shares were issued on the Emergence Date. The Company's certificate of incorporation was also amended and restated to authorize the issuance of 20 million shares of the Company's preferred stock, par value $0.01 per share (the "New Preferred Stock"), of which no shares were issued on the Emergence Date.
▪Exit Financing. The DIP Term Loan converted into an Exit Term Loan (as defined herein) and the Company incurred an additional $310 million under the Exit Term Loan Facility (including amounts incurred pursuant to a rights offering and amounts deemed incurred pursuant to the Plan by creditors under the Pre-Petition Debt Instruments) for an aggregate principal amount of $810 million, and the DIP ABL Loan converted into an Exit ABL Loan (as defined
herein) in the amount of approximately $128 million. As contemplated in the bankruptcy court proceedings and approved by the court, the imputed enterprise value of the Company upon Emergence was approximately $1,426 million.
▪Contracts with Customers and Suppliers. Suppliers and customers were paid or will be paid in full in respect of pre-petition amounts owed by the Company, and the Company assumed the Amended and Restated RingCentral Agreements (as defined within Note 18, "Commitments and Contingencies") (which agreements were entered into immediately prior to, and in connection with, the execution of the RSA).
▪PBGC Settlement. The Company entered into a settlement with the Pension Benefit Guaranty Corporation (the "PBGC") providing for the assumption of the hourly pension plan and the consensual termination of the settlement with the PBGC entered into as part of the Company's 2017 plan of reorganization, including the excess contribution obligations thereunder.
▪Settlements. The Company entered into a number of other settlements, including, inter alia, those with the Consenting Stakeholders and an ad hoc group of holders of the Convertible Notes, and all of these settlements became effective on the Emergence Date.
Adoption of Accounting Standards Codification ("ASC") Topic 852
On the Emergence Date, the Company may qualify for and adopt fresh start accounting in accordance with Financial Accounting Standards Board Codification Topic 852, Reorganizations ("ASC 852"), which specifies the accounting and financial reporting requirements for entities reorganizing through Chapter 11 bankruptcy proceedings. The application of fresh start accounting would result in a new basis of accounting and the Company would become a new entity for financial reporting purposes. As a result of the implementation of the Plan and the potential application of fresh start accounting, the Consolidated Financial Statements after the Emergence Date would not be comparable to the Consolidated Financial Statements before that date, and the historical financial statements on or before the Emergence Date would not be a reliable indicator of its financial condition and results of operations for any period after the Company's adoption of fresh start accounting.
Liquidity and Going Concern
The accompanying unaudited Condensed Consolidated Financial Statements of the Company have been prepared assuming the Company will continue as a going concern and in accordance with GAAP. The going concern basis of presentation assumes that the Company will continue in operation one year after the date these Condensed Consolidated Financial Statements are issued and will be able to realize its assets and discharge its liabilities and commitments in the normal course of business.
During the fiscal year ended September 30, 2022, the Company experienced a significant slowdown in its operations and had operating cash outflows of $312 million. Additionally, prior to the Chapter 11 Cases, the Company had been involved in discussions with its lenders relating to the financing transactions it completed in July 2022 (as described further in Note 7, "Financing Arrangements") and the scheduled June 2023 maturity of the Convertible Notes. In its Form 12b-25 in respect of the Quarterly Report on Form 10-Q for the period ended June 30, 2022 filed with the SEC on August 9, 2022, the Company indicated that in light of the Convertible Notes being characterized as a current liability and the related engagement with advisors to address the Convertible Notes, coupled with the decline in revenues during the third quarter, which represented substantially lower revenues than previous Company expectations, and the negative impact of significant operating losses on the Company's cash balance, the Company determined that there was substantial doubt about the Company's ability to continue as a going concern.
The Company has completed certain restructuring actions and is working to complete its remaining restructuring plan as its operating cash flows are expected to remain negative through at least fiscal 2023. The Company may take additional actions, as needed. The Company’s plans are designed to reduce its operating expenses and improve cash flows in line with its forecasted revenues. On the Emergence Date, the Company had approximately $585 million of cash and cash equivalents, and its post-Emergence debt profile was significantly improved (an aggregate principal amount of $810 million compared to $3,420 million at December 31, 2022), reducing its annual interest expense and extending the earliest maturity of its non-revolving long-term debt to 2028. This post-Emergence capital structure, coupled with restructuring actions that the Company executed to reduce its on-going operating expenses, have provided the Company with sufficient working capital to meet its operating cash flow requirements for at least one year from the issuance of these financial statements. Accordingly, as a result of the successful Emergence, the Company has alleviated the substantial doubt that had previously existed regarding the Company's ability to continue as a going concern. The Company's longer term liquidity profile will depend on successfully implementing its strategic plan which includes enhancing its product offerings, successfully partnering with alliance companies and executing on remaining cost reductions.
2. Recent Accounting Pronouncements
Recently Adopted Accounting Pronouncements
In August 2020, the Financial Accounting Standards Board ("FASB") issued Accounting Standards Update ("ASU") 2020-06, "Debt - Debt with Conversion and Other Options (Subtopic 470-20) and Derivatives and Hedging - Contracts in Entity’s Own Equity (Subtopic 815-40): Accounting for Convertible Instruments and Contracts in an Entity’s Own Equity." This standard simplifies the accounting for convertible instruments and the application of the derivatives scope exception for contracts in an entity's own equity. The standard also amends the accounting for convertible instruments in the diluted earnings per share calculation and requires enhanced disclosures of convertible instruments and contracts in an entity's own equity. The Company adopted the standard on a modified retrospective basis effective October 1, 2022.
Upon adoption, the Company recorded a cumulative effect adjustment which decreased the opening balance of Accumulated deficit on the Condensed Consolidated Balance Sheet by $47 million, decreased Additional paid-in-capital by $118 million and increased Debt maturing within one year and Long-term debt by $10 million and $61 million, respectively, to eliminate the historical separation of debt and equity components of the Company's convertible or exchangeable debt instruments.
Recent Standards Not Yet Adopted
In March 2020, the FASB issued ASU 2020-04, Reference Rate Reform (Topic 848): "Facilitation of the Effects of Reference Rate Reform on Financial Reporting". This standard, along with other guidance subsequently issued by the FASB, contains practical expedients for reference rate reform related activities that impact debt, derivatives and other contracts. The guidance in this standard is optional and may be elected at any time as reference rate reform activities occur. The standard may be applied prospectively to contract modifications made and hedging relationships entered into or evaluated on or before December 31, 2024. The Company intends to use the expedients, if needed, for the reference rate transition. The Company continues to monitor activities related to reference rate reform and does not currently expect this standard to have a material impact on the Company's Condensed Consolidated Financial Statements.
In October 2021, the FASB issued ASU 2021-08, Business Combinations (Topic 805): "Accounting for Contract Assets and Contract Liabilities from Contracts with Customers." This standard requires contract assets and contract liabilities acquired in a business combination to be recognized in accordance with Topic 606 as if the acquirer had originated the contracts. This standard is effective for the Company in the first quarter of fiscal 2024, with early adoption permitted. The impact of this standard will depend on the nature of future transactions within its scope.
