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SECURITIES AND EXCHANGE COMMISSIONWashington, D.C. 20549

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FORM 10-Q

|ý                                            | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 
|-------------------------------------------- | ----------------------------------------------------------------------------------------
|For The Quarterly Period Ended June 30, 2003
|OR                                          
|o                                            | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

Commission File Number 001-15951

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AVAYA INC.

|A DELAWARE
CORPORATION                                                            |  | I.R.S. EMPLOYER
NO. 22-3713430
|--------------------------------------------------------------------------------- |  | ------------------------------
|211 Mount Airy Road
Basking Ridge, New Jersey 07920
Telephone Number 908-953-6000

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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 ý    No o

At
June 30, 2003, 382,184,702 common shares were outstanding.

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TABLE OF CONTENTS

|Item                         |  | Description                                                                           |  | Page
|---------------------------- |  | ------------------------------------------------------------------------------------- |  | ----
|PART I FINANCIAL INFORMATION
|1.                           |  | Financial Statements                                                                  |  | 3   
|2.                           |  | Management's Discussion and Analysis of Financial Condition and Results of Operations |  | 28  
|3.                           |  | Quantitative and Qualitative Disclosures About Market Risk                            |  | 68  
|4.                           |  | Controls and Procedures                                                               |  | 68  
|PART II OTHER INFORMATION   
|1.                           |  | Legal Proceedings                                                                     |  | 69  
|2.                           |  | Changes in Securities and Use of Proceeds                                             |  | 69  
|3.                           |  | Defaults Upon Senior Securities                                                       |  | 69  
|4.                           |  | Submission of Matters to a Vote of Security Holders                                   |  | 69  
|5.                           |  | Other Information                                                                     |  | 69  
|6.                           |  | Exhibits and Reports on Form 8-K                                                      |  | 69  
|                             |  | Signatures                                                                            |  | 70  

This
Quarterly Report on Form 10-Q contains trademarks, service marks and registered marks of Avaya and its subsidiaries and other companies, as indicated. Unless
otherwise provided in this Quarterly Report on Form 10-Q, trademarks identified by ® and  are registered trademarks or trademarks, respectively, of
Avaya Inc. or its subsidiaries. All other trademarks are the properties of their respective owners. Liquid Yield Option Notes is a trademark of Merrill Lynch &
Co., Inc.

2

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PART I

Item 1.Financial Statements.

AVAYA INC. AND SUBSIDIARIES  CONSOLIDATED STATEMENTS OF OPERATIONS  (dollars in millions, except per share amounts)  (unaudited)

|                                                      |                                                                      | Three Months Ended
June 30, |       | Nine Months Ended
June 30, |  
|----------------------------------------------------- | -------------------------------------------------------------------- | --------------------------- | ----- | -------------------------- | -
|
|REVENUE                                               |                                                                      |                             |       |                            |  
|                                                      | Products                                                             |                             | $     | 614                        |  
|                                                      | Services                                                             |                             |       | 458                        |  
|                                                      |                                                                      |                             |       |                            |  
|                                                      |                                                                      |                             | 1,072 |                            |  
|                                                      |                                                                      |                             |       |                            |  
|COSTS                                                 |                                                                      |                             |       |                            |  
|                                                      | Products                                                             |                             |       | 354                        |  
|                                                      | Services                                                             |                             |       | 276                        |  
|                                                      |                                                                      |                             |       |                            |  
|                                                      |                                                                      |                             | 630   |                            |  
|                                                      |                                                                      |                             |       |                            |  
|GROSS MARGIN                                          |                                                                      |                             | 442   |                            |  
|                                                      |                                                                      |                             |       |                            |  
|OPERATING EXPENSES                                    |                                                                      |                             |       |                            |  
|                                                      | Selling, general and administrative                                  |                             |       | 326                        |  
|                                                      | Business restructuring charges (reversals) and
related expenses, net |                             |       | 7                          |  
|                                                      | Research and development                                             |                             |       | 92                         |  
|                                                      |                                                                      |                             |       |                            |  
|                                                      | TOTAL OPERATING EXPENSES                                             |                             |       | 425                        |  
|                                                      |                                                                      |                             |       |                            |  
|OPERATING INCOME (LOSS)                               |                                                                      |                             | 17    |                            |  
|                                                      | Gain (loss) on long-term debt extinguishment, net                    |                             |       | 1                          |  
|                                                      | Other income (expense), net                                          |                             |       | 16                         |  
|                                                      | Interest expense                                                     |                             |       | (21                        | )
|                                                      |                                                                      |                             |       |                            |  
|INCOME (LOSS) BEFORE INCOME TAXES                     |                                                                      |                             | 13    |                            |  
|                                                      | Provision (benefit) for income taxes                                 |                             |       | 5                          |  
|                                                      |                                                                      |                             |       |                            |  
|NET INCOME (LOSS)                                     |                                                                      | $                           | 8     |                            | $
|                                                      |                                                                      |                             |       |                            |  
|Net Income (Loss) Available to Common Stockholders:   |                                                                      |                             |       |                            |  
|Net income (loss)                                     |                                                                      | $                           | 8     |                            | $
|Accretion of Series B preferred stock                 |                                                                      |                             |      |                            |  
|Conversion charge related to Series B preferred stock |                                                                      |                             |      |                            |  
|                                                      |                                                                      |                             |       |                            |  
|Net income (loss) available to common stockholders    |                                                                      | $                           | 8     |                            | $
|                                                      |                                                                      |                             |       |                            |  
|Earnings (Loss) Per Common Share:                     |                                                                      |                             |       |                            |  
|                                                      | Basic and Diluted                                                    |                             | $     | 0.02                       |  
|                                                      |                                                                      |                             |       |                            |  

See
Notes to Consolidated Financial Statements.

3

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AVAYA INC. AND SUBSIDIARIES  CONSOLIDATED BALANCE SHEETS  (dollars in millions, except per share amounts)  (unaudited)

|                                           |                                                                                                                                                                                                                     | As of
June 30, 2003 |       | As of
September 30, 2002 |  
|------------------------------------------ | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- | ------------------- | ----- | ------------------------ | -
|ASSETS                                     |                                                                                                                                                                                                                     |                     |       |                          |  
|Current assets:                            |                                                                                                                                                                                                                     |                     |       |                          |  
|                                           | Cash and cash equivalents                                                                                                                                                                                           |                     | $     | 843                      |  
|                                           | Receivables, less allowances of $93 at June 30, 2003 and $121 at September 30, 2002                                                                                                                                 |                     |       | 703                      |  
|                                           | Inventory                                                                                                                                                                                                           |                     |       | 394                      |  
|                                           | Deferred income taxes, net                                                                                                                                                                                          |                     |       | 149                      |  
|                                           | Other current assets                                                                                                                                                                                                |                     |       | 223                      |  
|                                           |                                                                                                                                                                                                                     |                     |       |                          |  
|TOTAL CURRENT ASSETS                       |                                                                                                                                                                                                                     |                     | 2,312 |                          |  
|                                           |                                                                                                                                                                                                                     |                     |       |                          |  
|                                           | Property, plant and equipment, net                                                                                                                                                                                  |                     |       | 823                      |  
|                                           | Deferred income taxes, net                                                                                                                                                                                          |                     |       | 294                      |  
|                                           | Goodwill                                                                                                                                                                                                            |                     |       | 146                      |  
|                                           | Other assets                                                                                                                                                                                                        |                     |       | 175                      |  
|                                           |                                                                                                                                                                                                                     |                     |       |                          |  
|TOTAL ASSETS                               |                                                                                                                                                                                                                     | $                   | 3,750 |                          | $
|                                           |                                                                                                                                                                                                                     |                     |       |                          |  
|LIABILITIES AND STOCKHOLDERS' EQUITY       |                                                                                                                                                                                                                     |                     |       |                          |  
|Current liabilities:                       |                                                                                                                                                                                                                     |                     |       |                          |  
|                                           | Accounts payable                                                                                                                                                                                                    |                     | $     | 346                      |  
|                                           | Business restructuring reserve                                                                                                                                                                                      |                     |       | 81                       |  
|                                           | Payroll and benefit obligations                                                                                                                                                                                     |                     |       | 313                      |  
|                                           | Deferred revenue                                                                                                                                                                                                    |                     |       | 102                      |  
|                                           | Other current liabilities                                                                                                                                                                                           |                     |       | 326                      |  
|                                           |                                                                                                                                                                                                                     |                     |       |                          |  
|TOTAL CURRENT LIABILITIES                  |                                                                                                                                                                                                                     |                     | 1,168 |                          |  
|                                           |                                                                                                                                                                                                                     |                     |       |                          |  
|                                           | Long-term debt                                                                                                                                                                                                      |                     |       | 993                      |  
|                                           | Benefit obligations                                                                                                                                                                                                 |                     |       | 1,086                    |  
|                                           | Other liabilities                                                                                                                                                                                                   |                     |       | 503                      |  
|                                           |                                                                                                                                                                                                                     |                     |       |                          |  
|TOTAL NON-CURRENT LIABILITIES              |                                                                                                                                                                                                                     |                     | 2,582 |                          |  
|                                           |                                                                                                                                                                                                                     |                     |       |                          |  
|Commitments and contingencies              |                                                                                                                                                                                                                     |                     |       |                          |  
|STOCKHOLDERS' EQUITY                       |                                                                                                                                                                                                                     |                     |       |                          |  
|                                           | Series A junior participating preferred stock, par value $1.00 per share, 7.5 million shares authorized; none issued and outstanding                                                                                |                     |       |                         |  
|                                           | Common stock, par value $0.01 per share, 1.5 billion shares authorized, 382,830,680 and 364,752,178 issued (including 645,978 and 557,353 treasury shares) as of June 30, 2003 and September 30, 2002,
respectively |                     |       | 4                        |  
|                                           | Additional paid-in capital                                                                                                                                                                                          |                     |       | 1,785                    |  
|                                           | Accumulated deficit                                                                                                                                                                                                 |                     |       | (1,336                   | )
|                                           | Accumulated other comprehensive loss                                                                                                                                                                                |                     |       | (449                     | )
|                                           | Less treasury stock at cost                                                                                                                                                                                         |                     |       | (4                       | )
|                                           |                                                                                                                                                                                                                     |                     |       |                          |  
|TOTAL STOCKHOLDERS' EQUITY                 |                                                                                                                                                                                                                     |                     |      |                          |  
|                                           |                                                                                                                                                                                                                     |                     |       |                          |  
|TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY |                                                                                                                                                                                                                     | $                   | 3,750 |                          | $
|                                           |                                                                                                                                                                                                                     |                     |       |                          |  

See Notes to Consolidated Financial Statements.

4

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AVAYA INC. AND SUBSIDIARIES  CONSOLIDATED STATEMENTS OF CASH FLOWS  (dollars in millions)  (unaudited)

|                                                             |                                                                                            | Nine Months
Ended
June 30,                                                |    
|------------------------------------------------------------ | ------------------------------------------------------------------------------------------ | ------------------------------------------------------------------------- | ---
|
|OPERATING ACTIVITIES:                                        |                                                                                            |                                                                           |    
|                                                             | Net loss                                                                                   |                                                                           | $  
|                                                             | Adjustments to reconcile net loss to net cash provided by (used for) operating activities: |                                                                           |    
|                                                             |                                                                                            | Business restructuring charges (reversal)                                 |    
|                                                             |                                                                                            | Depreciation and amortization                                             |    
|                                                             |                                                                                            | Provision for uncollectible receivables                                   |    
|                                                             |                                                                                            | Deferred income taxes                                                     |    
|                                                             |                                                                                            | Deferred tax valuation allowance                                          |    
|                                                             |                                                                                            | Loss on extinguishment of debt, net                                       |    
|                                                             |                                                                                            | Gain on assets sold                                                       |    
|                                                             |                                                                                            | Lucent securities litigation charge                                       |    
|                                                             |                                                                                            | Amortization of debt discount (premium) and deferred financing costs, net |    
|                                                             |                                                                                            | Amortization of restricted stock units                                    |    
|                                                             |                                                                                            | Adjustments for other non-cash items, net                                 |    
|                                                             |                                                                                            | Changes in operating assets and liabilities:                              |    
|                                                             |                                                                                            |                                                                           |    
|                                                             |                                                                                            |                                                                           |    
|                                                             |                                                                                            |                                                                           |    
|                                                             |                                                                                            |                                                                           |    
|                                                             |                                                                                            |                                                                           |    
|                                                             |                                                                                            |                                                                           |    
|                                                             |                                                                                            |                                                                           |    
|                                                             |                                                                                            |                                                                           |    
|NET CASH PROVIDED BY (USED FOR) OPERATING ACTIVITIES         |                                                                                            |                                                                           | 147
|                                                             |                                                                                            |                                                                           |    
|INVESTING ACTIVITIES:                                        |                                                                                            |                                                                           |    
|                                                             | Capital expenditures                                                                       |                                                                           |    
|                                                             | Proceeds from the sale of property, plant and equipment                                    |                                                                           |    
|                                                             | Acquisition of business, net of cash acquired                                              |                                                                           |    
|                                                             | Other investing activities, net                                                            |                                                                           |    
|                                                             |                                                                                            |                                                                           |    
|NET CASH USED FOR INVESTING ACTIVITIES                       |                                                                                            |                                                                           | (20
|                                                             |                                                                                            |                                                                           |    
|FINANCING ACTIVITIES:                                        |                                                                                            |                                                                           |    
|                                                             | Issuance of common stock                                                                   |                                                                           |    
|                                                             | Net decrease in commercial paper                                                           |                                                                           |    
|                                                             | Issuance of long-term debt                                                                 |                                                                           |    
|                                                             | Repayment of other long-term borrowings                                                    |                                                                           |    
|                                                             | Repayment of other short-term borrowings, net                                              |                                                                           |    
|                                                             | Payment of issuance costs related to debt and equity offerings                             |                                                                           |    
|                                                             | Repayment of credit facility borrowing                                                     |                                                                           |    
|                                                             | Termination of accounts receivable securitization                                          |                                                                           |    
|                                                             | Other financing activities, net                                                            |                                                                           |    
|                                                             |                                                                                            |                                                                           |    
|NET CASH PROVIDED BY FINANCING ACTIVITIES                    |                                                                                            |                                                                           | 110
|                                                             |                                                                                            |                                                                           |    
|Effect of exchange rate changes on cash and cash equivalents |                                                                                            |                                                                           | 9  
|                                                             |                                                                                            |                                                                           |    
|Net increase in cash and cash equivalents                    |                                                                                            |                                                                           | 246
|Cash and cash equivalents at beginning of fiscal year        |                                                                                            |                                                                           | 597
|                                                             |                                                                                            |                                                                           |    
|Cash and cash equivalents at end of period                   |                                                                                            | $                                                                         | 843
|                                                             |                                                                                            |                                                                           |    

See Notes to Consolidated Financial Statements.

5

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AVAYA INC. AND SUBSIDIARIES        NOTES TO CONSOLIDATED FINANCIAL STATEMENTS        (unaudited)

1.    Background and Basis of Presentation

Background

Avaya Inc. (the "Company" or "Avaya") provides communication systems, applications and services for enterprises, including businesses, government agencies
and other organizations. The Company's product offerings include converged voice and data networks, traditional voice communication systems, customer relationship management applications, unified
communications applications and structured cabling products. The Company supports its broad customer base with comprehensive global service offerings that enable customers to plan, design, implement
and manage their communications networks.

Basis of Presentation

The accompanying unaudited consolidated financial statements as of June 30, 2003 and for the three and nine months ended June 30, 2003 and 2002,
have been prepared in accordance with accounting principles generally accepted in the United States of America for interim financial statements and the rules and regulations of the Securities and
Exchange Commission for interim financial statements, and should be read in conjunction with the Company's Annual Report on Form 10-K for the fiscal year ended September 30,
2002. In the Company's opinion, the unaudited interim consolidated financial statements reflect all adjustments, consisting of normal and recurring adjustments, necessary
for a fair presentation of the financial condition, results of operations and cash flows for the periods indicated. Certain prior year amounts have been reclassified to conform to the current interim
period presentation. The consolidated results of operations for the interim periods reported are not necessarily indicative of the results to be experienced for the entire fiscal year.

2.    Recent Accounting Pronouncements

FASB Interpretation No. 45

In November 2002, the Financial Accounting Standards Board ("FASB") issued Interpretation No. 45, "Guarantor's Accounting and Disclosure
Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others" ("FIN 45"). FIN 45 expands on the existing disclosure requirements for most guarantees, including loan guarantees
such as standby letters of credit. It also requires that at the time a company issues a guarantee, the company must recognize an initial liability for the fair market value of the obligation it
assumes under that guarantee and must disclose that information in its interim and annual financial statements. The initial recognition and measurement provisions of FIN 45 apply on a prospective
basis to guarantees issued or modified after December 31, 2002. The Company adopted the recognition and measurement provisions of FIN 45 beginning in the second quarter of fiscal 2003. The
applicable disclosures are reflected in Note 12-Commitments and Contingencies.

EITF Issue No. 00-21

In November 2002, the Emerging Issues Task Force ("EITF") reached a consensus on Issue No. 00-21, "Accounting for Revenue Arrangements
with Multiple Deliverables" ("EITF 00-21"). EITF 00-21 addresses certain aspects of the accounting by a vendor for arrangements that involve the delivery or performance of
multiple revenue generating activities, including the sale of products combined with initial installation, initiation, or activation services, that may occur at different points in time or over
different periods of time. This consensus addresses when and, if so, how an arrangement

6

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with
multiple deliverables should be divided into separate units of accounting. EITF 00-21 will apply to revenue arrangements entered into by the Company beginning in the fourth quarter of
fiscal 2003. The adoption of EITF 00-21 is not expected to have a material impact on the Company's consolidated results of operations, financial position or cash flows.