In March 2022, the FASB issued ASU 2022-02, "Financial Instruments – Credit Losses (Topic 326): Troubled Debt Restructurings and Vintage Disclosures." This standard requires an entity to disclose current-period gross write-offs by year of origination for financing receivables and net investment in leases measured at amortized cost. The standard also eliminates the existing troubled debt restructuring recognition and measurement guidance and, instead, requires an entity to evaluate whether the modification represents a new loan or a continuation of an existing loan in a manner consistent with other loan modifications. This standard is effective for the Company in the first quarter of fiscal 2024, with early adoption permitted. The Company is currently assessing the impact the new guidance will have on its Condensed Consolidated Financial Statements.
In September 2022, the FASB issued ASU 2022-04, "Liabilities—Supplier Finance Programs (Subtopic 405-50): Disclosure of Supplier Finance Program Obligations." This standard requires that a buyer in a supplier finance program disclose sufficient information about the program to allow a user of financial statements to understand the program’s nature, activity during the period, changes from period to period, and potential magnitude. The amendments in this standard do not affect the recognition, measurement, or financial statement presentation of obligations covered by supplier finance programs. The standard is effective for the Company in the first quarter of fiscal 2024, with early adoption permitted. Certain disclosures required by the standard are effective in the first quarter of fiscal 2025. The Company is currently assessing the impact the new guidance will have on its disclosures within its Condensed Consolidated Financial Statements.
3. Contracts with Customers
Disaggregation of Revenue
The following tables provide the Company's disaggregated revenue for the periods presented:
| | | | | | | | | | | | | | |
| | Three months ended
December 31, |
| (In millions) | | 2022 | | 2021 |
| Revenue: | | | | |
| Products & Solutions | | $ | 136 | | | $ | 231 | |
| Services | | 282 | | | 482 | |
| | | | |
| Total Revenue | | $ | 418 | | | $ | 713 | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Three months ended December 31, 2022 | | Three months ended December 31, 2021 |
| (In millions) | Products & Solutions | | Services | | | | Total | | Products & Solutions | | Services | | | | Total |
| Revenue: | | | | | | | | | | | | | | | |
| U.S. | $ | 62 | | | $ | 146 | | | | | $ | 208 | | | $ | 114 | | | $ | 261 | | | | | $ | 375 | |
International: | | | | | | | | | | | | | | | |
| Europe, Middle East and Africa | 38 | | | 71 | | | | | 109 | | | 65 | | | 127 | | | | | 192 | |
Asia Pacific | 19 | | | 37 | | | | | 56 | | | 32 | | | 49 | | | | | 81 | |
| Americas International - Canada and Latin America | 17 | | | 28 | | | | | 45 | | | 20 | | | 45 | | | | | 65 | |
| Total International | 74 | | | 136 | | | | | 210 | | | 117 | | | 221 | | | | | 338 | |
| Total Revenue | $ | 136 | | | $ | 282 | | | | | $ | 418 | | | $ | 231 | | | $ | 482 | | | | | $ | 713 | |
Transaction Price Allocated to the Remaining Performance Obligations
The transaction price allocated to remaining performance obligations that were wholly or partially unsatisfied as of December 31, 2022 was $1,920 million, of which 52% and 26% is expected to be recognized within 12 months and 13-24 months, respectively, with the remaining balance expected to be recognized thereafter. This excludes amounts for remaining performance obligations that are (1) for contracts recognized over time using the "right to invoice" practical expedient, (2) related to sales or usage based royalties promised in exchange for a license of intellectual property and (3) related to variable consideration allocated entirely to a wholly unsatisfied performance obligation.
Contract Balances
The following table provides information about accounts receivable, contract assets, contract costs and contract liabilities for the periods presented: | | | | | | | | | | | | | | | | | | | | |
| (In millions) | | December 31, 2022 | | September 30, 2022 | | Increase (Decrease) |
| Accounts receivable, net | | $ | 302 | | | $ | 322 | | | $ | (20) | |
| | | | | | |
| Contract assets, net: | | | | | | |
| Current | | $ | 505 | | | $ | 543 | | | $ | (38) | |
| Non-current (Other assets) | | 127 | | | 134 | | | (7) | |
| | $ | 632 | | | $ | 677 | | | $ | (45) | |
| | | | | | |
| Cost of obtaining a contract: | | | | | | |
| Current (Contract costs) | | $ | 78 | | | $ | 81 | | | $ | (3) | |
| Non-current (Other assets) | | 40 | | | 46 | | | (6) | |
| | $ | 118 | | | $ | 127 | | | $ | (9) | |
| | | | | | |
| Cost to fulfill a contract: | | | | | | |
| Current (Contract costs) | | $ | 26 | | | $ | 29 | | | $ | (3) | |
| | | | | | |
| Contract liabilities: | | | | | | |
| Current | | $ | 255 | | | $ | 245 | | | $ | 10 | |
| Non-current | | 287 | | | 300 | | | (13) | |
| | $ | 542 | | | $ | 545 | | | $ | (3) | |
The decrease in Contract assets was mainly driven by billings which outpaced bookings in the Company's subscription offerings during the quarter. The decrease in contract costs was driven by lower sales and continued shift to subscription offerings. The decrease in Contract liabilities was mainly driven by anticipated declines in hardware maintenance and software support services as customers continue to transition to the Company's subscription hybrid offering. The decrease was also driven by lower revenue earned from the consideration advance received in connection with the strategic partnership with RingCentral, Inc..
During the three months ended December 31, 2022 and 2021, the Company did not record any asset impairment charges related to contract assets.
During the three months ended December 31, 2022 and 2021, the Company recognized revenue of $109 million and $162 million that had been previously recorded as a Contract liability as of October 1, 2022 and October 1, 2021, respectively.
During the three months ended December 31, 2022 and 2021, the Company recognized a decrease in revenue of $4 million and $2 million, respectively, for performance obligations that were satisfied, or partially satisfied, in prior periods.
As disclosed in Note 19, "Subsequent Events,” the Company and RingCentral agreed to amend their agreement.
Contract Costs
The following table provides information regarding the location and amount for amortization of costs to obtain and costs to fulfill customer contracts recognized in the Company's Condensed Consolidated Statements of Operations for the periods presented: | | | | | | | | | | | | | | |
| | Three months ended
December 31, |
| (In millions) | | 2022 | | 2021 |
| Costs to obtain customer contracts: | | | | |
| Selling, general and administrative | | $ | 37 | | | $ | 44 | |
| Revenue | | 2 | | | 4 | |
| Total Amortization | | $ | 39 | | | $ | 48 | |
| | | | |
| Costs to fulfill customer contracts: | | | | |
| Costs | | $ | 3 | | | $ | 8 | |
Allowance for Credit Losses
The following table presents the change in the allowance for credit losses by portfolio segment for the period indicated: | | | | | | | | | | | | | | | | | | | | | | | | | | |
| (In millions) | | Accounts Receivable(1) | | Short-term Contract Assets(2) | | Long-term Contract Assets(3) | | Total |
| Allowance for credit loss as of September 30, 2022 | | $ | 5 | | | $ | 1 | | | $ | 2 | | | $ | 8 | |
| Adjustment to credit loss provision | | — | | | — | | | (1) | | | (1) | |
| Write-offs, net of recoveries | | — | | | — | | | — | | | — | |
| Allowance for credit loss as of December 31, 2022 | | $ | 5 | | | $ | 1 | | | $ | 1 | | | $ | 7 | |
(1)Recorded within Accounts receivable, net on the Condensed Consolidated Balance Sheets.
(2)Recorded within Contract assets, net on the Condensed Consolidated Balance Sheets.
(3)Recorded within Other assets on the Condensed Consolidated Balance Sheets.
4. Intangible Assets, net
The Company's intangible assets consist of the following for the periods indicated: | | | | | | | | | | | | | | | | | | | | | | | | | | |
| (In millions) | |
Technology
and Patents | | Customer
Relationships
and Other
Intangibles | | Trademarks and Trade Names | | Total |
| Balance as of December 31, 2022 | | | | | | | | |
| Finite-lived intangible assets: | | | | | | | | |
| Cost | | $ | 966 | | | $ | 2,149 | | | $ | 42 | | | $ | 3,157 | |
| Accumulated amortization | | (834) | | | (781) | | | (25) | | | (1,640) | |
| Finite-lived intangible assets, net | | 132 | | | 1,368 | | | 17 | | | 1,517 | |
| Indefinite-lived intangible assets: | | | | | | | | |
| Cost | | — | | | — | | | 333 | | | 333 | |
| Accumulated impairment | | — | | | — | | | (155) | | | (155) | |
| Indefinite-lived intangible assets, net | | — | | | — | | | 178 | | | 178 | |
| Intangible assets, net | | $ | 132 | | | $ | 1,368 | | | $ | 195 | | | $ | 1,695 | |
| Balance as of September 30, 2022 | | | | | | | | |
| Finite-lived intangible assets: | | | | | | | | |
| Cost | | $ | 964 | | | $ | 2,146 | | | $ | 42 | | | $ | 3,152 | |
| Accumulated amortization | | (797) | | | (741) | | | (25) | | | (1,563) | |
| Finite-lived intangible assets, net | | 167 | | | 1,405 | | | 17 | | | 1,589 | |
| Indefinite-lived intangible assets: | | | | | | | | |
| Cost | | — | | | — | | | 333 | | | 333 | |
| Accumulated impairment | | — | | | — | | | (146) | | | (146) | |
| Indefinite-lived intangible assets, net | | — | | | — | | | 187 | | | 187 | |
| Intangible assets, net | | $ | 167 | | | $ | 1,405 | | | $ | 204 | | | $ | 1,776 | |
Intangible assets with finite lives are amortized using the straight-line method over the estimated economic lives of the assets. Intangible assets with finite lives are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of such assets may not be recoverable. Intangible assets determined to have indefinite useful lives are not amortized but are subject to impairment testing annually, on July 1st, or more frequently if events occur or circumstances change that indicate an asset may be impaired.
As announced in a Form 8-K dated December 13, 2022, the Company was unable to reach an out-of-court resolution with certain holders of the Convertible Notes, Senior Notes, Exchangeable Notes, and the Term Loans outstanding under the Term Loan Credit Agreement, regarding one or more potential financings, refinancings, recapitalizations, reorganizations, restructurings, or investment transactions involving the Company. As a result, the Company revised its outlook to reflect the increased likelihood of a solvency event. The Company concluded that a triggering event had occurred and performed an interim quantitative impairment test for its indefinite-lived intangible asset, the Avaya Trade Name, as of December 31, 2022 to compare the fair value of the Avaya Trade Name to its carrying amount.
The fair value of the Avaya Trade Name was estimated using the relief-from-royalty model, a form of the income approach. Under this methodology, the fair value of the trade name was estimated by applying a royalty rate to forecasted net revenues which was then discounted using a risk-adjusted rate of return on capital. The model relies on assumptions regarding revenue growth rates, royalty rate, discount rate and terminal growth rate. Revenue growth rates inherent in the forecast were based on input from internal and external market intelligence research sources that compare factors such as growth in global economies, regional industry trends and product evolutions. The royalty rate was determined using a set of observed market royalty rates. The discount rate the Company used represents the estimated weighted average cost of capital, which reflects the overall level of inherent risk and the rate of return an outside investor would expect to earn. To estimate royalty cash flows beyond the final year of its model, the Company used a terminal value approach. Under this approach, the Company applied a perpetuity growth assumption to determine the terminal value. The Company incorporated the present value of the resulting terminal value into its estimate of fair value. The result of the interim impairment test of the Avaya Trade Name as of December 31, 2022 indicated that the carrying amount of the Avaya Trade Name exceeded its estimated fair value primarily due to the updated outlook. As a result, the Company recorded an indefinite-lived intangible asset impairment charge of $9 million within the Impairment charges line item in the Condensed Consolidated Statements of Operations, representing the amount by which the carrying
amount of the Avaya Trade Name exceeded its fair value. As of December 31, 2022, the remaining carrying amount of the Avaya Trade Name was $178 million.
To the extent that business conditions deteriorate further or if changes in key assumptions and estimates differ significantly from management's expectations, it may be necessary to record additional impairment charges in the future.
5. Supplementary Financial Information
The following table presents a summary of other (expense) income, net for the periods indicated: | | | | | | | | | | | |
| Three months ended
December 31, |
| (In millions) | 2022 | | 2021 |
| OTHER (EXPENSE) INCOME, NET | | | |
| Interest income | $ | 4 | | | $ | — | |
| Foreign currency losses, net | (10) | | | — | |
| | | |
| | | |
| Other pension and post-retirement benefit credits, net | 2 | | | 6 | |
| Change in fair value of 2017 Emergence Date Warrants | — | | | 1 | |
| | | |
| | | |
| Total other (expense) income, net | $ | (4) | | | $ | 7 | |
The following table presents supplemental cash flow information for the periods presented: | | | | | | | | | | | |
| Three months ended
December 31, |
| (In millions) | 2022 | | 2021 |
| OTHER PAYMENTS | | | |
| Interest payments (excluding lease related interest) | $ | 55 | | | $ | 33 | |
| Income tax payments | 5 | | | 7 | |
| | | |
| NON-CASH INVESTING ACTIVITIES | | | |
Increase (decrease) in Accounts payable for Capital expenditures | $ | 1 | | | $ | (2) | |
| Acquisition of equipment under operating leases | 1 | | | 7 | |
During the three months ended December 31, 2022 and 2021, the Company made payments for operating lease liabilities of $12 million and $15 million, respectively, and made payments for finance lease liabilities of $3 million and $3 million, respectively.