SFAS 148

In December 2002, the FASB issued Statement of Financial Accounting Standards ("SFAS") No. 148, "Accounting for Stock-Based Compensation-Transition
and Disclosure" ("SFAS 148"), which amends SFAS No. 123, "Accounting for Stock-Based Compensation" ("SFAS 123"). SFAS 148 provides alternative methods of transition for a
voluntary change to the fair value based method of accounting for stock-based employee compensation. SFAS 148 also amends the disclosure provisions of SFAS 123 to require prominent
disclosure about the effects on reported net income of an entity's accounting policy decisions with respect to stock-based employee compensation, and requires disclosure about those effects in both
annual and interim financial statements.

The
Company has elected to continue to account for its stock compensation plans under the recognition and measurement principles of Accounting Principles Board Opinion No. 25,
"Accounting for Stock Issued to Employees," and related interpretations. No stock-based employee compensation cost related to stock options is reflected in the Company's Statements of Operations, as
all options granted under the plan had an exercise price equal to the market value of the underlying common stock on the date of grant. The Company records compensation expense for the amortization of
restricted stock units issued to employees. The following table illustrates the effect on net income (loss) and earnings (loss) per share as if the Company had applied the fair value recognition
provisions of SFAS 123.

|                                                                                                                                     |                               | Three Months Ended
June 30, |    | Nine Months Ended
June 30, |  
|------------------------------------------------------------------------------------------------------------------------------------ | ----------------------------- | --------------------------- | -- | -------------------------- | -
|
|
|Net income (loss) available to common stockholders, as reported                                                                      |                               | $                           | 8  |                            | $
|Deduct: Total stock-based employee compensation income
(expense) determined under fair value based method,
net of related tax effect |                               |                             | (9 | )                          |  
|                                                                                                                                     |                               |                             |    |                            |  
|Pro forma net loss available to common stockholders                                                                                  |                               | $                           | (1 | )                          | $
|                                                                                                                                     |                               |                             |    |                            |  
|Earnings (loss) per share:                                                                                                           |                               |                             |    |                            |  
|                                                                                                                                     | Basic and Diluted-as reported |                             | $  | 0.02                       |  
|                                                                                                                                     |                               |                             |    |                            |  
|                                                                                                                                     | Basic and Diluted-pro forma   |                             | $  | 0.00                       |  
|                                                                                                                                     |                               |                             |    |                            |  

The
fair value of stock options used to compute pro forma net loss resulted in additional income in the nine months ended June 30, 2003 and 2002 because a substantial number of
previously granted options had been forfeited/expired and the cumulative reversal of pro forma expense related to these options exceeds the pro forma expense related to the remaining outstanding
options.

7

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FASB Interpretation No. 46

In January 2003, the FASB issued Interpretation No. 46, "Consolidation of Variable Interest Entities, an interpretation of Accounting Research
Bulletin No. 51" ("FIN 46"). FIN 46 requires certain variable interest entities to be consolidated by the primary beneficiary of the entity if the equity investors in the entity do not have the
characteristics of a controlling financial interest or do not have sufficient equity at risk for the entity to finance its activities without additional subordinated financial support from other
parties. The disclosure requirements of FIN 46 and the consolidation requirements for variable interest entities created or acquired subsequent to January 31, 2003 became effective for
financial statements issued by the Company beginning in the second quarter of fiscal 2003. For variable interest entities created or acquired prior to February 1, 2003, the consolidation
requirements of FIN 46 become effective for the Company in the fourth quarter of fiscal 2003. The Company currently has no significant contractual relationship or other business relationship with a
variable interest entity and therefore the adoption of FIN 46 did not have a material effect on the Company's consolidated results of operations, financial position or cash flows.

SFAS 149

In April 2003, the FASB issued SFAS No. 149, "Amendment of Statement 133 on Derivative Instruments and Hedging Activities" ("SFAS 149").
SFAS 149 amends and clarifies financial accounting and reporting for derivative instruments, including certain derivative instruments embedded in other contracts and for hedging activities
under SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities." The changes are intended to improve financial reporting by requiring that contracts with comparable
characteristics be accounted for similarly. Additionally, those changes are expected to result in more consistent reporting of contracts as either derivatives or hybrid instruments. The requirements
of SFAS 149 become effective for the Company for contracts entered into or modified after June 30, 2003, with the exception of Implementation Issues that have been cleared by the FASB
and have been effective for fiscal quarters that began prior to June 15, 2003, and for hedging relationships designated after June 30, 2003. The provisions of this statement are applied
on a prospective basis. The adoption of SFAS 149 is not expected to have a material effect on the Company's consolidated results of operations, financial position or cash flows.

SFAS 150

In May 2003, the FASB issued SFAS No. 150, "Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity"
("SFAS 150"). SFAS 150 establishes standards for the classification and measurement of certain financial instruments with characteristics of both liabilities and equity. The changes are
intended to result in a more complete representation of an entity's liabilities and equity and will, thereby, assist investors and creditors in assessing the amount, timing, and likelihood of
potential future cash outflows and equity share issuances. This Statement also requires that certain obligations that could be settled by the issuance of equity, but lack other characteristics of
equity, be reported as liabilities even though the obligation does not meet the definition of a liability. The requirements of SFAS 150 became effective for the Company for financial
instruments entered into or modified after May 31, 2003, or at the beginning of the fourth quarter of fiscal 2003 for financial instruments entered into on or prior to May 31, 2003. The
adoption of

8

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SFAS 150
is not expected to have a material effect on the Company's consolidated results of operations, financial position or cash flows.

3.    Goodwill and Intangible Assets

The carrying value of goodwill as of June 30, 2003, by operating segment, was comprised of $118 million attributed to the Enterprise Communications
Group, formerly named Converged Systems and Applications, and $28 million attributed to Small and Medium Business Solutions.

Amortization
expense for the Company's existing technology and other definite life intangible assets was $3 million and $9 million for the three months ended
June 30, 2003 and 2002, and $9 million and $26 million for the nine months ended June 30, 2003 and 2002, respectively. Estimated amortization expense for the succeeding
fiscal years as of June 30, 2003 is (i) $4 million for the remaining three months in fiscal 2003; (ii) $4 million in 2004; and (iii) $1 million in
2005. The net carrying value of intangible assets having definite lives was $9 million as of June 30, 2003 and is included in other assets.

4.    Comprehensive Income (Loss)

Other comprehensive income is recorded as a component of accumulated other comprehensive loss within the Stockholders' Equity section of the Consolidated Balance
Sheets and includes unrealized gains and losses excluded from the Consolidated Statements of Operations. These unrealized gains and losses for the three and nine months ended June 30, 2003 and
2002 consisted of foreign currency translation adjustments, which were not adjusted for income taxes as they primarily relate to indefinite investments in non-U.S. subsidiaries.

Three Months Ended
June 30,

Nine Months Ended
June 30,2003

2002

2003

2002(dollars in millions)Net income (loss)

$
8

$
(39
)
$
(154
)
$
(122
)Other comprehensive income:Foreign currency translations


31


39


63


14Total comprehensive income (loss)

$
39

$


$
(91
)
$
(108
)


9

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5.    Supplementary Financial Information

Statements of Operations Information

Other Income (Expense), Net

Three Months Ended
June 30,

Nine Months Ended
June 30,2003

2002

2003

2002(dollars in millions)Loss on foreign currency transactions

$
(2
)
$
(12
)
$
(3
)
$
(3
)Gain on assets sold


14





14


Impairment of investment











(4
)Interest income


4


5


12


16Lucent securities litigation charge








(25
)

Other, net





(3
)

(1
)

(1
)Total other income (expense), net

$
16

$
(10
)
$
(3
)
$
8


Balance Sheet Information

Inventory

As of
June 30, 2003

As of
September 30, 2002(dollars in millions)Finished goods

$
298

$
347Work in-process and raw materials


96


120Total inventory

$
394

$
467


Capitalized Software Costs

The Company's capitalized software costs, net of accumulated amortization, are included in other assets on the Consolidated Balance Sheet and amounted to
$45 million and $47 million as of June 30, 2003 and September 30, 2002, respectively. Amortization expense for the Company's capitalized software costs was
$6 million and $5 million for the three months ended June 30, 2003 and 2002, and $19 million and $15 million for the nine months ended June 30, 2003 and 2002,
respectively.

10

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Cash Flow Information

Non-Cash Transactions:

Nine Months Ended
June 30,2003

2002(dollars in millions)Exchange of LYONs for common stock

$
18

$
Warrants to purchase common stock issued in LYONs Exchange Offer


5


Accretion of Series B preferred stock





12Conversion of Series B preferred stock





395Conversion charge related to Series B preferred stock





125Issuance of common stock in connection with March 2002 equity transactions





(532
)Deferred taxes on stock options





4Total non-cash transactions

$
23

$
4


6.    Business Restructuring Reserve

The business restructuring reserve reflects the remaining balance associated with the Company's business restructuring charges recorded in fiscal 2000 through
2002. The following table summarizes the status of the Company's business restructuring reserve as of and for the nine months ended June 30, 2003:

Employee
Separation
Costs

Lease
Termination
Obligations

Total Business
Restructuring
Reserve(dollars in millions)Balance as of September 30, 2002

$
68

$
102

$
170Cash payments


(42
)

(30
)

(72
)Reversals


(15
)

(2
)

(17
)Balance as of June 30, 2003

$
11

$
70

$
81


In
the second quarter of fiscal 2003, the Company recorded a reversal of $17 million primarily attributable to higher employee attrition than originally anticipated and more
favorable than expected real estate lease termination costs.

The
charges for employee separation costs in fiscal 2002 were recorded in connection with the elimination of approximately 4,240 management and union-represented employee positions
worldwide. This workforce reduction has been substantially completed and the remaining employees are largely expected to depart the Company by the end of fiscal 2003. The workforce reductions
associated with the business restructuring activities in fiscal 2001 and 2000 have been completed. Payments on lease termination obligations are related to vacated real estate facilities and will be
substantially completed by 2011.

11

---

7.    Long-Term Debt and Derivative Financial Instruments

Long-term debt outstanding consisted of the following:

As of
June 30, 2003

As of
September 30, 2002(dollars in millions)LYONs convertible debt, net of discount

$
325

$
476Senior Secured Notes, net of discount and premium


668
(1)

457
(2)Total long-term debt

$
993

$
933


---

LYONs Convertible Debt

In December 2002, the Company, together with the Warburg Pincus Equity Partners L.P. and affiliated investment funds (the "Warburg Entities"), commenced an
exchange offer to purchase up to approximately $661 million aggregate principal amount at maturity, or 70%, of the Company's outstanding Liquid Yield Option Notes due 2021
("LYONs") (the "Exchange Offer").
Under the terms of the Exchange Offer, holders of LYONs could elect to receive, for each $1,000 aggregate principal amount at maturity of LYONs exchanged, either (i) $389.61 in cash (the "Cash
Consideration") or (ii) a combination of $208.40 in cash plus 77 shares of the Company's common stock (the "Mixed Consideration").

Avaya
and the Warburg Entities entered into a Backstop Agreement, as amended (the "Backstop Agreement"), which contains the terms relating to the Warburg Entities' participation in the
Exchange Offer. Under the terms of the Backstop Agreement, the Company granted the Warburg Entities series C warrants described in Note 8-Stock Compensation and Other Equity
Transactions, and reduced the exercise price of 5,581,101 of the 6,724,665 series A warrants held by the Warburg Entities to $0.01 per share. The Warburg Entities exercised the 5,581,101
series A warrants and converted the LYONs they acquired in the Exchange Offer into shares of the Company's common stock, each as described below.

In
January 2003, the Exchange Offer expired and an aggregate principal amount at maturity of LYONs of $84,426,000, representing approximately 8.9% of the outstanding LYONs, or
approximately $43 million in accreted value, was tendered. Of these LYONs, $84,416,000 aggregate principal amount at maturity were tendered for the Mixed Consideration and $10,000 aggregate
principal amount at maturity were tendered for the Cash Consideration. In exchange for the LYONs accepted in the Exchange Offer, the Warburg Entities paid an aggregate amount of approximately
$18 million in cash

12

---

and
the Company delivered 6,500,032 shares of its common stock. The Company delivered an additional 1,588,548 shares of its common stock to the Warburg Entities upon conversion of LYONs acquired by
them in the Exchange Offer.

In
the second quarter of fiscal 2003, the Company recognized in the Consolidated Statement of Operations a pre-tax charge of $36 million in loss on
long-term debt extinguishment, net related to the Exchange Offer. This charge reflects a $26 million loss related to the retirement of LYONs and $10 million of expenses
related to (a) series C warrants issued to the Warburg Entities; (b) common stock issued to the Warburg Entities; (c) estimated transaction costs; and (d) the
unamortized deferred financing costs from the original issuance of LYONs that were retired.

In
the first quarter of fiscal 2003, the Company recorded a deferred income tax valuation allowance through a non-cash income tax charge of $83 million in the
Consolidated Statement of Operations. This amount increased the deferred tax asset valuation allowance to reflect the difference between the actual and expected tax gain associated with the LYONs
Exchange Offer.

During
the second and third quarters of fiscal 2003, the Company repurchased $232 million aggregate principal amount at maturity of LYONs, or $119 million in accreted
value, in a series of open market transactions. The Company used a total of approximately $115 million in cash to repurchase these
LYONs of which $7 million has been recorded as a component of accounts payable as of June 30, 2003 since the cash settlement occurred in July 2003. The Company recognized a
pre-tax gain of approximately $1 million and $2 million, net of the write-off of deferred financing costs related to the LYONs repurchased, for the three and nine
months ended June 30, 2003, respectively.

Interest
expense related to the amortization of the discount on the LYONs of $4 million and $12 million was recorded for the three and nine months ended June 30,
2003, respectively. In addition, interest expense related to the amortization of deferred financing costs on the LYONs of $1 million and $3 million was recorded for the three and nine
months ended June 30, 2003, respectively.

Add-On Public Offering of Senior Secured Notes

In May 2003, the Company sold $200 million aggregate principal amount of 111/8% Senior Secured Notes due April 2009 ("Senior
Secured Notes"), at a price of 108% of par, resulting in net proceeds of approximately $212 million, which includes approximately $2 million in accrued interest and a $16 million
premium, partially offset by $6 million of issuance costs. The issuance costs, which were recorded as deferred financing costs, and premium are being amortized to interest expense over the term
of the Notes. These Notes constitute a further issuance of, and form a single series with, the 111/8% Senior Secured Notes due April 2009 that the Company issued in the
second quarter of fiscal 2002.

Interest
on the Senior Secured Notes is payable on April 1 and October 1 of each year. The Company recorded interest expense related to the Senior Secured Notes of
$15 million and $40 million for the three and nine months ended June 30, 2003, respectively. In addition, the Company recorded interest expense related to the amortization of
discount, premium and deferred financing costs on the Senior Secured Notes of $1 million and $2 million for the three and nine months ended June 30, 2003, respectively.

13

---

Interest Rate Swap Agreements

In December 2002, the Company cancelled two interest rate swap agreements under which the difference between fixed and floating rate interest amounts,
calculated on a $200 million notional principal amount which correlated to a like amount of fixed rate Senior Secured Notes, was exchanged at specified intervals. The cancellation resulted in a
reduction to other assets for the removal of the fair market value of the interest rate swaps and cash proceeds of $19 million representing a deferred gain, which is being recognized as a
reduction to interest expense over the remaining term to maturity of the Senior Secured Notes. For the three and nine months ended June 30, 2003, the Company recognized $1 million and
$2 million, respectively, as a reduction to interest expense related to this deferred gain.
The unamortized balance of the deferred gain is included in long-term debt on the Consolidated Balance Sheet and amounted to $17 million as of June 30, 2003.

Credit Facility

In April 2003, the Company and the lenders under the Company's five-year revolving credit agreement (the "Credit Facility") amended the Credit
Facility to reduce the size of the facility to $250 million and amend certain covenants included in the Credit Facility. As of June 30, 2003, there were no amounts outstanding under the
Credit Facility, which expires in September 2005.

The
Credit Facility contains covenants, including a requirement that the Company maintains certain financial covenants relating to a minimum amount of earnings before interest, taxes,
depreciation and amortization ("EBITDA"), adjusted for certain exclusions as summarized below ("Adjusted EBITDA") and a minimum ratio of Adjusted EBITDA to interest expense. The covenants permit the
Company to exclude up to a certain amount of business restructuring charges and related expenses, including asset impairment charges, from the calculation of Adjusted EBITDA. The definition of
Adjusted EBITDA in the Credit Facility also excludes certain other non-cash charges. The Company is permitted to exclude from the calculation of Adjusted EBITDA in the fourth quarter of
fiscal 2003, an additional $63 million in business restructuring charges and related expenses in connection with the amendments described below.

For
the four quarter period ending June 30, 2003, the Company was required to maintain a minimum Adjusted EBITDA of $190 million and a ratio of Adjusted EBITDA to interest
expense of 2.50 to 1. The Company was in compliance with all required covenants as of June 30, 2003.

The
amended Credit Facility requires the Company to maintain a ratio of consolidated Adjusted EBITDA to interest expense of:



14

---



If
the Company's Connectivity Solutions segment is sold, for purposes of these calculations, the ratios above will be reduced (i) by 0.20 for the fiscal quarter in which the
Company's Connectivity Solutions segment is sold, (ii) by 0.40 for the fiscal quarter following the fiscal quarter referred to in (i) above, (iii) by 0.60 for the fiscal quarter
following the fiscal quarter referred to in (ii) above and (iv) by 0.80 for each fiscal quarter thereafter.

The
Company is required to maintain consolidated Adjusted EBITDA of:



If
the Company's Connectivity Solutions segment is sold, for purposes of these calculations, the minimum Adjusted EBITDA amounts will be reduced (i) by $15 million for the
fiscal quarter in which the Company's Connectivity Solutions segment is sold, (ii) by $30 million for the fiscal quarter following the fiscal quarter referred to in (i) above,
(iii) by $45 million for the fiscal quarter following the fiscal quarter referred to in (ii) above and (iv) by $60 million for each fiscal quarter thereafter.

Prior
to the amendment, the Company's Credit Facility prohibited the Company from using more than $100 million in cash to redeem or repurchase the LYONs. However, under the
amended Credit Facility, this limitation may be increased, up to a maximum of $400 million, by an amount equal to 100% of the net cash proceeds of equity and debt issuances in the capital
markets, including the May 2003 issuance of the Senior Secured Notes, and 50% of the net cash proceeds from the sale of the Company's Connectivity Solutions segment and its corporate aircraft.
As of August 8, 2003, the Company has used approximately $156 million in cash to repurchase LYONs and, as a result of the amendments to the Credit Facility and the May 2003 public
offering of Senior Secured Notes, has the ability under the amended Credit Facility to use an additional $154 million in cash to repurchase LYONs.

The
amended Credit Facility also requires the Company to maintain, as of each day in the period commencing September 30, 2004 until the later of (a) the date that the put
obligation under the LYONs is satisfied and (b) the date upon which the Company delivers to the lenders under the amended Credit Facility a certificate certifying the Company's compliance with
the covenants included in the amended Credit Facility for the fiscal quarter ended September 30, 2004, liquidity of not less than $300 million on a pro forma basis as if the put
obligation under the LYONs had been satisfied as of such day. Holders of LYONs may require the Company to purchase all or a portion of their LYONs on October 31, 2004, 2006 and 2011 at a price
per LYON of $542.95, $583.40 and $698.20, respectively. For purposes of this calculation, liquidity is defined as the sum of the unused commitments under the Company's amended Credit Facility plus
domestic cash, to the extent free and clear of any liens other than liens under the collateral arrangements securing the Company's obligations to the lenders under

15

---

the
amended Credit Facility, less its obligations under its Senior Secured Notes and the put obligation related to the LYONs had it been satisfied as of such day.

The
Credit Facility was also amended to permit the Company to issue up to $200 million in debt provided such debt is junior to the amended Credit Facility and matures not less
than 90 days after the amended Credit Facility matures in September 2005. Pursuant to this provision of the amended Credit Facility, in May 2003, the Company issued
$200 million aggregate principal amount of Senior Secured Notes as described above. In addition, the Credit Facility was amended to reduce the Company's ability to incur other secured and
unsecured debt, make investments, and to prohibit the Company from prepaying long-term debt other than the LYONs.

8.    Stock Compensation and Other Equity Transactions

Stock Options and Restricted Stock Units Grants

During the nine months ended June 30, 2003, the Company granted to eligible employees approximately 13.7 million stock options at a weighted average
exercise price of $3.09 per option and 5.8 million restricted stock units at a weighted average market price of $3.01 per unit.

Warrants to Purchase Common Stock

In consideration of their agreement to participate in the LYONs Exchange Offer, in December 2002, the Company granted the Warburg Entities series C
warrants that have a four-year term and are exercisable for an aggregate of 7,355,824 shares of Avaya common stock at an exercise price of $3.50 per share. The fair value of these warrants
was estimated to be $5 million using a Black-Scholes securities-pricing model and has been included in additional paid-in capital. During the second quarter of fiscal 2003, upon
completion of the Exchange Offer, the Company recognized the cost of these warrants as a commitment fee and recorded the amount in loss on long-term debt extinguishment, net.

Following
completion of the Exchange Offer, in January 2003 the Warburg Entities exercised 5,581,101 of the series A warrants for an aggregate cash consideration of
$55,811.

As
of June 30, 2003, the Warburg Entities hold warrants to purchase the following additional shares of the Company's common stock:

Warrants

Number of Shares

Exercise Price

Expiration DateSeries A

1,143,564

$
34.73

October 2, 2004Series B

5,379,732

$
34.73

October 2, 2005Series C

7,355,824

$
3.50

December 23, 2006Total

13,879,120


16

---



AVAYA INC. AND SUBSIDIARIES  NOTES TO CONSOLIDATED FINANCIAL STATEMENTS        (unaudited)

9.    Earnings (Loss) Per Share of Common Stock

Basic earnings (loss) per common share is calculated by dividing net income (loss) available to common stockholders by the weighted average number of common
shares outstanding during the period. Diluted earnings (loss) per common share is calculated by adjusting net income (loss) available to common stockholders and weighted average outstanding shares,
assuming conversion of all potentially dilutive securities including stock options, restricted stock units, warrants, convertible participating preferred stock and convertible debt.

|                                                                                      |                              | Three Months Ended
June 30, |      | Nine Months Ended
June 30, |  
|------------------------------------------------------------------------------------- | ---------------------------- | --------------------------- | ---- | -------------------------- | -
|
|
|Net income (loss) available to common stockholders                                    |                              | $                           | 8    |                            | $
|                                                                                      |                              |                             |      |                            |  
|Shares used in computing earnings (loss) per common share:                            |                              |                             |      |                            |  
|Basic                                                                                 |                              |                             | 382  |                            |  
|                                                                                      |                              |                             |      |                            |  
|Diluted (1)                                                                           |                              |                             | 474  |                            |  
|                                                                                      |                              |                             |      |                            |  
|Earnings (Loss) per common share:                                                     |                              |                             |      |                            |  
|Basic and Diluted                                                                     |                              | $                           | 0.02 |                            | $
|                                                                                      |                              |                             |      |                            |  
|Securities excluded from the computation of diluted earnings (loss) per common share: |                              |                             |      |                            |  
|Options (2)                                                                           |                              |                             | 40   |                            |  
|Restricted stock units (2)                                                            |                              |                             |     |                            |  
|Series B preferred stock (2)                                                          |                              |                             |     |                            |  
|Warrants (2)                                                                          |                              |                             | 6    |                            |  
|Common shares issuable upon conversion of LYONs:                                      |                              |                             |      |                            |  
|                                                                                      | Settled in common shares (2) |                             |      |                           |  
|                                                                                      | Settled in cash (3)          |                             |      | 37                         |  
|                                                                                      |                              |                             |      |                            |  
|Total                                                                                 |                              |                             | 83   |                            |  
|                                                                                      |                              |                             |      |                            |  

---

10.    Operating Segments

During the third quarter of fiscal 2003, the Company changed the name of the Converged Systems and Applications segment to the Enterprise Communications Group.
The Company reports its operations in four segments: (1) Enterprise Communications Group ("ECG"), (2) Small and Medium Business Solutions ("SMBS"), (3) Services and
(4) Connectivity Solutions. The ECG segment is focused on large enterprises and includes converged systems products, unified communications applications and customer relationship management
offerings. The SMBS segment develops, markets and sells converged

17

---

and
traditional voice communications products for small and mid-sized enterprises and includes all key and Internet Protocol telephony systems and applications, as well as messaging
products. The Services segment offers a comprehensive portfolio of services that enable customers to plan, design, build and manage their communications networks. The Connectivity Solutions segment
provides structured cabling systems and electronic cabinets to its customers.

The
segments are managed as four functional businesses and, as a result, include certain allocated costs and expenses of shared services, such as information technology, human resources,
legal and finance. Costs remaining in the other unallocated category represent expenses that are not identified with the operating segments and include costs incurred to maintain vacant real estate
facilities. Intersegment sales approximate fair market value and are not significant.

Reportable Segments

Summarized financial information relating to the Company's reportable segments is shown in the following table:

|                                 |  | Reportable Segments |                       | Corporate |   |     |  
|-------------------------------- |  | ------------------- | --------------------- | --------- | - | --- | -
|
|                                 |  |                     | (dollars in millions) |          
|Three Months Ended
June 30, 2003 |  |                     |                       |           |   |     |  
|Revenue                          |  | $                   | 416                   |           | $ | 55  |  
|Operating income (loss)          |  | $                   | (13                   | )         | $ | (1  | )
|Three Months Ended
June 30, 2002 |  |                     |                       |           |   |     |  
|Revenue                          |  | $                   | 492                   |           | $ | 58  |  
|Operating income (loss)          |  | $                   | (47                   | )         | $ | (10 | )
|Nine Months Ended
June 30, 2003  |  |                     |                       |           |   |     |  
|Revenue                          |  | $                   | 1,281                 |           | $ | 166 |  
|Operating income (loss)          |  | $                   | (63                   | )         | $ | (6  | )
|Nine Months Ended
June 30, 2002  |  |                     |                       |           |   |     |  
|Revenue                          |  | $                   | 1,602                 |           | $ | 176 |  
|Operating income (loss)          |  | $                   | (134                  | )         | $ | (19 | )

18

---

Geographic Information

Financial information relating to the Company's revenue by geographic area was as follows:

|           |       | Three Months Ended
June 30, |     | Nine Months Ended
June 30,
|---------- | ----- | --------------------------- | --- | --------------------------
|
|
|Revenue(1) |       |                             |     |                           
|U.S.       |       | $                           | 811 |                           
|Non-U.S.   |       |                             | 261 |                           
|           |       |                             |     |                           
|           | Total |                             | $   | 1,072                     
|           |       |                             |     |                           

---

Concentrations

Following the Company's sale in March 2000 of its primary distribution function for voice communications systems for small and mid-sized
enterprises to Expanets, Inc. ("Expanets"), the Company agreed in May 2001 to provide a $125 million short-term secured line of credit to Expanets. The line of credit
applied to certain unpaid amounts and outstanding receivables due to Avaya by Expanets and was secured by a first priority lien on Expanets' receivables and inventory. In March 2002, the
Company entered into an amended Dealer Credit Agreement with Expanets and its parent company, NorthWestern Corporation ("NorthWestern") to
provide for installment payments under the line of credit with the final balance due to Avaya on December 31, 2002.

The
Company had been engaged in discussions with Expanets regarding certain operating issues and customer data and billing management services related to the March 2000 sale to
Expanets. Although these issues were unrelated to Expanets' and NorthWestern's obligations under the Dealer Credit Agreement, the Company, because of the importance of its relationship with Expanets
and the customer base served by Expanets, agreed in December 2002 to extend the term of the final installment payment of $27 million to February 2003.

In
March 2003, the Company entered into a restructured agreement with Expanets and NorthWestern to resolve matters related to the March 2000 sale to Expanets and to set
payment terms for the remaining amounts due to Avaya under the line of credit. In exchange for the companies providing mutual general releases of liability concerning the outstanding operational
issues, the parties agreed to, among other things, the following:



19

---



Additionally,
as of June 30, 2003 the Company recorded $22 million in receivables representing trade receivables due from Expanets on recurring sales of products and
maintenance services.

In
April 2003, NorthWestern announced that it expected to record charges in its December 31, 2002 financial statements related to, among other things, asset impairments and
deferred tax valuation allowances related to Expanets. In addition, NorthWestern announced that it filed for an extension to file its Annual Report on Form 10-K in order to take
certain actions related to identified deficiencies in internal controls. In its Annual Report on Form 10-K, NorthWestern disclosed that its independent auditors had advised its
Audit Committee that these internal control deficiencies constituted reportable conditions and, collectively, a material weakness as defined in Statement of Auditing Standards No. 60. In its
Quarterly Report on Form 10-Q for the quarter ended March 31, 2003, NorthWestern disclosed that the SEC is conducting an informal inquiry relating to the restatements of its
financial statements and other accounting and reporting matters.

In
June 2003, Expanets entered into a $25 million credit facility with a third party financial institution. As required by the terms of the March 2003 agreements
with Expanets, the Company agreed to subordinate its rights in the collateral securing the $27 million term loan from Expanets to the third party financial institution. Under the subordination
agreement, the Company may not take action with regard to the collateral until Expanets' obligations under the senior credit facility are paid in full. In addition, if a payment default has occurred
under the senior credit facility at the time a payment is due to the Company under the term loan, Expanets is prohibited under the subordination agreement from making such payment on the term loan
until the payment default under the senior credit facility has been cured or waived in writing by the third party financial institution. If a covenant default has occurred under the senior credit
facility at the time a payment is due to the Company under the term loan, Expanets is prohibited under the subordination agreement from making such payment on the term loan until the earlier of the
date the covenant default under the senior credit facility has been cured or waived in writing by the third party financial institution and 180 days from the date the notice of default is
delivered to the Company. The subordination agreement does not affect the Company's rights with regard to NorthWestern, including the Company's rights in the event of a default by NorthWestern under
the credit agreement governing the term loan.

20

---



AVAYA INC. AND SUBSIDIARIES  NOTES TO CONSOLIDATED FINANCIAL STATEMENTS        (unaudited)

There
can be no assurance that Expanets or NorthWestern will be able to comply with the terms of the restructured agreement. In the event Expanets or NorthWestern are unable to comply
with the terms of the restructured agreement and a default occurs, the remedies available to Avaya under such agreement may be insufficient to satisfy in full all of Expanets' obligations to the
Company.

11.    Related Party Transactions

The Warburg Entities are substantial stockholders of Avaya and are considered affiliates. As of June 30, 2003, the Warburg Entities hold approximately
60 million shares of Avaya common stock, which represents approximately 15.8% of the Company's outstanding common stock, and warrants to purchase approximately 14 million additional
shares of Avaya common stock.

In
connection with their agreement to participate in the LYONs Exchange Offer, the Company granted the Warburg Entities the right to designate one individual for election to Avaya's
board of directors for so long as they hold a specified number of shares of the Company's common stock. In accordance with these provisions, in January 2003, Joseph P. Landy,
Co-President of Warburg Pincus LLC, was appointed to Avaya's board of directors.

12.    Commitments and Contingencies

Legal Proceedings

From time to time, the Company is involved in legal proceedings arising in the ordinary course of business. Other than as described below, the Company believes
there is no litigation pending against it that could have, individually or in the aggregate, a material adverse effect on its financial position, results of operations or cash flows.

Year 2000 Actions

Three separate purported class action lawsuits are pending against Lucent Technologies, Inc. ("Lucent"), the Company's former parent, one in state court in
West Virginia, one in federal court in the Southern District of New York and another in federal court in the Southern District of California. The case in New York was filed in January 1999 and,
after being dismissed, was refiled in September 2000. The case in West Virginia was filed in April 1999 and the case in California was filed in June 1999, and amended in 2000 to
include Avaya as a defendant. The Company may also be named a party to the other actions and, in any event, has assumed the obligations of Lucent for all of these cases under the Contribution and
Distribution Agreement, as described in "Transactions with Lucent," between the Company and Lucent. All three actions are based upon claims that Lucent sold products that were not Year 2000 compliant,
meaning that the products were designed and developed without considering the possible impact of the change in the calendar from December 31, 1999 to January 1, 2000. The complaints
allege that the sale of these products violated statutory consumer protection laws and constituted breaches of implied warranties.

A
class has been certified in the West Virginia state court matter. The certified class in the West Virginia matter includes those persons or entities that purchased, leased or financed
the products in question. In addition, the court also certified as a subclass all class members who had service protection plans or other service or extended warranty contracts with Lucent in effect
as of April 1, 1998, as to which Lucent failed to offer a free Year 2000-compliant solution. The Fourth Circuit Court of Appeals

21

---

recently
denied the defendant's attempt to have the Federal District Court in West Virginia retain jurisdiction in this matter. This matter is now in West Virginia state court. The federal court in
the New York action has issued a decision and order denying class certification, dismissing all but certain fraud claims by one representative plaintiff. No class claims remain in this case at this
time. The federal court in the California action has issued an opinion and order granting class certification. The class includes any entities that purchased or leased certain products on or after
January 1, 1990, excluding those entities who did not have a New Jersey choice of law provision in their contracts and those who did not purchase equipment directly from defendants. The federal
court in the California action has issued an order staying the action pending the outcome of the West Virginia matter. The complaints seek, among other remedies, compensatory damages, punitive damages
and counsel fees in amounts that have not yet been specified. At this time, the Company cannot determine whether the outcome of these actions will have a material adverse effect on its financial
position, results of operations or cash flows. These cases have required in the past, and may require in the future, expenditure of significant legal costs related to their defense.

Lucent Securities Litigation

In November 2000, three purported class actions were filed against Lucent in the Federal District Court for the District of New Jersey alleging violations
of the federal securities laws as a result of the facts disclosed in Lucent's announcement on November 21, 2000 that it had identified a revenue recognition issue affecting its financial
results for the fourth quarter of fiscal 2000. The actions purport to be filed on behalf of purchasers of Lucent common stock during the period from October 10, 2000 (the date Lucent originally
reported these financial results) through November 21, 2000.

The
above actions have been consolidated with other purported class actions filed against Lucent on behalf of its stockholders in January 2000 and are pending in the Federal
District Court for the District of New Jersey. The consolidated cases were initially filed on behalf of stockholders of Lucent who bought Lucent common stock between October 26, 1999 and
January 6, 2000, but the consolidated complaint was amended to include purported class members who purchased Lucent common stock up to December 20, 2000. A class has not yet been
certified in the consolidated actions. The plaintiffs in all these stockholder class actions seek compensatory damages plus interest and attorneys' fees.

In
March 2003, Lucent announced that it had entered into a $420 million settlement of all pending shareholder and related litigation. Certain cases which are the subject of
the settlement are shared contingent liabilities under the Contribution and Distribution Agreement and accordingly, the Company is responsible for 10% of the liabilities attributable to those cases,
including 10% of the legal costs associated with the portion of the litigation for which the Company shares liability. The amount of the Company's portion of this liability has not yet been finally
determined. However, in the second quarter of fiscal 2003, the Company recorded a charge of $25 million representing the Company's estimate of its liability in this matter. Upon settlement, the
amount of this liability will be adjusted to reflect the Company's actual obligation in this matter. The liability may be settled, at the Company's option, in any combination of cash and the Company's
equity securities. See "Guarantees of Indebtedness-Transactions with Lucent" for a discussion of the maximum amount of the Company's liability in this matter.