The following table presents a reconciliation of cash, cash equivalents, and restricted cash that sum to the total of the same such amounts shown in the Condensed Consolidated Statements of Cash Flows for the periods presented: | | | | | | | | | | | | | | | | | | | | | | | | | | |
| (In millions) | | December 31, 2022 | | September 30, 2022 | | December 31, 2021 | | September 30, 2021 |
| CASH, CASH EQUIVALENTS, AND RESTRICTED CASH | | | | | | | | |
| Cash and cash equivalents | | $ | 225 | | | $ | 253 | | | $ | 354 | | | $ | 498 | |
| Restricted cash | | 223 | | | 222 | | | — | | | — | |
| Restricted cash included in other assets | | 4 | | | 3 | | | 4 | | | 4 | |
| Total cash, cash equivalents, and restricted cash | | $ | 452 | | | $ | 478 | | | $ | 358 | | | $ | 502 | |
6. Business Restructuring Reserves and Programs
The following table summarizes the restructuring charges by activity for the periods presented: | | | | | | | | | | | | | | |
| | Three months ended
December 31, |
| (In millions) | | 2022 | | 2021 |
| Employee separation costs | | $ | 8 | | | $ | 2 | |
| Facility exit costs | | 2 | | | 5 | |
| Total restructuring charges | | $ | 10 | | | $ | 7 | |
The Company's employee separation costs generally consist of severance charges which include, but are not limited to, termination payments, pension fund payments, health care and unemployment insurance costs to be paid to, or on behalf of, the affected employees and other associated costs. Facility exit costs primarily consist of lease obligation charges for exited facilities, including the impact of accelerated lease expense for right-of-use assets and accelerated depreciation expense for leasehold improvements with reductions in their estimated useful lives due to exited facilities. The restructuring charges include changes in estimates for increases and decreases in costs or changes in the timing of payments related to the restructuring programs of prior fiscal years. The Company does not allocate restructuring reserves to its operating segments.
The following table summarizes the activity for employee separation costs recognized under the Company's restructuring programs for the three months ended December 31, 2022: | | | | | | | | | | | | | | | | | | | | | | | |
| (In millions) | Fiscal 2023 Restructuring Program(1) | | Fiscal 2022 Restructuring Program(1) | | Fiscal 2021 and prior Restructuring Programs(2) | | Total |
| Accrual balance as of September 30, 2022 | $ | — | | | $ | 26 | | | $ | 23 | | | $ | 49 | |
| Restructuring charges | 8 | | | — | | | — | | | 8 | |
| Cash payments | (2) | | | (11) | | | (3) | | | (16) | |
| | | | | | | |
| Impact of foreign currency fluctuations | — | | | 2 | | | 2 | | | 4 | |
| Accrual balance as of December 31, 2022 | $ | 6 | | | $ | 17 | | | $ | 22 | | | $ | 45 | |
(1)Payments related to the fiscal 2023 and fiscal 2022 restructuring programs are expected to be completed in fiscal 2028.
(2)Payments related to the fiscal 2021 and prior restructuring programs are expected to be completed in fiscal 2027.
7. Financing Arrangements
The following table reflects principal amounts of debt and debt net of discounts and issuance costs for the periods presented:
| | | | | | | | | | | | | | | | | | | | | | | |
| December 31, 2022 | | September 30, 2022 |
| (In millions) | Principal amount | | Net of discounts and issuance costs | | Principal amount | | Net of discounts and issuance costs |
| Senior 6.125% Notes due September 15, 2028 | $ | 1,000 | | | $ | 988 | | | $ | 1,000 | | | $ | 988 | |
| Tranche B-1 Term Loans due December 15, 2027 | 800 | | | 784 | | | 800 | | | 783 | |
| Tranche B-2 Term Loans due December 15, 2027 | 743 | | | 738 | | | 743 | | | 738 | |
| Tranche B-3 Term Loans due December 15, 2027 | 350 | | | 285 | | | 350 | | | 282 | |
| Exchangeable 8.00% Senior Notes due December 15, 2027 | 250 | | | 231 | | | 250 | | | 169 | |
| Convertible 2.25% Senior Notes due June 15, 2023 | 221 | | | 220 | | | 221 | | | 210 | |
| ABL Credit Agreement due September 25, 2025 | 56 | | | 56 | | | — | | | — | |
| Total debt | $ | 3,420 | | | $ | 3,302 | | | $ | 3,364 | | | $ | 3,170 | |
| Embedded derivatives liabilities | 56 | | | 56 | | | 72 | | | 72 | |
| Debt maturing within one year | (3,476) | | | (3,358) | | | (221) | | | (210) | |
| Long-term debt, net of current portion and derivatives | $ | — | | | $ | — | | | $ | 3,215 | | | $ | 3,032 | |
Term Loan and ABL Credit Agreements
As of December 31, 2022 and September 30, 2022, the Company maintained (i) its Term Loan Credit Agreement among Avaya Inc., as borrower, Avaya Holdings, the lending institutions from time to time party thereto, and Goldman Sachs Bank USA, as administrative agent and collateral agent (the "Term Loan Credit Agreement") and (ii) its ABL Credit Agreement, among Avaya Inc., as borrower, Avaya Holdings, the several other borrowers party thereto, the several lenders from time to time party thereto, and Citibank, N.A., as administrative agent and collateral agent, which provided a revolving credit facility consisting of a U.S. tranche and a foreign tranche allowing for borrowings of up to an aggregate principal amount of $200 million subject to borrowing base availability (the "ABL Credit Agreement"). The ABL Credit Agreement matures on September 25, 2025.
Prior to July 12, 2022, the Term Loan Credit Agreement matured in two tranches, with principal amounts of $800 million (the "Tranche B-1 Term Loans") and $743 million (the "Tranche B-2 Term Loans") maturing on December 15, 2027. On July 12, 2022, the Company amended the Term Loan Credit Agreement ("Amendment No. 4"), pursuant to which the Company incurred incremental term loans in an aggregate principal amount of $350 million (the "Tranche B-3 Term Loans"). The Tranche B-3 Term Loans bear interest (a) in the case of alternative base rate ("ABR") Loans at rate per annum equal to 9.00% plus the highest of (i) the Federal Funds Rate plus 0.50%, (ii) the U.S. prime rate as publicly announced in the Wall Street
Journal and (iii) the greater of (x) the adjusted Secured Overnight Financing Rate ("SOFR") Rate for an interest period of one month plus 1.00% and (y) 2.00% and (b) in the case of SOFR Loans, bear interest at a rate per annum equal to 10.00% plus the applicable SOFR rate, subject to a 1.00% floor. Amendment No. 4 also made certain other changes to the Term Loan Credit Agreement solely for the benefit of the lenders providing the Tranche B-3 Term Loans, including reducing flexibility for the Company to incur additional debt and liens or make restricted payments or investments under certain of the negative covenants. The Company placed $221 million of the net proceeds of the Tranche B-3 Term Loans in escrow. Filing of the Chapter 11 Cases triggered an event of default under the Term Loan Credit Agreement causing the automatic acceleration of all obligations thereunder, including the Tranche B-3 Term Loans.