22

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Licensing Arbitration

In March 2001, Voxem, Inc. made formal demand for alleged royalty payments which it claims the Company owes as a result of a contract between it and
the Company's predecessors, initially entered into in 1995, and renewed in 1997. Voxem claims that the Company owes royalty payments for software integrated into certain of the Company's products.
Voxem also alleges that the Company has breached the governing contract by not honoring a right of first refusal related to development of fax software for next generation products. In
May 2003, the arbitrator awarded Voxem approximately $650,000 in total damages, including interest and certain legal costs.

Commissions Arbitration Demand

In July 2002, Communications Development Corporation, a British Virgin Islands corporation, made formal demand for arbitration for alleged unpaid
commissions in an amount in excess of $10 million, stemming from the sale of products from the Company's businesses that were formerly owned by Lucent involving the Ministry of Russian
Railways. The plaintiff alleges that as a result of agreements entered into between the plaintiff and the Company, it is owed commissions on sales by the Company to the Ministry of Russian Railways on
a continuing basis. The Company believes that the agreements relating to their claim have expired or do not apply to the products in question. As the sales of products continue, Communications
Development Corporation may likely increase its commission demand. The claimant recently filed its arbitration demand with the American Arbitration Association.

Lucent Consumer Products Class Actions

In several class action cases (the first of which was filed on June 24, 1996), plaintiffs claim that AT&T and Lucent engaged in fraud and deceit in
continuing to lease residential telephones to consumers without adequate notice that the consumers would pay well in excess of the purchase price of a telephone by continuing to lease. The cases were
removed and consolidated in federal court in Alabama, and were subsequently remanded to their respective state courts (Illinois, Alabama, New Jersey, New York and California). In July 2001, the
Illinois state court certified a nationwide class of plaintiffs. The case in Illinois was scheduled for trial on August 5, 2002. Prior to commencement of trial, however, the Company was advised
that the parties agreed to a settlement of the claims on a class-wide basis. The settlement was approved by the court on November 4, 2002. Claims from Class members were required to
be filed on or about January 15, 2003. The amount of Avaya's portion of the liability has not yet been determined.

Any
liability incurred by Lucent in connection with these class action cases will be considered an exclusive Lucent liability under the Contribution and Distribution Agreement between
Lucent and Avaya and, as a result, Avaya would be responsible for 10% of any such liability in excess of $50 million.

Environmental Matters

The Company is subject to a wide range of governmental requirements relating to employee safety and health and to the handling and emission into the environment
of various substances used in its operations. The Company is subject to certain provisions of environmental laws, particularly in the

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United
States, governing the cleanup of soil and groundwater contamination. Such provisions impose liability for the costs of investigating and remediating releases of hazardous materials at currently
or formerly owned or operated sites. In certain circumstances, this liability may also include the cost of cleaning up historical contamination, whether or not caused by the Company. The Company is
currently conducting investigation and/or cleanup of known contamination at approximately seven of its facilities either voluntarily or pursuant to government directives. None of the sites is
reasonably likely to generate environmental costs that will be individually material. There are no known third parties who may be responsible for investigation and/or cleanup at these sites and
therefore, for purposes of assessing the adequacy of financial reserves for these liabilities, the Company has not assumed that it will recover amounts from any third party, including under any
insurance coverage or indemnification arrangement. The Company does not separately track recurring costs of managing hazardous substances and pollutants in ongoing operations, but does not believe
them to be material.

It
is often difficult to estimate the future impact of environmental matters, including potential liabilities. The Company has established financial reserves to cover environmental
liabilities where they
are probable and reasonably estimable. Reserves for estimated losses from environmental matters are undiscounted and consist primarily of estimated remediation and monitoring costs and are, depending
on the site, based primarily upon internal or third-party environmental studies and the extent of contamination and the type of required cleanup. The Company is not aware of, and has not included in
reserves any provision for, any unasserted environmental claims.

The
reliability and precision of estimates of the Company's environmental costs may be affected by a variety of factors, including whether the remediation treatment will be effective,
contamination sources have been accurately identified and assumptions regarding the movement of contaminants are accurate. In addition, estimates of environmental costs may be affected by changes in
law and regulation, including the willingness of regulatory authorities to conclude that remediation and/or monitoring performed by the Company is adequate.

The
Company assesses the adequacy of environmental reserves on a quarterly basis. For the three and nine months ended June 30, 2003 and 2002, respectively, no amounts were charged
to the Statements of Operations for environmental costs as reserves were deemed to be adequate. Expenditures for environmental for the three and nine months ended June 30, 2003 were not
material to the Company's financial position, results of operations or cash flows. Payment for the environmental costs covered by the reserves may be made over a 30-year period. Although
the Company believes that its current reserves are adequate to cover known environmental liabilities, due to the uncertainties described above, there can be no assurance that the actual amount of
environmental liabilities will not exceed the amount of reserves for such matters or will not have a material adverse effect on the Company's consolidated financial position, results of operations or
cash flows.

Product Warranties

The Company recognizes a liability for the estimated costs that may be incurred to remedy certain deficiencies of quality or performance of Avaya products. These
product warranties extend over a specified period of time generally ranging up to one year from the date of sale depending upon the product subject to the warranty. The Company accrues a provision for
estimated future warranty costs based upon the historical relationship of warranty claims to sales. The Company periodically reviews the adequacy of its product warranties and adjusts, if necessary,
the warranty percentage and accrued

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warranty
reserve, which is included in other current liabilities in the Consolidated Balance Sheets, for actual experience.

The
following table reconciles the changes in the Company's product warranty reserve as of and for the nine months ended June 30, 2003:

(dollars in millions)Balance at September 30, 2002

$
40Warranties accrued during the nine months ended June 30, 2003


43Less actual warranty expenses incurred during the period


(43
)Balance at June 30, 2003

$
40


Guarantees of Indebtedness

Irrevocable Letters of Credit and Other Arrangements

The Company has entered into several uncommitted credit facilities totaling $44 million and other arrangements similar to irrevocable letters of credit
that vary in term, of which an aggregate of $32 million in irrevocable letters of credit and other arrangements were outstanding as of June 30, 2003. Letters of credit are purchased
guarantees that ensure the Company's performance or payment to third parties in accordance with specified terms and conditions.

Purchase Commitments and Termination Fees

The Company has commitment contracts with certain suppliers in which Avaya is obligated to purchase a specified amount of inventory based on its forecasts, or pay
a charge in the event the Company does not meet its designated purchase commitments. Additionally, certain agreements call for an early termination fee, obligating the Company to make a payment to the
supplier. As of June 30, 2003, the maximum potential payment under these commitments was approximately $82 million, of which the Company recorded $3 million in other current
liabilities and $5 million in other liabilities.

Product Financing Arrangements

Avaya sells products to various resellers that may obtain financing from certain unaffiliated third party lending institutions.

For
the Company's U.S. product financing arrangement with resellers, in the event the lending institution repossesses the reseller's inventory of Avaya products, Avaya is obligated under
certain circumstances to repurchase such inventory from the lending institution. The Company's obligation to repurchase inventory from the lending institution terminates 180 days from the date
of invoicing by Avaya to the reseller. The repurchase amount is equal to the price originally paid to Avaya by the lending institution for the inventory. During the third quarter of fiscal 2003, one
of the resellers that previously participated in this type of arrangement established a direct line of credit with the Company. The remaining reseller has financed inventory purchases under this
agreement of approximately $35 million as of June 30, 2003. There have not been any repurchases made by Avaya since the Company entered into this agreement in March 2001. The
Company has estimated the fair value of this guarantee as of June 30, 2003 and has adequately provided for this guarantee in its financial statements

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at
June 30, 2003. The fair value of the guarantee is not significant. There can be no assurance that the Company will not be obligated to repurchase inventory under this arrangement in the
future.

For
the Company's product financing arrangement with resellers outside the U.S., in the event participating resellers default on their payment obligation to the lending institution, the
Company is obligated under certain circumstances to guarantee repayment to the lending institution. The repayment amount fluctuates with the level of product financing activity. The guarantee
repayment amount reported to the Company from the lending institution was approximately $17 million as of June 30, 2003. Avaya reviews and sets the maximum credit limit for each reseller
participating in this financing arrangement. There have not been any guarantee repayments by Avaya since the Company entered in this arrangement in October 2000. The Company has estimated the
fair value of this guarantee as of June 30, 2003 and has adequately provided for this guarantee in its financial statements at June 30, 2003. The fair value of the guarantee is not
significant. There can be no assurance that the Company will not be obligated to repurchase inventory under this arrangement in the future.

Credit Facility Indemnification

In connection with its obligations under the amended Credit Facility described in Note 7-Long-Tem Debt and Derivative Financial
Instruments, the Company has agreed to indemnify the third party lending institutions for costs incurred by the institutions related to changes in tax law or other legal requirements. While there have
been no amounts paid to the lenders pursuant to this indemnity in the past, there can be no assurance that the Company will not be obligated to indemnify the lenders under this arrangement in the
future.

Transactions with Lucent

In connection with the Company's spin-off from Lucent in September 2000, the Company and Lucent executed and delivered the Contribution and
Distribution Agreement and certain related agreements.

Pursuant
to the Contribution and Distribution Agreement, Lucent contributed to the Company substantially all of the assets, liabilities and operations associated with its enterprise
networking businesses (the "Company's Businesses"). The Contribution and Distribution Agreement, among other things, provides that, in general, the Company will indemnify Lucent for all liabilities
including certain pre-Distribution tax obligations of Lucent relating to the Company's Businesses and all contingent liabilities primarily relating to the Company's Businesses or otherwise
assigned to the Company. In addition, the Contribution and Distribution Agreement provides that certain contingent liabilities not allocated to one of the parties will be shared by Lucent and the
Company in prescribed percentages. The Contribution and Distribution Agreement also provides that each party will share specified portions of contingent liabilities based upon agreed percentages
related to the business of the other party that exceed $50 million. In the second quarter of fiscal 2003, the Company recorded a charge of $25 million representing its estimate of the
amount of its liability associated with the settlement by Lucent of the securities litigation described previously. The Company cannot at this time determine the maximum amount of its liability for
this matter, however, because it is not responsible for all of the cases which are the subject of Lucent's $420 million settlement. The maximum amount of the Company's liability will be less
than $42 million, or 10% of the total Lucent settlement. The Company

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is
unable to determine the maximum potential amount of other future payments, if any, that it could be required to make under this agreement.

In
addition, if the separation from Lucent fails to qualify as a tax-free distribution under Section 355 of the Internal Revenue Code because of an acquisition of the
Company's stock or assets, or some other actions of the Company, then the Company will be solely liable for any resulting corporate taxes.

13.    Subsequent Events

Repurchases of LYONs

In July and August 2003, the Company repurchased $78 million aggregate principal amount at maturity of LYONs, or $41 million in accreted
value, in a series of open market transactions. The Company used a total of approximately $41 million in cash to repurchase these LYONs.

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Item 2.Management's Discussion and Analysis of Financial Condition and Results of Operations

The following section should be read in conjunction with the consolidated financial statements and the notes included elsewhere in this Quarterly Report on
Form 10-Q.

Our
accompanying unaudited consolidated financial statements as of June 30, 2003 and for the three and nine months ended June 30, 2003 and 2002, have been prepared in
accordance with accounting principles generally accepted in the United States of America for interim financial statements and the rules and regulations of the Securities and Exchange Commission for
interim financial statements, and should be read in conjunction with our Annual Report on Form 10-K for the fiscal year ended September 30, 2002. In our opinion, the
unaudited interim consolidated financial statements reflect all adjustments, consisting of normal and recurring adjustments, necessary for a fair presentation of the financial condition, results of
operations and cash flows for the periods indicated. Certain prior year amounts have been reclassified to conform to the current interim period presentation. The consolidated results of operations for
the interim periods reported are not necessarily indicative of the results to be experienced for the entire fiscal year.

Forward Looking Statements

(Cautionary Statements Under the Private Securities Litigation Reform Act of 1995)

Our
disclosure and analysis in this report contain some forward-looking statements. Forward-looking statements give our current expectations or forecasts of future events. You can
identify these statements by the fact that they do not relate strictly to historical or current facts. They use words such as "anticipate," "estimate," "expect," "project," "intend," "plan,"
"believe," and other words and terms of similar meaning in connection with any discussion of future operating or financial performance. From time to time, we also may provide oral or written
forward-looking statements in other materials we release to the public.

Any
or all of our forward-looking statements in this report, and in any other public statements we make may turn out to be wrong. They can be affected by inaccurate assumptions we might
make or by known or unknown risks and uncertainties. Many factors mentioned in the discussion below will be important in determining future results. Consequently, no forward-looking statement can be
guaranteed. Actual future results may vary materially.

Except
as may be required under the federal securities laws, we undertake no obligation to publicly update forward-looking statements, whether as a result of new information, future
events or otherwise. You are advised, however, to consult any further disclosures we make on related subjects in our Form 10-K and 8-K reports to the SEC. Also note that
we provide the following cautionary discussion of risks, uncertainties and possibly inaccurate assumptions relevant to our businesses. These are factors that we think could cause our actual results to
differ materially from expected and historical results. Other factors besides those listed here could also adversely affect us. This discussion is provided as permitted by the Private Securities
Litigation Reform Act of 1995.

The
risks and uncertainties referred to above include, but are not limited to:



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The
categorization of risks set forth below is meant to help you better understand the risks facing our business and are not intended to limit your consideration of the possible effects
of these risks to the listed categories. Any adverse effects related to the risks discussed above may, and likely will, adversely affect many aspects of our business.

Risks Related To Our Revenue and Business Strategy

Our revenue has declined significantly during the past several years and if business capital spending, particularly for enterprise
communications products, applications and services, does not improve or deteriorates, our revenue may continue to decline and our operating results may be adversely affected.

Our
revenue for the quarter ended June 30, 2003 was $1,072 million, a decrease of 12.1%, or $147 million, from $1,219 million for the quarter ended
June 30, 2002, and a sequential decrease of 0.8%, or $9 million, from $1,081 million for the quarter ended March 31, 2003, and an increase of 0.5%, or $5 million,
from $1,067 million for the quarter ended December 31, 2002.

Our
operating results are significantly affected by the impact of economic conditions on the willingness of enterprises to make capital investments, particularly in enterprise
communications technology and related services. Although general economic conditions have shown some signs of improvement recently, we have seen a continued decline in spending on enterprise
communications technology and services by our customers. We believe that enterprises continue to be concerned about their ability to increase revenue and thereby increase their profitability.
Accordingly, they have tried to maintain or improve profitability through cost reduction and reduced capital spending. Because we do not believe that enterprise communications spending will improve
significantly in the near term, we expect continued pressure on our ability to generate revenue.

To
the extent that enterprise communications spending does not improve or deteriorates, our revenue and operating results will continue to be adversely affected and we may not be able to
comply with the financial covenants included in our credit agreement.

Revenue generated by our traditional business, enterprise voice communications systems, has been declining for the last several years and if we do not
successfully implement our strategy to expand our sales in market segments with higher growth rates, our revenue and operating results may continue to be adversely affected.

We
have been experiencing declines in revenue from our traditional business, enterprise voice communications systems. We expect, based on various industry reports, a low growth rate or
no growth in the future in the market segments for these traditional systems. We are implementing a strategy to capitalize on the higher growth opportunities in our market, including converged voice
and data network products, customer relationship management applications and unified communication

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applications.
This strategy requires us to make a significant change in the direction and strategy of our company to focus on the development and sales of these products and applications.

Our
traditional enterprise voice communications systems and the advanced communications products and applications described above are a part of our Enterprise Communications Group and
Small and Medium Business Solutions segments. If we are unsuccessful in implementing our strategy, the contribution to our results from these segments may decline, reducing our overall operating
results and thereby requiring a greater need for external capital resources. In addition, our Services segment may be adversely affected to the extent that Services revenue are related to sales of
these products and applications.

We are significantly changing our focus in order to concentrate on the development and marketing of advanced communications products and applications, including
converged voice and data network products, and this change in focus may not be successful or may adversely affect our business.

We
are making a significant change in the direction and strategy of our company to focus on the development and sales of converged voice and data networks and other advanced
communications products and applications. In order to implement this change, we must:



If
we do not successfully implement this change in focus, our operating results may be adversely affected. However, even if we successfully address these challenges, our operating
results may still be adversely affected if the market opportunity for advanced communications products and applications, including converged voice and data network products, does not develop in the
ways that we anticipate. Because this market opportunity is in its early stages, we cannot predict whether:



Risks Related To Our Liquidity And Capital Resources



Our cash needs include making payments on and refinancing our indebtedness and funding working capital, capital expenditures, strategic acquisitions, business
restructuring charges and related expenses, employee benefit obligations and for general corporate purposes. Our ability to satisfy our cash needs depends on our ability to generate cash from
operations and access the financial markets, both of which are subject to general economic, financial, competitive, legislative, regulatory and other factors that are beyond our control, including the
risks described in this Form 10-Q.

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Our
ability to generate cash from operations is affected by the terms of our credit agreement, the indenture governing our Liquid Yield Option Notes due 2021, or LYONs, and
the indenture governing our 111/8% Senior Secured Notes due April 2009, or senior secured notes. These instruments impose, and any future indebtedness may impose, various
restrictions and covenants, including financial covenants, that may limit our ability to respond to market conditions, provide for unanticipated capital investments, make strategic acquisitions or
take advantage of business opportunities.

If
we do not generate sufficient cash from operations, we will need to access the financial markets. External financing may not be available to us on acceptable terms or at all. Under
the terms of any external financing, we may incur higher than expected financing expenses, and become subject to additional restrictions and covenants. In addition, our ability to obtain external
financing is affected by the terms of our debt agreements. Our existing debt agreements include covenants that limit our ability to incur additional indebtedness. In addition, our credit agreement
requires us to comply with certain financial covenants. In February 2002, September 2002 and April 2003, we amended our credit agreement in order to ensure our compliance with the
financial covenants. If we are unable to comply with our financial covenants and cannot amend or waive those covenants, an event of default under our credit agreement would occur. If a default occurs,
the lenders under our credit agreement could accelerate the maturity of our debt obligations and terminate their commitments to lend to us. If such a default occurs when our debt obligations under the
credit agreement exceed $100 million, our debt obligations in respect of the LYONs and the senior secured notes could be accelerated. Currently there are no funds drawn under our credit
agreement.

Our
ability to obtain external financing and, in particular, debt financing, is also affected by our debt ratings, which are periodically reviewed by the major credit rating agencies.
Our corporate credit is currently rated B+ and our long-term senior unsecured debt is currently rated B by Standard & Poor's, each with a stable outlook, and our
long-term senior unsecured debt is currently rated B3 by Moody's with a negative outlook. Any increase in our level of indebtedness or deterioration of our operating results may cause a
further reduction in our current debt ratings. Any downgrade of our credit rating, among other factors, could impair our ability to secure additional
financing on acceptable terms, and we cannot assure you that we will be successful in raising any new financing on acceptable terms.

Our substantial amount of debt could limit our ability to obtain additional financing, limit our ability to react to changes in business conditions and require us
to divert financial resources from investments in our business to servicing our debt.

We
have a substantial amount of debt. At June 30, 2003, we had approximately $993 million of debt outstanding on a consolidated basis and $250 million available
under our credit agreement.

Our
substantial amount of debt and other obligations could have important consequences to you. For example, it could:



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The
agreements governing our debt limit, but do not prohibit, us from incurring additional debt, and we may incur a significant amount of additional debt in the future. If new debt is
added to our current debt levels, these related risks could increase.

Our
ability to make scheduled payments on or to refinance our debt and other obligations will depend on our financial and operating performance, which, in turn, is subject to prevailing
economic conditions and to certain financial, business and other factors beyond our control. If our cash flow and capital resources are insufficient to fund our debt service and other obligations, we
may be forced to reduce or delay scheduled expansion plans and capital expenditures, sell material assets or operations, obtain additional capital or restructure our debt. We cannot assure you that
our operating performance, cash flow and capital resources will be sufficient to pay our debt obligations when they become due. In the event that we are required to dispose of material assets or
operations or restructure our debt or other obligations, we cannot assure you as to the terms of any such transactions or how soon any such transaction could be completed.

The value of the assets in our pension plans has decreased significantly and, as a result, we will likely incur additional expense and funding obligations that
may have an adverse effect on our financial position, results of operations and cash flows.

The
decline in the global equity markets and interest rates over the past few years has resulted in a decrease in the value of the assets and an increase in the value of the obligation
in our pension plans. As a result, the value of the assets in our pension plans is currently less than the obligations they are intended to fund. This decline may adversely affect our related
accounting results in future periods through higher pension expense, additional minimum liabilities with corresponding reductions in stockholders' equity, and increased cash funding requirements.

The
indices we use to select a discount rate for measuring the value of our pension obligations at year-end have declined during the year. Therefore, we may be required to
record an additional minimum liability with a corresponding reduction to stockholders' equity as of September 30, 2003. Currently, a 25 basis point decline in the discount rate will generate an
increase in our accumulated benefit obligation of approximately $80 million.

In
compliance with ERISA/IRS requirements, we have made cash contributions of $7 million to fund our pension obligations during the first nine months of fiscal 2003. We are
required to fund an additional $35 million to the plans in the fourth quarter of fiscal 2003. We estimate that for fiscal 2004, we will be required to fund approximately $44 million to
our pension plans.

One of our largest dealers may not be able to satisfy in full its obligations to us under a short-term line of credit.

As
of December 31, 2002, $27 million was due to us under a short-term line of credit we provided to Expanets Inc., currently one of our largest dealers.
At that time, we were engaged in discussions with Expanets regarding operational issues related to the March 2000 sale of our primary distribution function for voice communications systems for
small and mid-sized enterprises to Expanets. Although these issues were unrelated to the obligations of Expanets and its parent company, NorthWestern Corporation, under the credit
agreement, because of the importance to us of our relationship with Expanets and the customer base served by Expanets, in December 2002, we agreed to extend the term of the final installment
payment of $27 million to February 2003.

In
March 2003, we entered into a restructured agreement with Expanets and NorthWestern regarding the operational issues. In exchange for a general release of liability from
Expanets related to the operational issues, we agreed, among other things, to extend the payment term of the remaining balance under the credit agreement. The amended credit facility provides that the
$27 million will be repaid in three equal $9 million installments on January 1, 2004, April 1, 2004 and July 1, 2004.

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Outstanding
amounts under the line of credit are secured by Expanets' accounts receivable and inventory. In addition, NorthWestern has effectively guaranteed Expanets' obligations under
the credit agreement. A default by NorthWestern of its guarantee obligations under the credit agreement would constitute a default under Expanets' dealer agreement with Avaya, resulting in a
termination of certain non-competition provisions contained in the dealer agreement and permitting us to sell products to certain of Expanets' customers.

In
April 2003, NorthWestern announced that it expected to record charges in its December 31, 2002 financial statements related to, among other things, asset impairments and
deferred tax valuation allowances related to Expanets. In addition, NorthWestern announced that it filed for an extension to file its Annual Report on Form 10-K in order to take
certain actions related to identified deficiencies in internal controls. In its Annual Report on Form 10-K, NorthWestern disclosed that its independent auditors had advised its
Audit Committee that these internal control deficiencies constituted reportable conditions and, collectively, a material weakness as defined in Statement on Auditing Standards No. 60. In its
Quarterly Report on Form 10-Q for the quarter ended March 31, 2003, NorthWestern disclosed that the SEC is conducting an informal inquiry relating to the restatements of its
financial statements and other accounting and reporting matters.

In
June 2003, Expanets entered into a $25 million credit facility with a third party financial institution. As required by the terms of the March 2003 agreements
with Expanets, we agreed to subordinate our
rights in the collateral securing the $27 million term loan from Expanets to the third party financial institution. Under the subordination agreement, we may not take action with regard to the
collateral until Expanets' obligations under the senior credit facility are paid in full. In addition, if a payment default has occurred under the senior credit facility at the time a payment is due
to us under the term loan, Expanets is prohibited under the subordination agreement from making such payment on the term loan until the payment default under the senior credit facility has been cured
or waived in writing by the third party financial institution. If a covenant default has occurred under the senior credit facility at the time a payment is due to us under the term loan, Expanets is
prohibited under the subordination agreement from making such payment on the term loan until the earlier of the date the covenant default under the senior credit facility has been cured or waived in
writing by the third party financial institution and 180 days from the date the notice of default is delivered to us. The subordination agreement does not affect our rights with regard to
NorthWestern, including our rights in the event of a default by NorthWestern under the credit agreement governing the term loan.

There
can be no assurance that Expanets or NorthWestern will be able to comply with the terms of the credit facility. In the event Expanets or NorthWestern are unable to comply with the
terms of the credit facility and a default occurs, the remedies available to Avaya under such agreement may be insufficient to satisfy in full all of Expanets' obligations to Avaya.

Risks Related To Our Operating Results

Disruption of, or changes in the mix of, our product distribution model or customer base could affect our revenue and gross
margin.

If
we fail to manage distribution of our products and services properly, or if our distributors' financial condition or operations weaken, our revenue and gross margin could be adversely
affected. Furthermore, a change in the mix of direct sales and indirect sales could adversely affect our revenue and gross margin.

We
use a variety of channels to bring our products to customers, including direct sales, distributors, dealers, value-added resellers and system integrators. Since each distribution
channel has a distinct profile, the failure to achieve the most advantageous balance in the delivery model for our products and services could adversely affect our gross margins and operating results.

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We
must manage inventory effectively, particularly with respect to sales to distributors. Distributors may increase orders during periods of product shortages, cancel orders if their
inventory is too high, or
delay orders in anticipation of new products. Distributors also may adjust their orders in response to the supply of our products and the products of our competitors that are available to the
distributor and to seasonal fluctuations in end-user demand. If we have excess inventory, we may have to reduce our prices and write down inventory, which in turn could result in lower
gross margins. In addition, if sales through indirect channels increase, this may lead to greater difficulty in forecasting the mix of our products, and to a certain degree, the timing of orders from
our customers.

Changes in effective tax rates or the recording of increased deferred tax asset valuation allowances in the future could affect our operating
results.

Our
effective tax rates in the future could be adversely affected by earnings being lower or losses being higher than anticipated in countries where we have tax rates that are lower than
the U.S. statutory rate and earnings being higher or losses lower than anticipated in countries where we have tax rates that are higher than the U.S. statutory tax rate, changes in our net deferred
tax assets valuation allowance, or by changes in tax laws or interpretations thereof.

For
example, during fiscal 2002 our effective tax rate was adversely affected by an unfavorable geographic distribution of earnings and losses and we recorded an increase in our net
deferred tax assets valuation allowance of $364 million. If the geographic distribution of our earnings and losses continues to be unfavorable in the future, our effective tax rate could be
adversely affected. In addition, in the first quarter of fiscal 2003, we recorded a deferred income tax valuation allowance through a non-cash income tax charge of $83 million to
reflect the difference between the actual and expected tax gain associated with our December 2002 exchange offer for a portion of the LYONs. Based on our assessment of our deferred tax assets,
we determined, based on certain available tax planning strategies, that $443 million of our deferred tax assets as of June 30, 2003 will more likely than not be realized in the future
and no valuation allowance is currently required for this portion of our deferred tax assets. Should we determine in the future that it is no longer more likely than not that these assets will be
realized, we will be required to record an additional valuation allowance in connection with these deferred tax assets and our operating results would be adversely affected in the period such
determination is made.

Risks Related To Our Operations

We have restructured our business to respond to industry and market conditions, however, the assumptions underlying our restructuring
efforts may prove to be inaccurate and we may have to restructure our business again in the future.

In
response to changes in industry and market conditions, we have restructured our business in the past and may again restructure our business in the future to achieve certain cost
savings and to strategically realign our resources. We have based our restructuring plans on certain assumptions regarding the cost structure of our business and the nature, severity and duration of
the current slowdown in enterprise
communications technology spending which may not prove to be accurate. We will continue to assess our cost structure and restructuring efforts based on an ongoing assessment of industry conditions.

Our
restructuring initiatives may not be sufficient to meet the changes in industry and market conditions, and such conditions may continue to deteriorate or last longer than we expect.
In addition, we may not be able to successfully implement our restructuring initiatives and may be required to refine, expand or extend our restructuring initiatives, which may result in additional
charges. Furthermore, our workforce reductions may impair our ability to realize our current or future business objectives. Lastly, costs incurred in connection with restructuring actions may be
higher than the estimated costs of such actions and/or may not lead to the anticipated cost savings. As a result, our

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restructuring
efforts may not result in our return to profitability within the currently expected timeframe.

We depend on contract manufacturers to produce most of our products and if these manufacturer are unable to fill our orders on a timely and reliable basis, we
will likely be unable to deliver our products to meet customer orders or satisfy their requirements.

We
have outsourced all of the manufacturing operations related to our Enterprise Communications Group and Small and Medium Business Solutions segments. Substantially all of these
operations have been outsourced to Celestica Inc. Our ability to realize the intended benefits of our manufacturing outsourcing initiative will depend on the willingness and ability of
Celestica and other contract manufacturers to produce our products. We may experience significant disruption to our operations by outsourcing so much of our manufacturing. If Celestica or the other
contract manufacturers terminate their relationships with us or are unable to fill our orders on a timely basis, we may be unable to deliver our products to meet our customers' orders, which could
delay or decrease our revenue or otherwise have an adverse effect on our operations.

The termination of strategic alliances or the failure to form additional strategic alliances could limit our access to customers and harm our reputation with
customers.

Our
strategic alliances are important to our success because they provide us the ability to offer comprehensive advanced communications products and applications, reach a broader
customer base and strengthen brand awareness. We may not be successful in creating new strategic alliances on acceptable terms or at all. In addition, most of our current strategic alliances can be
terminated under various circumstances, some of which may be beyond our control. Further, our alliances are generally non-exclusive, which means our partners may develop alliances with
some of our competitors. We may rely more on strategic alliances in the future, which would increase the risk to our business of losing these alliances.

If we are unable to protect our proprietary rights, our business and future prospects may be harmed.

Although
we attempt to protect our intellectual property through patents, trademarks, trade secrets, copyrights, confidentiality and nondisclosure agreements and other measures,
intellectual property is difficult to protect and these measures may not provide adequate protection for our proprietary rights. Patent filings by third parties, whether made before or after the date
of our filings, could render our intellectual property less valuable. Competitors may misappropriate our intellectual property, disputes as to ownership of intellectual property may arise and our
intellectual property may otherwise become known or independently developed by competitors. The failure to protect our intellectual property could seriously harm our business and future prospects
because we believe that developing new products and technology that are unique to us is critical to our success. If we do not obtain sufficient international protection for our intellectual property,
our competitiveness in international markets could be significantly impaired, which would limit our growth and future revenue.

In
addition, we rely on the security of our information systems, among other things, to protect our proprietary information and information of our customers. If we do not maintain
adequate security procedures over our information systems, we may be susceptible to computer hacking, cyberterrorism or other unauthorized attempts by third parties to access our proprietary
information or that of our customers. The failure to protect our proprietary information could seriously harm our business and future prospects or expose us to claims by our customers that we did not
adequately protect their proprietary information.

Risks Related To Contingent Liabilities

We may incur liabilities as a result of our obligations to indemnify, and to share certain liabilities with, Lucent
Technologies Inc. in connection with our spin-off from Lucent in September 2000.

35

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Pursuant
to the contribution and distribution agreement we entered into with Lucent in connection with our spin-off from Lucent on September 30, 2000, Lucent
contributed to us substantially all of the assets, liabilities and operations associated with its enterprise networking businesses and distributed all of the outstanding shares of our common stock to
its stockholders. The contribution and distribution agreement, among other things, provides that, in general, we will indemnify Lucent for all liabilities including certain
pre-distribution tax obligations of Lucent relating to our businesses and all contingent liabilities primarily relating to our businesses or otherwise assigned to us. In addition, the
contribution and distribution agreement provides that certain contingent liabilities not directly identifiable with one of the parties will be shared in the proportion of 90% by Lucent and 10% by us.
The contribution and distribution agreement also provides that
contingent liabilities in excess of $50 million that are primarily related to Lucent's businesses shall be borne 90% by Lucent and 10% by us and contingent liabilities in excess of
$50 million that are primarily related to our businesses shall be borne equally by the parties.

See
"Legal Proceedings" in this quarterly report on Form 10-Q for a description of certain matters involving Lucent for which we have assumed responsibility under the
contribution and distribution agreement and a description of other matters for which we may be obligated to indemnify, or share the cost with, Lucent. In March 2003, Lucent announced that it
had entered into a $420 million settlement of all pending shareholder and related litigation described under "Lucent Securities Litigation" in the "Legal Proceedings" section of this quarterly
report on Form 10-Q. Certain cases which are the subject of the settlement are shared contingent liabilities under the contribution and distribution agreement and accordingly, we
are responsible for 10% of the liabilities attributable to those cases, including 10% of the legal costs associated with the portion of the litigation for which we share liability. The amount of our
portion of this liability has not yet been finally determined, however, in the second quarter of fiscal of 2003, we recorded a charge of $25 million, representing our estimate of our liability
in this matter. Upon settlement, the amount of the liability will be adjusted to reflect our actual obligation in this matter.

We
cannot assure you we will not have to make other indemnification or other cost sharing payments to Lucent in connection with these matters or that Lucent will not submit a claim for
indemnification or cost sharing to us in connection with any future matter. In addition, our ability to assess the impact of matters for which we may have to indemnify, or share the cost with, Lucent
is made more difficult by the fact that we do not control the defense of these matters.

We may be subject to litigation and infringement claims, which could cause us to incur significant expenses or prevent us from selling our products or
services.

We
cannot assure you that others will not claim that our proprietary or licensed products, systems and software are infringing their intellectual property rights or that we do not in
fact infringe those intellectual property rights. We may be unaware of intellectual property rights of others that may cover some of our technology. If someone claimed that our proprietary or licensed
systems and software infringed their intellectual property rights, any resulting litigation could be costly and time consuming and would divert the attention of management and key personnel from other
business issues. The complexity of the technology involved and the uncertainty of intellectual property litigation increase these risks. Claims of intellectual property infringement also might require
us to enter into costly royalty or license agreements. However, we may be unable to obtain royalty or license agreements on terms acceptable to us or at all. We also may be subject to significant
damages or an injunction against use of our proprietary or licensed systems. A successful claim of patent or other intellectual property infringement against us could materially adversely affect our
operating results.

In
addition, third parties may claim that a customer's use of our product's, systems or software infringes the third party's intellectual property rights. Under certain circumstances, we
may be required to indemnify our customers for some of the costs and damages related to such an infringement claim.

36

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Any
indemnification requirement could have a material adverse effect on our business and our operating results.

If our separation from Lucent does not qualify for tax-free treatment, we could be required to pay Lucent or the Internal Revenue Service a
substantial amount of money.

Lucent
has received a private letter ruling from the Internal Revenue Service stating, based on certain assumptions and representations, that our separation from Lucent would not be
taxable to Lucent. Nevertheless, Lucent could incur significant tax liability if our separation from Lucent did not qualify for tax-free treatment because any of those assumptions or
representations were not correct.