The Company evaluated Amendment No. 4 in accordance with ASC 815, Derivatives and Hedging, and determined that there are embedded features in the amendment that are not clearly and closely related to the underlying debt instrument and did not qualify for any scope exceptions set forth in the accounting standards. Accordingly, these embedded features are required to be bifurcated from their host instrument and accounted for separately as an embedded derivative liability. As a result, the Company recorded the fair value of the embedded derivatives as of the issuance date as a $30 million reduction of the initial carrying amount of the Tranche B-3 Term Loans (as part of the debt discount). The discount is amortized to interest expense using the effective interest method over the life of the Tranche B-3 Term Loans. The embedded derivatives will be adjusted to fair value each reported period with changes in fair value subsequent to the issuance date recognized within Interest Expense in the Condensed Consolidated Statements of Operations. See Note 8, "Derivative Instruments and Hedging Activities," for further information regarding the valuation of the embedded derivatives. The aggregate fair value of the embedded derivatives is reflected within Long-term debt in the Condensed Consolidated Balance Sheets.
For the three months ended December 31, 2022 and 2021, the Company recognized interest expense of $30 million and $18 million, respectively, related to the Term Loan Credit Agreement, including the amortization of the underwriting discount and issuance costs. The three months ended December 31, 2022 includes $(17) million of interest expense related to the change in the fair value of the Tranche B-3 Term Loans embedded derivatives during the period.
As of December 31, 2022, the Company had an outstanding balance of $56 million under the ABL Credit Agreement, which includes borrowings of $90 million and repayments of $34 million made during the first quarter of fiscal 2023. The borrowing matures monthly and is renewable at the Company's election in accordance with the terms and conditions of the ABL Credit Agreement. As of December 31, 2022, the Company has the ability and intent to repay the ABL Credit Agreement balance within one year and has classified the balance as current. Under the terms of the ABL Credit Agreement, the Company can issue letters of credit up to $150 million. At December 31, 2022, the Company had issued and outstanding letters of credit and guarantees of $38 million under the ABL Credit Agreement. The aggregate additional principal amount that may be borrowed under the ABL Credit Agreement, based on the borrowing base less $38 million of outstanding borrowings, letters of credit and guarantees was $21 million at December 31, 2022. For the three months ended December 31, 2022, recognized interest expense related to the ABL Credit Agreement was $1 million. For the three months ended December 31, 2021, recognized interest expense related to the ABL Credit Agreement was not material.
Senior Notes
The Company’s Senior 6.125% First Lien Notes have an aggregate principal amount outstanding of $1,000 million and mature on September 15, 2028 (the "Senior Notes"). The Senior Notes were issued on September 25, 2020, pursuant to an indenture among the Company, the Company's subsidiaries that are guarantors of the Senior Notes and party thereto and Wilmington Trust, National Association, as trustee and notes collateral agent.
For each of the three months ended December 31, 2022 and 2021, the Company recognized interest expense of $16 million related to the Senior Notes, including the amortization of debt issuance costs.
Convertible Notes
The Company's 2.25% Convertible Notes have an aggregate principal amount outstanding of $350 million (including notes issued in connection with the underwriters' exercise in full of an over-allotment option of $50 million) and mature on June 15, 2023. The Convertible Notes were issued under an indenture, by and between the Company and the Bank of New York Mellon Trust Company N.A., as trustee.
On July 12, 2022, the Company repurchased approximately $129 million principal amount of the Company's $350 million Convertible Notes due June 15, 2023. The repurchase was accounted for as a loan extinguishment. Based on the application of the loan extinguishment guidance within ASC 470, the Company recorded a $5 million gain on extinguishment within Interest expense in the Consolidated Statements of Operations during fiscal 2022. In connection with the repurchase, the Company terminated a portion of the Bond Hedge and Call Spread Warrants, each representing 4.7 million of its common stock.
For the three months ended December 31, 2022 and 2021, the Company recognized interest expense of $2 million and $7 million related to the Convertible Notes, which includes $0 million and $5 million of amortization of the debt discount and issuance costs, respectively.
The net carrying amount of the Convertible Notes for the periods indicated was as follows:
| | | | | | | | | | | | | | |
| (In millions) | | December 31, 2022 | | September 30, 2022 |
| Principal | | $ | 221 | | | $ | 221 | |
| Less: | | | | |
| Unamortized debt discount | | — | | | (10) | |
| Unamortized issuance costs | | (1) | | | (1) | |
| Net carrying amount | | $ | 220 | | | $ | 210 | |
The net carrying amount of the equity component of the Convertible Notes for the periods indicated was as follows:
| | | | | | | | | | | | | | |
| (In millions) | | December 31, 2022 (1) | | September 30, 2022 |
| Debt discount for conversion option | | $ | 79 | | | $ | 92 | |
| Less: | | | | |
| Conversion option retirement | | — | | | (10) | |
| Issuance costs | | — | | | (3) | |
| Adoption of ASU 2020-06 | | (56) | | | — | |
| Net carrying amount | | $ | 23 | | | $ | 79 | |
(1)Upon adoption of ASU 2020-06 on October 1, 2022, the Company recorded an adjustment to reclassify the debt discount for the conversion option and issuance costs associated with the equity component of the Convertible Notes. See Note 2, "Recent Accounting Pronouncements," for further information regarding the cumulative effect adjustment made by the Company upon adoption. The remaining equity component of the Convertible Notes is related to the $129 million of the Convertible Notes which were repurchased prior to the adoption of ASU 2020-06 as described above.
Exchangeable Notes
On July 12, 2022, the Company issued its 8.00% Exchangeable Senior Secured Notes due 2027 with an aggregate principal amount of $250 million (the "Exchangeable Notes"). The Exchangeable Notes were issued pursuant to an indenture by and among Avaya Inc., the guarantors party thereto and Wilmington Trust, National Association, as trustee, exchange agent and notes collateral agent.
The Company evaluated the indenture governing the Exchangeable Notes in accordance with ASC 815, Derivatives and Hedging, and determined that there are embedded features in the indenture that are not clearly and closely related to the underlying debt instrument and did not qualify for any scope exceptions set forth in the accounting standards. Accordingly, these embedded features are required to be bifurcated from their host instrument and accounted for separately as an embedded derivative liability. As a result, the Company recorded the fair value of the embedded derivatives as of the issuance date as a $4 million reduction of the initial carrying amount of the Exchangeable Notes (as part of the debt discount). The discount is amortized to interest expense using the effective interest method over the life of the Exchangeable Notes. The embedded derivatives will be adjusted to fair value each reported period with changes in fair value subsequent to the issuance date recognized within Interest Expense in the Condensed Consolidated Statements of Operations. See Note 8, "Derivative Instruments and Hedging Activities," for further information regarding the valuation of the embedded derivatives. The aggregate fair value of the embedded derivatives is reflected within Long-term debt in the Condensed Consolidated Balance Sheets.
For the three months ended December 31, 2022, the Company recognized interest expense of $7 million related to the Exchangeable Notes, which includes $1 million of amortization of the debt issuance costs, and $1 million related to the change in the fair value of the Exchangeable Notes embedded derivatives during the period.