Although
any U.S. federal income taxes imposed in connection with our separation from Lucent generally would be imposed on Lucent, we could be liable for all or a portion of any taxes
owed for the reasons described below. First, as part of our separation from Lucent, we and Lucent entered into a tax sharing agreement. This agreement generally allocates between Lucent and us the
taxes and liabilities relating to the failure of our separation from Lucent to be tax-free. Under the tax sharing agreement, if our separation from Lucent fails to qualify as a
tax-free distribution to Lucent under Section 355 of the Internal Revenue Code because of an issuance or an acquisition of our stock or an acquisition of our assets, or some other
actions of ours, then we will be solely liable for any resulting taxes to Lucent.

Second,
aside from the tax sharing agreement, under U.S. federal income tax laws, we and Lucent are jointly and severally liable for Lucent's U.S. federal income taxes resulting from our
separation from Lucent being taxable. This means that even if we do not have to indemnify Lucent under the tax sharing agreement, we may still be liable to the Internal Revenue Service for all or part
of these taxes if Lucent fails to pay them. These liabilities of Lucent could arise from actions taken by Lucent over which we have no control, including an issuance or acquisition of stock (or
acquisition of assets) of Lucent.

Overview

We are a leading provider of communications systems, applications and services for enterprises, including businesses, government agencies and other organizations.
Our product offerings include converged voice and data networks, traditional voice communication systems, customer relationship management applications, unified communications applications and
structured cabling products. We support our broad customer base with comprehensive global service offerings that enable our customers to plan, design, implement and manage their communications
networks. We believe our global service organization is an important consideration for customers purchasing our products and is a source of significant revenue for us, primarily from maintenance
contracts.

We
offer a broad array of communications systems, applications and services that enable enterprises to communicate with their customers, suppliers, partners and employees through voice,
Web, electronic mail, facsimile, Web chat sessions and other forms of communication, across an array of devices. These devices include telephones, computers, cell phones and personal digital
assistants. Our broad portfolio of products includes:



37

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Our
products range from systems designed for multinational enterprises with multiple locations worldwide, thousands of employees and advanced communications requirements to systems
designed for businesses with less than ten employees.

Although
our revenue has remained relatively stable over the past two fiscal quarters, it has declined significantly during the past several years. Revenue for the fiscal years ended
September 30, 2000, 2001 and 2002 was $7,732 million, $6,793 million and $4,956 million, respectively, and revenue for the nine months ended June 30, 2003 was
$3,220 million. The decline in revenue is attributable to, among other things, declines in the market for our traditional business, enterprise voice communications products, and the effect of
general economic conditions on our customers' willingness to spend on enterprise communications technology during the last several years. The decline in revenue has contributed to our net losses for
the fiscal years ended September 30, 2000, 2001 and 2002 of $375 million, $352 million and $666 million, respectively, and our net loss for the nine months ended
June 30, 2003 of $154 million. The decline in revenue has also contributed to our large accumulated deficit, which was $1,336 million as of June 30, 2003. We continue to
remain focused on our strategy to become increasingly more profitable by strengthening our financial position and focusing on sustainable cost and expense reduction through business restructuring and
other initiatives in order to right-size our business to adapt to current market conditions.

Collective Bargaining Agreements

We recently reached agreement on new collective bargaining agreements with the Communications Workers of America and the International Brotherhood of Electrical
Workers, which have been ratified by the union membership and will be retroactive to June 1, 2003.

Business Restructuring Reserve

The business restructuring reserve reflects the remaining balance associated with our business restructuring charges recorded in fiscal 2000 through 2002. The
following table summarizes the status of our business restructuring reserve as of and for the nine months ended June 30, 2003:

|                                 |  | Employee
Separation
Costs |     | Lease
Termination
Obligations |   | Total Business
Restructuring
Reserve |  
|-------------------------------- |  | ------------------------- | --- | ----------------------------- | - | ------------------------------------ | -
|
|Balance as of September 30, 2002 |  | $                         | 68  |                               | $ | 102                                  |  
|Cash payments                    |  |                           | (42 | )                             |   | (30                                  | )
|Reversals                        |  |                           | (15 | )                             |   | (2                                   | )
|                                 |  |                           |     |                               |   |                                      |  
|Balance as of June 30, 2003      |  | $                         | 11  |                               | $ | 70                                   |  
|                                 |  |                           |     |                               |   |                                      |  

In
the second quarter of fiscal 2003, we recorded a reversal of $17 million primarily attributable to higher employee attrition than originally anticipated and more favorable than
expected real estate lease termination costs.

The
charges for employee separation costs in fiscal 2002 were recorded in connection with the elimination of approximately 4,240 management and union-represented employee positions
worldwide. This workforce reduction has been substantially completed and the remaining employees are largely expected to depart by the end of fiscal 2003. The workforce reductions associated with the
business restructuring activities in fiscal 2001 and 2000 have been completed. Payments on lease termination obligations are related to vacated real estate facilities and will be substantially
completed by 2011.

38

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Results of Operations

The following table sets forth certain line items from our Consolidated Statements of Operations as a percentage of revenue for the periods indicated:

|                                                  |                                                                      | Three Months Ended
June 30, |      | Nine Months Ended
June 30, |     
|------------------------------------------------- | -------------------------------------------------------------------- | --------------------------- | ---- | -------------------------- | ----
|
|Revenue                                           |                                                                      | 100.0                       | %    | 100.0                      | %   
|Costs                                             |                                                                      | 58.8                        |      | 60.5                       |     
|                                                  |                                                                      |                             |      |                            |     
|Gross margin                                      |                                                                      | 41.2                        |      | 39.5                       |     
|                                                  |                                                                      |                             |      |                            |     
|Operating expenses:                               |                                                                      |                             |      |                            |     
|                                                  | Selling, general and administrative                                  |                             | 30.4 |                            | 31.0
|                                                  | Business restructuring charges (reversals) and related expenses, net |                             | 0.6  |                            | 0.7 
|                                                  | Research and development                                             |                             | 8.6  |                            | 9.4 
|                                                  |                                                                      |                             |      |                            |     
|Total operating expenses                          |                                                                      | 39.6                        |      | 41.1                       |     
|                                                  |                                                                      |                             |      |                            |     
|Operating income (loss)                           |                                                                      | 1.6                         |      | (1.6                       | )   
|Gain (loss) on long-term debt extinguishment, net |                                                                      | 0.1                         |      |                           |     
|Other income (expense), net                       |                                                                      | 1.5                         |      | (0.9                       | )   
|Interest expense                                  |                                                                      | (2.0                        | )    | (1.3                       | )   
|Provision (benefit) for income taxes              |                                                                      | 0.5                         |      | (0.6                       | )   
|                                                  |                                                                      |                             |      |                            |     
|Net income (loss)                                 |                                                                      | 0.7                         | %    | (3.2                       | )%  
|                                                  |                                                                      |                             |      |                            |     

Three Months Ended June 30, 2003 Compared To Three Months Ended June 30, 2002

Revenue

The following table presents our U.S. and non-U.S. revenue:

|                 |       | Three Months Ended
June 30, |     | Change |  
|---------------- | ----- | --------------------------- | --- | ------ | -
|
|
|U.S revenue      |       | $                           | 811 |        | $
|Non-U.S. revenue |       |                             | 261 |        |  
|                 |       |                             |     |        |  
|                 | Total |                             | $   | 1,072  |  
|                 |       |                             |     |        |  

Revenue
decreased 12.1%, or $147 million, to $1,072 million for the third quarter of fiscal 2003 from $1,219 million for the same period in fiscal 2002, due to
decreases within the global marketplace and across all of our operating segments. The weak economy coupled with the downturn in the industry resulted in significant reductions in capital investments
by enterprises of information technology and communications products and services. However, during the first three quarters of fiscal 2003, revenue has somewhat stabilized and remained within a narrow
range. The trends underlying this stabilization of revenue can be attributed to our products and services that support the market for converged communications products. Specifically, revenue from the
sale of our IP hardware and software products have increased throughout fiscal 2003, which has mitigated the decline in sales of our traditional voice systems.

40

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Costs and Gross MarginTotal costs decreased 14.6%, or $108 million, to $630 million in the third quarter of
fiscal 2003 from $738 million in the same quarter of fiscal 2002. Gross margin percentage increased for our product and services offerings in the third quarter of fiscal 2003 to 41.2% as
compared with 39.5% in the same period of fiscal 2002. Gross margin on products increased to 42.3% in the third quarter of fiscal 2003 from 41.5% in the same quarter last year. Similarly, Services'
gross margin increased to 39.7% from 36.6% when comparing the same periods. Our ECG and Services segments were the significant contributors to our gross margin. Although gross margin percentage
deteriorated in our ECG segment due to pricing pressures and a higher mix of indirect sales partially mitigated by benefits realized from our outsourcing agreement with Celestica Inc., it
increased in each of our SMBS, Services and Connectivity Solutions segments when comparing the third quarter of fiscal 2003 to the same period in fiscal 2002. The overall improvement is attributable
to a favorable product mix, the impact of our continuing cost reductions and restructuring activities, and improved utilization of our variable technician workforce. Because sales within the U.S.,
including both direct and indirect channels, typically have higher margins than sales made internationally, the decline in U.S. sales adversely impacted all segments.

See
"Results of Operations by Segment" for a discussion of segment revenue and operating income (loss).

Selling, General and AdministrativeSelling, general and administrative expenses decreased by 13.5%, or $51 million, to
$326 million in the third quarter of fiscal 2003 from $377 million in the third quarter of fiscal 2002. The decrease was primarily due to savings associated with our business
restructuring initiatives, including a reduction of $13 million of IT expenses, $7 million in reduced salary and other employee related expenses as a result of lower staffing levels, and
a $3 million decrease in rental expense in connection with terminated real estate lease obligations. The reduction in IT expenses also reflects a favorable renegotiated agreement for the
outsourcing of certain IT functions and lower networking costs. In addition, the decline in SG&A was due to a reduction in marketing and promotional costs of $11 million. The prior year period
included costs related to our sponsorship of the Federation International Football Association (FIFA) World Cup. A $6 million decrease in our provision for uncollectible receivables was
attributable primarily to the implementation of billing and collections process improvements. Furthermore, we had a reduction in our current year's depreciation and amortization expense of
$6 million as a result of the write-down of the carrying value of
intangible assets recorded in the fourth quarter of fiscal 2002. These reductions in SG&A were partially offset by an $8 million increase in incentive compensation expense related to
performance bonuses.

Business Restructuring Charges (Reversals) and Related Expenses, NetBusiness restructuring related expenses of
$7 million in the third quarter of fiscal 2003 represent expenses associated with the fourth quarter of fiscal 2002 business restructuring initiative, primarily related to information
technology transition expenditures.

Business
restructuring charges and related expenses of $9 million in the third quarter of fiscal 2002 relate to $6 million for incremental period costs, including
relocation and consolidation costs and computer transition expenditures, and a $3 million asset impairment.

Research and DevelopmentResearch and development expenses decreased 20.0%, or $23 million, to $92 million in
the third quarter of fiscal 2003 from $115 million in the third quarter of fiscal 2002. As a percentage of total revenue, our investment in R&D represented 8.6% in the third quarter of fiscal
2003 versus 9.4% in the same period of fiscal 2002. This decline was attributed mainly to lower staffing levels. Investments in R&D have been focused on the high growth areas of our business while
spending on our more mature product lines has decreased.

Gain (Loss) on Long-Term Debt Extinguishment, NetDuring the third quarter of fiscal 2003, we recognized a gain of
$1 million, net of the write-off of deferred financing costs, as the result of the

41

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repurchase
of LYONs in a series of open market transactions. The LYONs repurchased had an accreted value of $112 million, or an aggregate principal amount at maturity of $218 million.

Other Income (Expense), NetOther income (expense), net in the third quarter of fiscal 2003 improved by $26 million to
$16 million of income from $10 million of expense in the third quarter of fiscal 2002. Other income in the third quarter of fiscal 2003 includes a $14 million gain on the sale of
assets. In addition, we recognized a $2 million loss in the current quarter related to foreign currency transactions while the third quarter of fiscal 2002 includes $12 million of such
loss.

Interest ExpenseInterest expense increased by $5 million to $21 million in the third quarter of fiscal 2003
from $16 million in the third quarter of fiscal 2002 primarily due to interest expense associated with our add-on public offering, during the third quarter of fiscal 2003, to our
111/8% Senior Secured Notes due April 1, 2009. The third quarter of fiscal 2003 includes $15 million of interest expense on our senior secured notes that were issued
during the second quarter of fiscal 2002 and third quarter of fiscal 2003, $6 million of amortization of debt discount, premium and
deferred financing costs related primarily to our LYONs issued during the first quarter of fiscal 2002, and $1 million of interest expense related to commitment fees on our credit facility.
Interest expense was partially offset by $1 million of income related to the amortization of a gain resulting from the termination of interest rate swaps in December 2002.

Interest
expense for the third quarter of fiscal 2002 included $12 million of interest expense on our senior secured notes, and $6 million of amortization of both debt
discount and deferred financing costs related primarily to our LYONs. Interest expense was partially offset by $2 million of income related to the hedging of the senior secured notes with our
interest rate swaps.

Provision (Benefit) for Income TaxesIn the third quarter of fiscal 2003, we recorded a provision for income taxes of
$5 million as compared with a benefit of $7 million for the same period of fiscal 2002. For the three months ended June 30, 2003, the $5 million income tax provision
included a $6 million provision for state and foreign income taxes, a $1 million provision for other adjustments and a $2 million benefit related to a favorable audit settlement.

For
the three months ended June 30, 2002, the tax benefit of $7 million included a favorable benefit relating to an audit settlement and the favorable impact of the
adoption of Statement of Financial Accounting Standards No. 142, "Goodwill and Other Intangible Assets" in the beginning of fiscal 2002.

Nine Months Ended June 30, 2003 Compared To Nine Months Ended June 30, 2002

Revenue

The following table presents our U.S. and non-U.S. revenue:

Nine Months Ended
June 30,

Change2003

2002

$

%(dollars in millions)U.S revenue

$
2,378

$
2,780

$
(402
)
(14.5
)%Non-U.S. revenue


842


1,024


(182
)
(17.8
)Total

$
3,220

$
3,804

$
(584
)
(15.4
)%


Revenue
decreased 15.4%, or $584 million, to $3,220 million for the nine months ended June 30, 2003 from $3,804 million for the same period in fiscal 2002,
due to decreases both in the U.S. and international regions as well as across all of our operating segments. The decline in revenue is the result of a prolonged economic and industry downturn, which
has led to a reduction in capital spending

42

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by
enterprises in IT and communications products and services. During the nine month period ended June 30, 2003, we have experienced a stabilization of revenue which we attribute to the effect
of somewhat improved economic conditions on our customers' willingness to invest in converged communications. Specifically, revenue from the sale of our IP hardware and software products have
increased throughout fiscal 2003, which has mitigated the decline in sales of our traditional voice systems.

Costs and Gross MarginTotal costs decreased 17.4%, or $401 million, to $1,899 million in the nine month period
ended June 30, 2003 from $2,300 million in the same period of fiscal 2002. Gross
margin percentage increased for products and services in the first three quarters of fiscal 2003 to 41.0% as compared with 39.5% in the same period of fiscal 2002. Gross margin increased in our
product offerings to 42.3% in the nine months ended June 30, 2003 from 40.2% in the same period last year. Similarly, Services' gross margin increased to 39.3% from 38.6% when comparing the
same periods. Our ECG and Services segments represented the significant contributors to our gross margin. Although gross margin deteriorated in our ECG segment due to increased discounting and a
higher mix of indirect sales partially offset by benefits realized from our outsourcing agreement with Celestica Inc., it increased in each of our SMBS, Services and Connectivity Solutions
segments due to favorable product mix, the impact of our continuing cost reductions and restructuring activities, and improved utilization of our variable technician workforce. Because sales within
the U.S., including both direct and indirect channels, typically have higher margins than sales made internationally, the decline in U.S. sales adversely impacted all segments.

See
"Results of Operations by Segment" for a discussion of segment revenue and operating income (loss).

Selling, General and AdministrativeFor the nine months ended June 30, 2003, selling, general and administrative
expenses decreased by 15.3%, or $184 million, to $1,018 million from $1,202 million in the first three quarters of fiscal 2002. The decrease was primarily due to savings
associated with our business restructuring initiatives, including a reduction of $64 million in salary and other employee related expenses as a result of lower staffing levels,
$27 million in reduced IT expenses and a $9 million decrease in rental expense in connection with terminated real estate lease obligations. The reduction in IT expenses also reflects a
favorable renegotiated agreement for the outsourcing of certain IT functions and lower networking costs. In addition, our provision for uncollectible receivables decreased by $38 million due to
a change in the methodology used to calculate bad debt expense that was effective in the third quarter of fiscal 2002. The decrease in our provision for uncollectible receivables also reflects the
implementation of billing and collections process improvements. Furthermore, we had a reduction of our current year's depreciation and amortization expense of $20 million, primarily as a result
of the write-down of the carrying value of intangible assets recorded in the fourth quarter of fiscal 2002. These decreases in SG&A were partially offset by a $22 million increase
in incentive compensation expense related to performance bonuses.

Business Restructuring Charges (Reversals) and Related Expenses, NetFor the nine months ended June 30, 2003,
$3 million of business restructuring reversals, net of related expenses include a second quarter reversal of $17 million of business restructuring liabilities established in prior
periods, partially offset by $14 million of expenses associated with our fourth quarter of fiscal 2002 business restructuring initiative that primarily relate to information technology
transition expenditures. The $17 million reversal was attributable primarily to higher employee attrition than originally anticipated and more favorable than expected real estate lease
termination costs.

Business
restructuring charges and related expenses of $103 million in the first three quarters of fiscal 2002 included an $84 million restructuring charge related to
headcount reductions associated with our efforts to improve our business performance, and $16 million of incremental period costs, including

43

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relocation
and consolidation costs and computer transition expenditures, and $3 million for an asset impairment.

Research and DevelopmentResearch and development expenses decreased 21.2%, or $75 million, to $279 million for
the nine months ended June 30, 2003 from $354 million in the same period of fiscal 2002. As a percentage of total revenue, our investment in R&D represented 8.7% in the first three
quarters of fiscal 2003 versus 9.3% in the same period of fiscal 2002. This decline was attributed mainly to lower staffing levels. Investments in R&D have been focused on the high growth areas of our
business while spending on our more mature product lines has decreased.

Gain (Loss) on Long-Term Debt Extinguishment, NetDuring the nine months ended June 30, 2003, we incurred a
$34 million net loss as a result of the extinguishment of a portion of our LYONs. In January 2003, we incurred a $36 million loss resulting from the exchange of LYONs having an
accreted value of $43 million, or an aggregate principal amount at maturity of $84 million. This loss was partially offset by a $2 million gain, net of the write-off
of deferred financing costs, recognized as the result of the repurchase of LYONs in a series of open market transactions during the second and third quarter of fiscal 2003. The LYONs repurchased had
an accreted value of $119 million, or an aggregate principal amount at maturity of $232 million.

Other Income (Expense), NetOther income (expense), net for the nine months ended June 30, 2003 worsened by
$11 million to $3 million of expense from $8 million of income in the same period of fiscal 2002. This change was attributable primarily to a $25 million charge recorded in
the second quarter of fiscal 2003, which represents an estimate of the amount of our liability related to a litigation settlement, which is discussed in "Legal Proceedings-Lucent Securities
Litigation." This charge was partially offset by other income of $14 million related to a gain on the sale of assets. Also included in other income was $3 million of foreign currency
transaction loss for each of the nine month periods ended June 30, 2003 and 2002. Interest income of $12 million decreased by $4 million from $16 million in the prior year
period primarily due to a lower outstanding balance on a term loan, formerly a line of credit, extended to Expanets, Inc. The prior year period also included a $4 million impairment of
an investment accounted for under the cost method whereas there was no such charge incurred for the current year period.

Interest ExpenseInterest expense increased by $24 million to $57 million for the nine months ended
June 30, 2003 from $33 million for the same period of fiscal 2002. Interest expense for the nine months ended June 30, 2003 includes $40 million of interest expense on our
senior secured notes that were issued during the second quarter of fiscal 2002 and third quarter of fiscal 2003, $17 million of amortization of debt discount, premium and deferred financing
costs related primarily to our LYONs which were issued during the latter part of the first quarter of fiscal 2002, and $2 million of interest
expense related to commitment fees on our credit facility. Interest expense for the nine months ended June 30, 2003 was partially offset by $2 million of income related to the
amortization of a gain resulting from the termination of interest rate swaps in December 2002.

Interest
expense for the first three quarters of fiscal 2002 included $13 million of interest expense on our senior secured notes, $8 million for interest on commercial
paper and other short-term borrowings, and $14 million of amortization of both debt discount and deferred financing costs related primarily to our LYONs. Interest expense was
partially offset by $2 million of income related to the hedging of the senior secured notes with our interest rate swaps.

Provision (Benefit) for Income TaxesWe recorded a provision for income taxes of $87 million for the nine months ended
June 30, 2003, as compared with an income tax benefit of $58 million for the same period of fiscal 2002. For the nine months ended June 30, 2003, the $87 million provision
included an $83 million provision to increase the deferred tax asset valuation allowance, a $17 million provision for state and foreign income taxes, a $1 million provision for
other adjustments, a $4 million benefit related to a favorable audit settlement and a $10 million benefit related to the extinguishment

44

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in
January 2003 of a portion of our LYONs. The $83 million provision for the increase in the deferred tax asset valuation allowance reflects the difference between the actual and
expected tax gain associated with the LYONs Exchange Offer.

For
the nine months ended June 30, 2002, the tax benefit of $58 million included a favorable benefit relating to an audit settlement and the favorable impact of the
adoption of SFAS 142 in the beginning of fiscal 2002.

Results of Operations by Segment

Operating Segments

During the third quarter of fiscal 2003, we changed the name of our Converged Systems and Applications segment to the Enterprise Communications Group. We manage
our operations in four segments: (1) Enterprise Communications Group, or ECG, (2) Small and Medium Business Solutions, or SMBS, (3) Services and (4) Connectivity Solutions.
The ECG segment is focused on large enterprises and includes converged systems products, unified communications applications and customer
relationship management offerings. The SMBS segment develops, markets and sells converged and traditional voice communications products for small and mid-sized enterprises and includes all
key and Internet Protocol telephony systems and applications, as well as messaging products. The Services segment offers a comprehensive portfolio of services to enable customers to plan, design,
build and manage their communications networks. The Connectivity Solutions segment provides structured cabling systems and electronic cabinets to its customers. Corporate consists of other expenses
that are not identified with the operating segments such as business restructuring charges and related expenses, costs incurred to maintain vacant real estate facilities. During the fourth quarter of
fiscal 2003, we will reclassify our Professional Services Organization, or PSO, which is currently included in our ECG segment, to our Services segment. PSO's revenue for fiscal 2002 was
$111 million.

Three Months Ended June 30, 2003 Compared To Three Months Ended June 30, 2002

|                                    |                                                                        | Three Months
Ended
June 30, |    
|----------------------------------- | ---------------------------------------------------------------------- | --------------------------- | ---
|
|
|Enterprise Communications Group     |                                                                        | $                           | 416
|Small and Medium Business Solutions |                                                                        |                             | 55 
|Services                            |                                                                        |                             | 458
|Connectivity Solutions              |                                                                        |                             | 143
|                                    |                                                                        |                             |    
|                                    | Total Operating Segments                                               |                             |    
|                                    | Business restructuring (charges) reversals and related (expenses), net |                             |    
|                                    | Other unallocated amounts                                              |                             |    
|                                    |                                                                        |                             |    
|                                    |                                                                        | Total                       |    
|                                    |                                                                        |                             |    

45

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ECG

|                                |                   | Three Months Ended
June 30, |      | Change |  
|------------------------------- | ----------------- | --------------------------- | ---- | ------ | -
|
|
|U.S revenue                     |                   | $                           | 281  |        | $
|Non-U.S. revenue                |                   |                             | 135  |        |  
|                                |                   |                             |      |        |  
|                                | Total ECG revenue |                             | $    | 416    |  
|                                |                   |                             |      |        |  
|Percent of consolidated revenue |                   |                             | 38.8 | %      |  
|                                |                   |                             |      |        |  
|Operating loss                  |                   | $                           | (13  | )      | $
|                                |                   |                             |      |        |  

ECG's
revenue, which represented 38.8% and 40.4% of our total revenue in the third quarter of fiscal 2003 and 2002, respectively, decreased by $76 million, or 15.4%, from the same
period in fiscal 2002 due primarily to declines of $64 million in converged systems, $12 million in unified communications applications, and $4 million in customer relationship
management, partially offset by an increase of $4 million in other related revenue. ECG generated 67.5% of its revenue within the U.S. in the third quarter of fiscal 2003, as compared with
65.0%, in the same period of fiscal 2002. The reduction in this segment's revenue was due primarily to the lack of capital spending by our customers. A decrease in sales volumes coupled with
competitive pricing pressures have also contributed to the revenue decline. Demand for our products has been inhibited, in part, by cautiousness among our customers in transitioning to
IP-based voice systems while at the same time avoiding further spending on traditional voice communications systems. However, revenue from the sale of IP hardware and software have
increased throughout fiscal 2003, which has mitigated the decline in sales of traditional voice systems. IP hardware and software include mainly the gateways, servers, Multivantage software and IP
phones that comprise our suite of IP offerings. Sales through our indirect channel increased slightly to 49.7% of total ECG revenue in the third quarter of fiscal 2003, from 49.6% in the same period
of fiscal 2002.

Despite
the decrease in revenue, ECG's operating loss for the third quarter of fiscal 2003 improved by $34 million as compared with the same period in fiscal 2002. This
improvement was attributable to declines in SG&A and R&D expenses due primarily to savings associated with our business restructuring initiatives, including reduced headcount. Additionally, SG&A
decreased due to targeted reductions in advertising and marketing. R&D expenses also declined due to the shift away from spending on mature product lines and focusing investments primarily on high
growth areas of our business. These reductions were partially offset by a decline in gross margin percentage. This decline was primarily due to increased discounts resulting from pricing pressures and
a higher mix of indirect sales. The decline in the gross margin percentage was partially mitigated by efficiencies gained in our manufacturing process through our outsourcing agreement with Celestica.

46

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SMBS

|                                |                    | Three Months
Ended
June 30, |     | Change |  
|------------------------------- | ------------------ | --------------------------- | --- | ------ | -
|
|
|U.S. revenue                    |                    | $                           | 38  |        | $
|Non-U.S. revenue                |                    |                             | 17  |        |  
|                                |                    |                             |     |        |  
|                                | Total SMBS revenue |                             | $   | 55     |  
|                                |                    |                             |     |        |  
|Percent of consolidated revenue |                    |                             | 5.1 | %      |  
|                                |                    |                             |     |        |  
|Operating loss                  |                    | $                           | (1  | )      | $
|                                |                    |                             |     |        |  

SMBS'
revenue represented 5.1% and 4.7% of our total revenue in the third quarter of fiscal 2003 and 2002, respectively. Although revenue in this segment declined overall
by $3 million from the third quarter of fiscal 2002, the reduction was mitigated by the impact of the introduction in the second quarter of fiscal 2002 of IP Office, our
IP telephony offering for small and mid-sized enterprises. Revenue from IP Office represented 26% of total SMBS' revenue in the third quarter of fiscal 2003 compared to less
than 15% in the prior year period. Sales from our SMBS segment were generated almost entirely through our indirect channel.

SMBS'
operating loss for the third quarter of fiscal 2003 improved by $9 million compared with the same period in fiscal 2002. This was due primarily to savings associated with
the development of a more cost effective support organization within the SMBS segment. Furthermore, gross margin percentage increased primarily due to a favorable product mix, which included an
increase in sales of IP Office.

Services

|                                |                        | Three Months Ended
June 30, |      | Change |  
|------------------------------- | ---------------------- | --------------------------- | ---- | ------ | -
|
|
|U.S. revenue                    |                        | $                           | 405  |        | $
|Non-U.S. revenue                |                        |                             | 53   |        |  
|                                |                        |                             |      |        |  
|                                | Total Services revenue |                             | $    | 458    |  
|                                |                        |                             |      |        |  
|Percent of consolidated revenue |                        |                             | 42.7 | %      |  
|                                |                        |                             |      |        |  
|Operating income                |                        | $                           | 43   |        | $
|                                |                        |                             |      |        |  

Services'
revenue, which represented 42.7% and 41.4% of our total revenue in the third quarter of fiscal 2003 and 2002, respectively, decreased by $47 million of
which $42 million occurred within the U.S. This decline was largely due to a decline in maintenance contract renewals caused by the softened economy and customer cost cutting initiatives. In
addition, we saw a decline in our maintenance services billed on a time and materials basis due also to customer cost reduction initiatives. Lower discretionary spending resulted in reduced demand for
equipment adds, moves and changes. Lower product sales in our ECG segment resulted in fewer installations of communication networks. Outsourcing, which is part of our contract-based revenue, declined
due to lower product volume under contract as well as reduced pricing on renewal contracts. Services revenue generated through our direct channel represented 84.8% of this segment's revenue for the
third quarter of fiscal 2003 as compared with 83.9% for the same period of fiscal 2002.

47

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Services'
operating income for the third quarter of fiscal 2003 decreased by $9 million compared with the same period in fiscal 2002 driven primarily by revenue erosion. This
decrease was partially offset by an improvement in gross margin percentage resulting from headcount reductions associated with business restructuring activities and improved utilization of our
variable technician workforce. R&D expenses increased primarily from investments in the development of service diagnostic tools. Additionally, a small increase in SG&A expenses was primarily due to
the creation of a dedicated sales organization in the first quarter of fiscal 2003.

Connectivity Solutions

|                                |                                      | Three Months Ended
June 30, |      | Change |  
|------------------------------- | ------------------------------------ | --------------------------- | ---- | ------ | -
|
|
|U.S. revenue                    |                                      | $                           | 87   |        | $
|Non-U.S. revenue                |                                      |                             | 56   |        |  
|                                |                                      |                             |      |        |  
|                                | Total Connectivity Solutions revenue |                             | $    | 143    |  
|                                |                                      |                             |      |        |  
|Percent of consolidated revenue |                                      |                             | 13.4 | %      |  
|                                |                                      |                             |      |        |  
|Operating income                |                                      | $                           | 3    |        | $
|                                |                                      |                             |      |        |  

Connectivity
Solutions' revenue, which represented 13.4% and 13.5% of our total revenue in the third quarter of fiscal 2003 and 2002, respectively, decreased by
$21 million due to declines of $16 million in sales of ExchangeMAX® cabling for telecommunications services providers and $9 million in sales related to electronic
cabinets, a services provider offering, due to a continued constraint on the capital budgets of telecommunications services providers. Revenue generated from our SYSTIMAX® structured
cabling systems for enterprises increased by $4 million for the same period and represented $120 million, or 83.9%, and $116 million, or 70.7%, of Connectivity Solutions' total
revenue in the third quarter of fiscal 2003 and 2002, respectively. This increase was a result of our strategy implemented at the beginning of the market recession to reduce standard pricing, product
redesign, vendor cost support and redeployment of market resources. Sales through our indirect channel increased to 89.0% of Connectivity Solutions' revenue in the third quarter of fiscal 2003 from
82.9% in the same period of fiscal 2002.

Connectivity
Solutions' operating income for the third quarter of fiscal 2003 decreased by $1 million compared with the same period in fiscal 2002. Gross margin percentage
improved overall due primarily to reduced headcount and lower production costs of SYSTIMAX cabling as a result of efficiencies gained from capital expenditures made during fiscal 2002 that focused on
automation of processes. Additionally, cost savings related to purchased materials were generated by leveraging the segment's growing market share with vendors.

48

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Nine Months Ended June 30, 2003 Compared To Nine Months Ended June 30, 2002

|                                    |                                                                        | Nine Months
Ended
June 30, |      
|----------------------------------- | ---------------------------------------------------------------------- | -------------------------- | -----
|
|
|Enterprise Communications Group     |                                                                        | $                          | 1,281
|Small and Medium Business Solutions |                                                                        |                            | 166  
|Services                            |                                                                        |                            | 1,378
|Connectivity Solutions              |                                                                        |                            | 395  
|                                    |                                                                        |                            |      
|                                    | Total Operating Segments                                               |                            |      
|                                    | Business restructuring (charges) reversals and related (expenses), net |                            |      
|                                    | Other unallocated amounts                                              |                            |      
|                                    |                                                                        |                            |      
|                                    |                                                                        |                            | Total
|                                    |                                                                        |                            |      

ECG

|                                |  | Nine Months Ended
June 30, |       | Change |  
|------------------------------- |  | -------------------------- | ----- | ------ | -
|
|
|U.S revenue                     |  | $                          | 835   |        | $
|Non-U.S. revenue                |  |                            | 446   |        |  
|                                |  |                            |       |        |  
|Total ECG revenue               |  | $                          | 1,281 |        | $
|                                |  |                            |       |        |  
|Percent of consolidated revenue |  |                            | 39.8  | %      |  
|                                |  |                            |       |        |  
|Operating loss                  |  | $                          | (63   | )      | $
|                                |  |                            |       |        |  

ECG's
revenue represented 39.8% and 42.1% of our total revenue for the nine months ended June 30, 2003 and 2002, respectively. ECG's revenue declined by $321 million, or
20.0%, as compared with the same period in fiscal 2002 primarily due to declines of $254 million in converged systems, $41 million in unified communications applications, and
$38 million in customer relationship management, partially offset by an increase of $12 million in other related revenue. ECG generated $835 million, or 65.2%, of its revenue
within the U.S. in the first three quarters of fiscal 2003, as compared with $1,014 million, or 63.3%, in the same period of fiscal 2002. The reduction in this segment's revenue was
attributable primarily to the restraint on capital spending by our customers, which resulted in lower sales volumes and an increase in discounting. This decline was mitigated by an increase in sales
of IP hardware and software throughout fiscal 2003 which has offset the reduction in revenue from our traditional voice communications systems. Sales through our indirect channel increased to 49.1% of
total ECG revenue in the first three quarters of fiscal 2003, from 46.5% in the same period of fiscal 2002.

ECG's
operating loss for the first three quarters of fiscal 2003 improved by $71 million compared with the same period in fiscal 2002. This improvement was primarily due to
declines in SG&A and R&D expenses resulting from savings associated with our business restructuring initiatives. Furthermore, SG&A decreased due to targeted reductions in advertising and marketing.
R&D expenses declined due to the shift away from spending on mature product lines and the focus of investments

49

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primarily
on high growth areas of our business. These reductions were partially offset by a decline in gross margin percentage primarily due to higher discounts and a greater mix of indirect sales,
partially offset by benefits realized from our outsourcing agreement with Celestica.

SMBS

|                                |  | Nine Months Ended
June 30, |     | Change |  
|------------------------------- |  | -------------------------- | --- | ------ | -
|
|
|U.S revenue                     |  | $                          | 105 |        | $
|Non-U.S. revenue                |  |                            | 61  |        |  
|                                |  |                            |     |        |  
|Total SMBS revenue              |  | $                          | 166 |        | $
|                                |  |                            |     |        |  
|Percent of consolidated revenue |  |                            | 5.2 | %      |  
|                                |  |                            |     |        |  
|Operating loss                  |  | $                          | (6  | )      | $
|                                |  |                            |     |        |  

SMBS'
revenue represented 5.2% and 4.7% of our total revenue in the nine months ended June 30, 2003 and 2002, respectively. Although SMBS' revenue declined from the nine months
period ended June 30, 2002, the reduction was partially mitigated by the impact of the introduction in the second quarter of fiscal 2002 of IP Office, our IP telephony offering for small and
mid-sized enterprises. Revenue from IP Office represented 24% of total SMBS' revenue in the first three quarters of fiscal 2003 while such revenue in the prior year period totaled 7%.
Sales from our SMBS segment were generated almost entirely through our indirect channel.