The net carrying amount of the Exchangeable Notes for the periods indicated was as follows:
| | | | | | | | | | | | | | |
| (In millions) | | December 31, 2022 | | September 30, 2022 |
| Principal | | $ | 250 | | | $ | 250 | |
| Less: | | | | |
| Unamortized debt discount | | — | | | (65) | |
| Unamortized issuance costs | | (15) | | | (12) | |
| Unamortized debt discount - Embedded derivative liability | | (4) | | | (4) | |
| Net carrying amount | | $ | 231 | | | $ | 169 | |
The net carrying amount of the equity component of the Exchangeable Notes for the period indicated was as follows:
| | | | | | | | | | | | | | |
| (In millions) | | December 31, 2022 (1) | | September 30, 2022 |
| Debt discount for conversion option | | $ | 62 | | | $ | 66 | |
| Less: | | | | |
| Issuance costs | | — | | | (4) | |
| Adoption of ASU 2020-06 | | (62) | | | — | |
| Net carrying amount | | $ | — | | | $ | 62 | |
(1)Upon adoption of ASU 2020-06 on October 1, 2022, The Company recorded an adjustment to reclassify the debt discount for the conversion option and issuance costs associated with the equity component of the Exchangeable Notes. See Note 2, "Recent Accounting Pronouncements," for further information regarding the cumulative effect adjustment made by the Company upon adoption.
The weighted average contractual interest rate of the Company's outstanding debt was 8.0% as of December 31, 2022 and 7.4% as of September 30, 2022, including adjustments related to the Company's interest rate swap agreements (see Note 8, "Derivative Instruments and Hedging Activities"). The effective interest rate for the Term Loan Credit Agreement was 10.7% as of December 31, 2022 and 9.0% as of September 30, 2022. The effective interest rate for the Senior Notes as of December 31, 2022 and September 30, 2022 was not materially different than its contractual interest rate. The effective interest rate for the Convertible Notes was 2.8% as of December 31, 2022, reflecting adjustment to the conversion feature in equity upon adoption of ASU 2020-06. The effective interest rate for the Convertible Notes was 9.2% as of September 30, 2022, reflecting the separation of the conversion feature in equity. The effective interest rate for the Exchangeable Notes was 9.9% as of December 31, 2022, reflecting adjustment to the conversion feature in equity upon adoption of ASU 2020-06. The effective interest rate for the Exchangeable Notes was 17.7% as of September 30, 2022, reflecting the separation of the conversion feature in equity. The effective interest rates include interest on the debt and amortization of discounts and issuance costs.
On December 29, 2022, the Company provided Notices of Default to the administrative agents of the Term Loan Credit Agreement and ABL Credit Agreement; and the trustees of the Senior Notes, Convertible Notes and Exchangeable Notes due to the Company's failure to timely deliver financial statements for the nine months ended June 30, 2022 and the fiscal year ended September 30, 2022. It is not probable that the violation will be cured during the grace period and therefore, in accordance with the terms of the credit agreements, the debt is deemed callable and has been classified as a current liability on the Condensed Consolidated Balance Sheet as of December 31, 2022. As noted in Note 1, "Background and Basis of Presentation," all of the Debtors' pre-petition equity and debt facilities as well as the Debtors' securities were extinguished upon Emergence.
Debtor in Possession Financing
On the Petition Date, the Debtors entered into the DIP Term Loan Facility. On February 24, 2023, the Debtors entered into the DIP ABL Facility. The Bankruptcy Court provided final approval for both facilities on March 7, 2023.
The filing of the Chapter 11 Cases constituted an event of default under the ABL Credit Agreement, the Term Loan Credit Agreement, the Senior Notes, the Convertible Notes and the Exchangeable Notes, that accelerated and, as applicable, increased certain obligations thereunder.
Reorganized Company Financing
On the Emergence Date, the DIP Term Loan converted on a dollar-for-dollar basis into a term loan under a senior secured exit term loan facility and the Company incurred an additional $310 million under the facility (including amounts incurred pursuant to a rights offering) for an aggregate principal amount of $810 million (the "Exit Term Loan", such facility, the "Exit Term Loan Facility", and the agreement providing for such facility, the "Exit Term Loan Credit Agreement") and the DIP ABL Facility converted on a dollar-for-dollar basis into a senior secured exit asset-based revolving loan facility (the "Exit ABL Loan", such facility, the "Exit ABL Loan Facility", and the agreement providing for such facility, the "Exit ABL Credit Agreement"). The Exit Term Loan bears interest at a rate equal to (1) Term SOFR plus (i) 7.50% to the extent interest is paid
entirely in cash or (ii) 8.50% to the extent interest is paid with a combination of cash and payment in kind (consisting of 1.50% payable in cash and 7.00% paid in kind) or (1) Base Rate plus (i) 6.50% to the extent interest is paid entirely in cash or (ii) 7.50% to the extent interest is paid with a combination of cash and payment in kind (consisting of 1.00% payable in cash and 6.50% paid in kind), subject to a 1.00% floor and matures on August 1, 2028. The Company has the option to pay interest with a combination of cash and payment-in-kind for interest payment dates through, and including, June 30, 2024. For interest payments dates after June 30, 2024, interest is payable in cash. The Exit ABL Loan bears interest at a rate equal to Term SOFR plus 3.00% or Base Rate plus 2.00% and matures on May 1, 2026.
The Exit Term Loan Credit Agreement and the Exit ABL Credit Agreement each include conditions precedent, representations and warranties, affirmative and negative covenants, and events of default customary for financings of this type and size. The Borrower's obligations under the Exit Term Loan Credit Agreement and the Exit ABL Credit Agreement are guaranteed by the Company and are collectively secured by a security interest in, and a lien on, substantially all property (subject to certain exceptions) of the Company. The Exit Term Loan Credit Agreement and the Exit ABL Credit Agreement also contain customary covenants that limit the ability of the Company to, among other things, (1) incur additional indebtedness and permit liens to exist on their assets, (2) pay dividends or make certain other restricted payments, (3) sell assets or (4) make certain investments. These covenants are subject to exceptions and qualifications as set forth in each of the Exit Term Loan Credit Agreement and the Exit ABL Credit Agreement.
8. Derivative Instruments and Hedging Activities
The Company accounts for derivative financial instruments in accordance with FASB ASC Topic 815, "Derivatives and Hedging," ("ASC 815") and does not enter into derivatives for trading or speculative purposes.
Interest Rate Contracts
The Company, from time to time, enters into interest rate swap contracts as a hedge against changes in interest rates on its outstanding variable rate loans.
On May 16, 2018, the Company entered into interest rate swap agreements with six counterparties, which fixed a portion of the variable interest due under its Term Loan Credit Agreement (the "Original Swap Agreements"). Under the terms of the Original Swap Agreements, which matured on December 15, 2022, the Company paid a fixed rate of 2.935% and received a variable rate of interest based on one-month LIBOR. Through September 23, 2020, the total $1,800 million notional amount of the Original Swap Agreements were designated as cash flow hedges and deemed highly effective as defined under ASC 815.
On September 23, 2020, the Company entered into an interest rate swap agreement for a notional amount of $257 million (the “Offsetting Swap Agreement”). Under the terms of the Offsetting Swap Agreement, which matured on December 15, 2022, the Company paid a variable rate of interest based on one-month LIBOR and received a fixed rate of 0.1745%. The Company entered into the Offsetting Swap Agreement to maintain a net notional amount less than the amount of the Company’s variable rate loans outstanding. The Offsetting Swap Agreement was not designated for hedge accounting treatment. On September 23, 2020, Original Swap Agreements with a notional amount of $257 million were also de-designated from hedge accounting treatment. Through June 30, 2022, Original Swap Agreements with a notional amount of $1,543 million were designated as cash flow hedges and deemed highly effective as defined under ASC 815. On June 30, 2022, the Company determined that the hedged transactions were no longer highly probable of occurring as forecasted, and as such, the Company de-designated the remaining Original Swap Agreements from hedge accounting treatment.
On July 1, 2020, the Company entered into interest rate swap agreements with four counterparties, which fixed a portion of the variable interest due under its Term Loan Credit Agreement (the "Forward Swap Agreements") from December 15, 2022 (the maturity date of the Original Swap Agreements) through December 15, 2024. Under the terms of the Forward Swap Agreements, the Company would pay a fixed rate of 0.7047% and receive a variable rate of interest based on one-month LIBOR. The total notional amount of the Forward Swap Agreements was $1,400 million. Through March 23, 2022, the Forward Swap Agreements were designated as cash flow hedges and deemed highly effective as defined by ASC 815.
On March 23, 2022, the Company terminated the Forward Swap Agreements and simultaneously entered into new interest rate swap agreements with four counterparties (the "New Forward Swap Agreements"), which resulted in the receipt of $52 million cash proceeds. The New Forward Swap Agreements fixed a portion of the variable interest due under the Company's Term Loan Credit Agreement from December 15, 2022 through June 15, 2027. Under the terms of the New Forward Swap Agreements, the Company paid a fixed rate of 2.5480% and received a variable rate of interest based on one-month SOFR. The total notional amount of the New Forward Swap Agreements is $1,000 million. Through June 30, 2022, the New Forward Swap Agreements were designated as cash flow hedges and deemed highly effective as defined by ASC 815. On June 30, 2022, the Company determined that the hedged transactions were no longer highly probable of occurring as forecasted, and as such, the Company de-designated the New Forward Swap Agreements from hedge accounting treatment.
The Company records changes in the fair value of interest rate swap agreements designated as cash flow hedges initially within Accumulated other comprehensive income (loss) in the Condensed Consolidated Balance Sheets. As interest expense is recognized on the Term Loan Credit Agreement, the corresponding deferred gain or loss on the cash flow hedge is reclassified from Accumulated other comprehensive income (loss) to Interest expense in the Condensed Consolidated Statements of Operations. The Company records changes in the fair value of interest rate swap agreements not designated for hedge accounting within Interest expense. On September 23, 2020, the Company froze a $15 million deferred loss within Accumulated other comprehensive income (loss) related to the de-designated Original Swap Agreements, which was reclassified to Interest expense over the term of the Original Swap Agreements. On March 23, 2022, the Company froze a $52 million deferred gain within Accumulated other comprehensive income (loss) related to the termination of the Forward Swap Agreements, which was reclassified to Interest expense over the term of the original Forward Swap Agreements. On June 30, 2022, the Company froze a $9 million deferred gain within Accumulated other comprehensive income (loss) related to the de-designation of the Original Swap Agreements and New Forward Swap Agreements, which was reclassified to Interest expense over the term of the respective swap agreements.
In December 2022, the Company concluded that the hedged forecasted transactions related to the interest rate swap agreements are probable of not occurring as a result of the Company's inability to reach an out of court solution regarding potential financings, refinancings, recapitalizations, reorganizations, restructurings or investment transactions involving the Company and certain debt holders. As a result, frozen deferred gains of $63 million related to the Company's interest rate swap agreements were reclassified to Interest expense during the first quarter of fiscal 2023. The Company later terminated its New Forward Swap Agreements resulting in the receipt of $40 million of net cash proceeds which is reflected within cash used for operating activities in the Condensed Consolidated Statements of Cash Flows for the three months ended December 31, 2022.
It is management's intention that the net notional amount of interest rate swap agreements be less than or equal to the variable rate loans outstanding during the life of the derivatives.
Debt-Related Embedded Derivatives
The Company's Tranche B-3 Term Loans and Exchangeable Notes contain embedded features that, in certain scenarios, could modify the cash flows of their respective debt instruments. These embedded features (the "Debt-related embedded derivatives") are required to be bifurcated from their host contracts and accounted for as an embedded derivative. The Debt-related embedded derivatives are recorded at fair value with changes in fair value subsequent to the issuance date recorded in Interest expense in the Condensed Consolidated Statements of Operations.
On July 12, 2022, the issuance date, the aggregate fair value of the Debt-related embedded derivatives was $34 million, which was recorded as a debt discount (contra liability) and a derivative liability within Long-term debt on the Consolidated Balance Sheets. As of December 31, 2022 and September 30, 2022, the aggregate fair value of the Debt-related embedded derivatives was $56 million and $72 million, respectively.
The fair value of the derivatives is determined using the with-and-without model which compares the estimated fair value of the underlying debt instrument with the embedded features to the estimated fair value of the underlying debt instrument without the embedded features, with the difference representing the estimated fair value of the embedded derivative features. The with-and-without model includes significant unobservable estimates, including estimated market yield, an estimation of the Company’s probability of default and creditor recovery rates, and the probability of the occurrence of a change of control event or asset sale.
The fair value of the derivatives as of December 31, 2022 was determined using the market assumptions summarized below:
| | | | | | | | |
| | December 31, 2022 |
| Tranche B-3 Term Loans due December 15, 2027 | | |
| Credit Spread | | 31.03 | % |
| Risk-free interest rates | | 3.99 | % |
| Exchangeable 8.00% Senior Secured Notes due 2027 | | |
| Credit Spread | | 31.03 | % |
| Risk-free interest rates | | 3.99 | % |
| Implied volatility | | 273.31 | % |
| Price per share of common stock | | $0.20 |
Foreign Currency Forward Contracts
The Company, from time to time, utilizes foreign currency forward contracts primarily to hedge fluctuations associated with certain monetary assets and liabilities including receivables, payables and certain intercompany balances. These foreign currency forward contracts are not designated for hedge accounting treatment. As a result, changes in the fair value of these
contracts are recorded as a component of Other income, net to offset the change in the value of the hedged assets and liabilities. As of December 31, 2022, the Company had no open foreign currency forward contracts. As of September 30, 2022, the Company maintained open foreign currency forward contracts with a total notional value of $12 million, hedging the Czech Koruna.
2017 Emergence Date Warrants
In accordance with the bankruptcy plan of reorganization adopted in connection with the Company's emergence from bankruptcy on December 15, 2017 (the "2017 Plan of Reorganization"), the Company issued warrants to purchase 5,645,200 shares of the Company's common stock to the holders of the second lien obligations extinguished pursuant to the 2017 Plan of Reorganization (the "2017 Emergence Date Warrants"). Each 2017 Emergence Date Warrant had an exercise price of $25.55 per share and expired on December 15, 2022. The 2017 Emergence Date Warrants contained certain derivative features that required them to be classified as a liability and for changes in the fair value of the liability to be recognized in earnings each reporting period. On November 14, 2018, the Company's Board approved a warrant repurchase program, authorizing the Company to repurchase up to $15 million worth of the 2017 Emergence Date Warrants. None of the 2017 Emergence Date Warrants were exercised or repurchased.
The fair value of the 2017 Emergence Date Warrants was determined using a probability weighted Black-Scholes option pricing model. This model requires certain input assumptions including risk-free interest rates, volatility, expected life and dividend rates. Selection of these inputs involves significant judgment. The fair value of the 2017 Emergence Date Warrants as of September 30, 2022 was determined using the input assumptions summarized below: | | | | | | | | |
| | September 30, 2022 (1) |
| Expected volatility | | 113.93 | % |
| Risk-free interest rates | | 2.36 | % |
| Contractual remaining life (in years) | | 0.46 |
| Price per share of common stock | | $2.24 |
(1)The Company qualitatively determined the fair value of the 2017 Emergence Date Warrants as of September 30, 2022 to be negligible as a result of the decline in Company's stock price since the most recent quantitative analysis (June 30, 2022) and the remaining contractual term of 0.21 years as of September 30, 2022. The amounts presented represent the input assumptions as of June 30, 2022.
In determining the fair value of the 2017 Emergence Date Warrants, the dividend yield was assumed to be zero as the Company did not anticipate paying dividends on its common stock throughout the term of the warrants.
Financial Statement Information Related to Derivative Instruments
The following table summarizes the fair value of the Company's derivatives on a gross basis, including accrued interest: | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | | | December 31, 2022 | | September 30, 2022 |
| (In millions) | | Balance Sheet Caption | | Asset | | Liability | | Asset | | Liability |
| Derivatives Not Designated as Hedging Instruments: | | | | | | | | | | |
| Interest rate contracts | | Other current assets | | $ | — | | | $ | — | | | $ | 15 | | | $ | — | |
| Interest rate contracts | | Other assets | | — | | | — | | | 40 | | | — | |
| Interest rate contracts | | Other current liabilities | | — | | | — | | | — | | | 2 | |
| | | | | | | | | | |
| Debt-related embedded derivatives | | Debt maturing within one year | | — | | | 56 | | | — | | | — | |
| Debt-related embedded derivatives | | Long-term debt | | — | | | — | | | — | | | 72 | |
| | | | | | | | | | |
| | | | | | | | | | |
| | | | | | | | | | |
| | | | — | | | 56 | | | 55 | | | 74 | |
| Total derivatives fair value | | | | $ | — | | | $ | 56 | | | $ | 55 | | | $ | 74 | |
The following table provides information regarding the location and amount of pre-tax gains (losses) for interest rate contracts designated as cash flow hedges:
| | | | | | | | | | | | | | | | | | | | | | | | | | |
| | Three months ended
December 31, |
| | 2022 | | 2021 |
| (In millions) | | Interest Expense | | Other Comprehensive Loss | | Interest Expense | | Other Comprehensive Income |
| Financial Statement Line Item in which Cash Flow Hedges are Recorded | | $ | (5) | | | $ | (100) | | | $ | (54) | | | $ | 40 | |
| | | | | | | | |
| Impact of cash flow hedging relationships: | | | | | | | | |
| Gain recognized in AOCI on interest rate swaps | | — | | | — | | | — | | | 15 | |
| Interest expense reclassified from AOCI | | (62) | | | 62 | | | (13) | | | 13 | |
The following table provides information regarding the pre-tax (losses) gains for derivatives not designated as hedging instruments on the Condensed Consolidated Statements of Operations: | | | | | | | | | | | | | | | | | | | | |
| | | | Three months ended
December 31, |
| (In millions) | | Location of Derivative Pre-tax (Loss) Gain | | 2022 | | 2021 |
| Interest rate contracts | | Interest expense | | $ | (13) | | | $ | — | |
| Debt-related embedded derivatives | | Interest expense | | (16) | | | — | |
| 2017 Emergence Date Warrants | | Other income, net | | — | | | 1 | |
| | | | | | |
The Company records its derivatives on a gross basis in the Condensed Consolidated Balance Sheets. The Company has master netting agreements with several of its financial institution counterparties. The following table provides information on the Company's derivative positions as if those subject to master netting arrangements were presented on a net basis, allowing for the right to offset by counterparty per the master netting agreements: | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | December 31, 2022 | | September 30, 2022 |
| (In millions) | | Asset | | Liability | | Asset | | Liability |
| Gross amounts recognized in the Condensed Consolidated Balance Sheets | | $ | — | | | $ | 56 | | | $ | 55 | | | $ | 74 | |
| Gross amount subject to offset in master netting arrangements not offset in the Condensed Consolidated Balance Sheets | | — | | | — | | | (2) | | | (2) | |
| Net amounts | | $ | — | | | $ | 56 | | | $ | 53 | | | $ | 72 | |
9. Fair Value Measurements
Pursuant to the accounting guidance for fair value measurements, fair value is defined as the price that would be received from selling an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. When determining the fair value measurements for assets and liabilities required or permitted to be recorded at fair value, the
Company considers the principal or most advantageous market in which it would transact and it considers assumptions that market participants would use when pricing the asset or liability. Considerable judgment was required in developing certain of the estimates of fair value and accordingly, the estimates presented herein are not necessarily indicative of the amounts that the Company could realize in a current market exchange.
Fair Value Hierarchy
The accounting guidance for fair value measurements also requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. A financial instrument's categorization within the fair value hierarchy is based upon the lowest level of input that is significant to the fair value measurement. The inputs are prioritized into three levels that may be used to measure fair value:
Level 1: Inputs that reflect quoted prices for identical assets or liabilities in active markets that are observable.
Level 2: Inputs that reflect quoted prices for similar assets or liabilities in active markets; quoted prices for identical or similar assets or liabilities in markets that are not active; or model-derived valuations in which significant inputs are observable or can be derived principally from, or corroborated by, observable market data.
Level 3: Inputs that are unobservable to the extent that observable inputs are not available for the asset or liability at the measurement date.
Assets and Liabilities Measured at Fair Value on a Recurring Basis
Assets and liabilities measured at fair value on a recurring basis as of December 31, 2022 and September 30, 2022 were as follows: | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | December 31, 2022 | | September 30, 2022 |
| | Fair Value Measurements Using | | Fair Value Measurements Using |
| (In millions) | Total | | Level 1 | | Level 2 | | Level 3 | | Total | | Level 1 | | Level 2 | | Level 3 |
| Assets: | | | | | | | | | | | | | | | |
| Interest rate contracts | $ | — | | | $ | — | | | $ | — | | | $ | — | | | $ | 55 | | | $ | — | | | $ | 55 | | | $ | — | |
| | | | | | | | | | | | | | | |
| Total assets | $ | — | | | $ | — | | | $ | — | | | $ | — | | | $ | 55 | | | $ | — | | | $ | 55 | | | $ | — | |
| | | | | | | | | | | | | | | |
| Liabilities: | | | | | | | | | | | | | | | |
| Interest rate contracts | $ | — | | | $ | — | | | $ | — | | | $ | — | | | $ | 2 | | | $ | — | | | $ | 2 | | | $ | — | |
| | | | | | | | | | | | | | | |
| Debt-related embedded derivatives | 56 | | | — | | | — | | | 56 | | | 72 | | | — | | | — |