SMBS'
operating loss for the nine months ended June 30, 2003 improved by $13 million as compared with the same period in fiscal 2002. This improvement in operating loss was
primarily associated with the development of a more cost effective support organization within the SMBS segment. Additionally,
gross margin percentage increased primarily due to a favorable product mix, which included an increase in sales of IP Office.

Services

|                                |  | Nine Months Ended
June 30, |       | Change |  
|------------------------------- |  | -------------------------- | ----- | ------ | -
|
|
|U.S revenue                     |  | $                          | 1,217 |        | $
|Non-U.S. revenue                |  |                            | 161   |        |  
|                                |  |                            |       |        |  
|Total Services revenue          |  | $                          | 1,378 |        | $
|                                |  |                            |       |        |  
|Percent of consolidated revenue |  |                            | 42.8  | %      |  
|                                |  |                            |       |        |  
|Operating income                |  | $                          | 118   |        | $
|                                |  |                            |       |        |  

Revenue
from our Service segment represented 42.8% and 41.6% of our total revenue for the nine months ended June 30, 2003 and 2002, respectively. Services' revenue for the first
three quarters of fiscal 2003 decreased as compared to the same period in fiscal 2002 primarily due to the decline in maintenance contract renewals resulting from the weakened economy and customer
cost cutting initiatives. The decline also reflects the full effect in the first nine months of fiscal 2003 of the loss of a major services contract in our Europe/Middle East/Africa region in the
second quarter of fiscal 2002

50

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and
the renegotiation of a maintenance contract with a major distributor in March 2002, which extended the term of the agreement but lowered the monthly revenue. Outsourcing, which is part of
our contract-based revenue, declined due to fewer renewals and pricing pressures compounded by a decline resulting from customer consolidation of call centers and fewer active ports. In addition, we
saw a decline in our maintenance services billed on a time and materials basis, and continued reductions in capital expenditures and lower discretionary spending resulted in lower demand for equipment
adds, moves and changes. Lower product sales in our ECG segment resulted in fewer installations of communication networks. Services revenue generated through our direct channel represented 84.4% of
this segment's revenue for the first three quarters of fiscal 2003 as compared with 82.9% for the same period of fiscal 2002.

Services'
operating income for the first three quarters of fiscal 2003 decreased by $76 million compared with the same period in fiscal 2002 driven primarily by revenue erosion.
This decrease was partially offset by an improvement in gross margin percentage resulting from a more efficient use of our variable technician workforce and business restructuring activities which
included reduced employee related costs. R&D expenses increased primarily from investments in the development of service diagnostic tools. SG&A expenses also increased, although to a lesser extent,
due to the creation of a dedicated sales organization in the first quarter of fiscal 2003.

Connectivity Solutions

|                                     |  | Nine Months Ended
June 30, |      | Change |  
|------------------------------------ |  | -------------------------- | ---- | ------ | -
|
|
|U.S revenue                          |  | $                          | 221  |        | $
|Non-U.S. revenue                     |  |                            | 174  |        |  
|                                     |  |                            |      |        |  
|Total Connectivity Solutions revenue |  | $                          | 395  |        | $
|                                     |  |                            |      |        |  
|Percent of consolidated revenue      |  |                            | 12.2 | %      |  
|                                     |  |                            |      |        |  
|Operating income                     |  | $                          | (2   | )      | $
|                                     |  |                            |      |        |  

Connectivity
Solutions' revenue, which represented 12.2% and 11.6% of our total revenue for the nine month period ended June 30, 2003, and 2002, respectively, decreased by
$48 million due to declines of $32 million in sales of ExchangeMAX® cabling for telecommunications services providers and $24 million in sales related to electronic
cabinets, a services provider offering, due to a lack of capital spending by telecommunications services providers. These declines were partially offset by an $8 million increase in revenue
generated from our SYSTIMAX® structured cabling systems for enterprises. SYSTIMAX revenue represented $322 million, or 81.5%, of Connectivity Solutions' total revenue in the nine
month period ended June 30, 2003 as compared with $314 million, or 70.9%, in the same period of fiscal 2002. This increase is a result of our strategy implemented at the beginning of the
market recession to reduce standard pricing, product redesign, vendor cost support and redeployment of market resources. Sales through our indirect channel increased to 86.6% of Connectivity
Solutions' revenue in the first three quarters of fiscal 2003 from 77.7% in the same period of fiscal 2002.

Despite
the decline in revenue, Connectivity Solutions' operating loss for the first three quarters of fiscal 2003 improved by $63 million from the same period in fiscal 2002 due
primarily to an increase in gross margin percentage. This improvement is attributable to several factors including reduced headcount, lower material costs and lower production costs of SYSTIMAX
cabling as a result of efficiencies gained from capital expenditures made during fiscal 2002 that focused on automation of processes.

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Liquidity and Capital Resources

Statement of Cash Flows Discussion

Avaya's cash and cash equivalents increased to $843 million at June 30, 2003 from $597 million at September 30, 2002. The
$246 million increase resulted primarily from an increase in net cash provided by operating and financing activities of $147 million and $110 million, respectively, partially
offset by $20 million of cash used for investing activities. For the nine months ended June 30, 2002, cash and cash equivalents increased $156 million provided primarily from
financing activities partially offset by uses of cash for operating and investing activities.

Operating Activities

Our net cash provided by operating activities of $147 million for the nine months ended June 30, 2003 increased substantially from the same period
in fiscal 2002 in which we reported net cash used for operating activities of $3 million. In the first three quarters of fiscal 2003, net cash provided by operating activities was comprised of
a net loss of $154 million adjusted for non-cash items of $329 million and net cash used for changes in operating assets and liabilities of $28 million. Included in
the non-cash items are $398 million of charges that increased our net loss, but did not result in the usage of cash, which consisted mainly of depreciation and amortization, an
increase in our deferred tax asset valuation, the loss on the extinguishment of a portion of our LYONs, and a charge for our estimated liability related to the Lucent Technologies Inc.
securities litigation. Also included in such non-cash items are $69 million of amounts that generated net income, but did not provide cash from operations including an increase in
our deferred tax assets, a reversal of certain business restructuring reserves and a gain on assets sold. Net cash provided by operating assets and liabilities was attributed mainly to receipts of
cash on amounts due from our customers and a decrease in our inventory balance. In addition, we received $19 million of cash as a result of the
termination of interest rate swap agreements. These increases in cash were partially offset by payments made for accounts payable and other short-term liabilities, business restructuring
activities, and interest on our senior secured notes.

In
the first quarter of fiscal 2003, we changed the way in which we calculate days sales outstanding from the two-point method to the one-point method, which
represents the industry standard. The one-point method uses accounts receivable outstanding at the end of a reporting period, whereas the two-point method uses an average of
accounts receivable outstanding at the beginning and at the end of a reporting period. Under the one-point method, our days sales outstanding in accounts receivable for the third quarter
of fiscal 2003 was 59 days versus 60 days for the second quarter of fiscal 2003. The improvement in our days sales outstanding is attributable primarily to the implementation of process
improvements whereby we have simplified our billing process and strengthened our collections of accounts receivable.

In
the second quarter of fiscal 2003, we also changed the way in which we calculate days sales of inventory on-hand from the two-point method to the
one-point method in order to be consistent with the other metrics we use to assess operational performance. The one-point method uses the inventory balance at the end of a
reporting period, whereas the two-point method uses an average inventory amount based on such balances at the beginning and at the end of a reporting period. Under the
one-point method, days sales of inventory on-hand for the third quarter of fiscal 2003 was 56 days versus 59 days for the second quarter of fiscal 2003.

In
the first three quarters of fiscal 2002, net cash used for operating activities of $3 million was comprised of a net loss of $122 million adjusted for
non-cash items of $291 million, and net cash used for changes in operating assets and liabilities of $172 million. Included in the non-cash items are
$369 million of charges that increased our net loss, but did not result in the usage of cash. These charges consisted mainly of depreciation and amortization, business restructuring charges and
a provision for uncollectible receivables. Also included in such non-cash items is a $78 million increase in

52

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our
deferred tax asset that generated net income, but did not provide cash. Net cash used for operating assets and liabilities was attributed primarily to cash payments made on our accounts payable
and other short term liabilities, business restructuring activities, and payroll related liabilities. These usages of cash were partially offset by receipts of cash on amounts due from our customers
and a decrease in our inventory balance.

Investing Activities

Our net cash used for investing activities was $20 million for the nine months ended June 30, 2003 compared with $96 million for the same
period in fiscal 2002. The usage of cash in both periods resulted primarily from capital expenditures. For the first three quarters of fiscal 2003, capital expenditure related primarily to the
implementation of a Company-wide enterprise resource planning system. For the same period in fiscal 2002, capital expenditures were largely made for the renovation of our corporate
headquarters facility, purchase of a corporate aircraft as a result of the termination of an aircraft sale-leaseback agreement, and upgrades to our information technology systems. The
reduction in capital expenditures in the first three quarters of fiscal 2003 as compared with the same period in fiscal 2002 was due to a continuing effort to limit spending as a result of declines in
our revenue. During the third quarter of fiscal 2003, we received $13 million for the sale of land and $7 million for the sale of a building and equipment.

Financing Activities

Net cash provided by financing activities was $110 million in the first three quarters of fiscal 2003 compared with $252 million for the same period
in fiscal 2002. Cash flows from financing activities for the nine months ended June 30, 2003 were mainly attributed to the issuance and retirement of long-term debt and the issuance
of $8 million of common stock primarily through our employee stock purchase plan. We received gross proceeds of $216 million from the issuance of senior secured notes in May 2003.
The receipt of cash for this debt offering was partially offset by the payment of $6 million of issuance costs. In addition, we made cash payments of $108 million related to the
repurchase of LYONs during the second and third quarters of fiscal 2003.

Net
cash provided by financing activities for the nine months ended June 30, 2002 of $252 million was mainly due to the issuance of LYONs and senior secured notes, which
provided gross proceeds of $460 million and $435 million, respectively. In addition, we received cash proceeds of $232 million from the issuance of our common stock, related to
(i) the sale of 19.55 million shares of our common stock for $5.90 per share in a public offering resulting in gross proceeds of approximately $115 million, (ii) an equity
transaction entered into with the Warburg Entities which resulted in gross proceeds of $100 million, and (iii) purchases under our employee stock purchase plan. These receipts were
partially offset by $29 million in cash used to pay costs related to the issuance of these debt and equity offerings. In addition, we made net payments of $432 million for the retirement
of commercial paper and $200 million for the repayment of an amount drawn on our five-year credit facility in September 2001. In connection with our election to terminate our
accounts receivable securitization in March 2002, $200 million of collections of qualified trade accounts receivable were used to liquidate the financial institution's
$200 million investment.

Expanets Arrangements

Following the sale in March 2000 of our primary distribution function for voice communications systems for small and mid-sized enterprises to
Expanets, Inc., we agreed in May 2001 to provide a $125 million short-term secured line of credit to Expanets. The line of credit applied to certain unpaid amounts and
outstanding receivables due to Avaya by Expanets and was secured by a first priority lien on Expanets' receivables and inventory. In March 2002, we entered into an amended Dealer Credit

53

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Agreement
with Expanets and its parent company, NorthWestern Corporation to provide for installment payments under the line of credit with the final balance due to us on December 31, 2002.

We
had been engaged in discussions with Expanets regarding certain operating issues and customer data and billing management services related to the March 2000 sale to Expanets.
Although these issues were unrelated to Expanets' and NorthWestern's obligations under the Dealer Credit Agreement, we, because of the importance to us of our relationship with Expanets and the
customer base served by Expanets, agreed in December 2002 to extend the term of the final installment payment of $27 million to February 2003.

In
March 2003, we entered into a restructured agreement with Expanets and NorthWestern to resolve matters related to the March 2000 sale to Expanets and to set payment
terms for the remaining amounts due to us under the line of credit. In exchange for the companies providing mutual general releases of liability concerning the outstanding operational issues, the
parties agreed to, among other things, the following:



Additionally,
as of June 30, 2003 we have recorded $22 million in receivables representing trade receivables due from Expanets on recurring sales of products and
maintenance services.

In
April 2003, NorthWestern announced that it expected to record charges in its December 31, 2002 financial statements related to, among other things, asset impairments and
deferred tax valuation allowances related to Expanets. In addition, NorthWestern announced that it filed for an extension to file its Annual Report on Form 10-K in order to take
certain actions related to identified deficiencies in internal controls. In its Annual Report on Form 10-K, NorthWestern disclosed that its independent auditors had advised its
Audit Committee that these internal control deficiencies constituted reportable conditions and, collectively, a material weakness as defined in Statement of Auditing Standards No. 60. In its
Quarterly Report on Form 10-Q for the quarter ended March 31, 2003, NorthWestern disclosed that the SEC is conducting an informal inquiry relating the restatements of its
financial statements and other accounting and reporting matters.

54

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In
June 2003, Expanets entered into a $25 million credit facility with a third party financial institution. As required by the terms of the March 2003 agreements
with Expanets, we agreed to subordinate our rights in the collateral securing the $27 million term loan from Expanets to the third party financial institution. Under the subordination
agreement, we may not take action with regard to the collateral until Expanets' obligations under the senior credit facility are paid in full. In addition, if a payment default has occurred under the
senior credit facility at the time a payment is due to us under the term loan, Expanets is prohibited under the subordination agreement from making such payment on the term loan until the payment
default under the senior credit facility has been cured or waived in writing by the third party financial institution. If a covenant default has occurred under the senior credit facility at the time a
payment is due to us under the term loan, Expanets is prohibited under the subordination agreement from making such payment on the term loan until the earlier of the date the covenant default under
the senior credit facility has been cured or waived in writing by the third party financial institution and 180 days from the date the notice of default is delivered to us. The subordination
agreement does not affect our rights with regard to NorthWestern, including our rights in the event of a default by NorthWestern under the credit agreement governing the term loan.

There
can be no assurance that Expanets or NorthWestern will be able to comply with the terms of the restructured agreement. In the event Expanets or NorthWestern are unable to comply
with the terms of the restructured agreement and a default occurs, the remedies available to us under such agreement may be insufficient to satisfy in full all of Expanets' obligations to us.

Debt Ratings

Our ability to obtain external financing and the related cost of borrowing is affected by our debt ratings, which are periodically reviewed by the major credit
rating agencies. During the first quarter of fiscal 2003, Moody's downgraded our long-term debt ratings. In May 2003, Standard & Poor's lowered our corporate credit rating to
B+ and changed the outlook on each of our long-term senior unsecured debt, senior secured notes and corporate credit from negative to stable. The debt ratings and outlook assigned to us as
of June 30, 2003 were as follows:

|                   |                                 | As of June 30, 2003
|------------------ | ------------------------------- | -------------------
|
|Moody's:           |                                 |                    
|                   | Long-term senior unsecured debt |                    
|                   | Senior secured notes            |                    
|Standard & Poor's: |                                 |                    
|                   | Long-term senior unsecured debt |                    
|                   | Senior secured notes            |                    
|                   | Corporate credit                |                    

55

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Any increase in our level of indebtedness or deterioration of our operating results may cause a further reduction in our current debt ratings. A further reduction in our current
long-term debt rating by Moody's or Standard & Poor's could affect our ability to access the long-term debt markets, significantly increase our cost of external
financing, and result in additional restrictions on the way we operate and finance our business.

A
security rating by the major credit rating agencies is not a recommendation to buy, sell or hold securities and may be subject to revision or withdrawal at any time by the rating
agencies. Each rating should be evaluated independently of any other rating.

Credit Facility

In April 2003, we and the lenders under our five-year revolving credit agreement amended the credit facility to reduce the size of the facility
to $250 million and amend certain covenants included in the credit facility. As of June 30, 2003, there were no amounts outstanding under the credit facility, which expires in
September 2005.

The
credit facility contains covenants, including a requirement that we maintain certain financial covenants relating to a minimum amount of earnings before interest, taxes, depreciation
and amortization, or EBITDA, adjusted for certain exclusions as summarized below, or adjusted EBITDA, and a minimum ratio of adjusted EBITDA to interest expense. The covenants permit us to exclude up
to a certain amount of business restructuring charges and related expenses, including asset impairment charges, from the calculation of adjusted EBITDA. The definition of adjusted EBITDA in the credit
facility also excludes certain other non-cash charges. We are permitted to exclude from the calculation of adjusted EBITDA in the fourth quarter of fiscal 2003, an additional
$63 million in business restructuring charges and related expenses in connection with the amendments described below.

For
the four quarter period ending June 30, 2003, we were required to maintain a minimum adjusted EBITDA of $190 million and a ratio of adjusted EBITDA to interest expense
of 2.50 to 1. We were in compliance with all required covenants as of June 30, 2003.

The
amended credit facility requires us to maintain a ratio of consolidated adjusted EBITDA to interest expense of:



If
our Connectivity Solutions segment is sold, for purposes of these calculations, the ratios above will be reduced (i) by 0.20 for the fiscal quarter in which our Connectivity
Solutions segment is sold, (ii) by 0.40 for the fiscal quarter following the fiscal quarter referred to in (i) above, (iii) by 0.60 for the fiscal quarter following the fiscal
quarter referred to in (ii) above and (iv) by 0.80 for each fiscal quarter thereafter.

We
are required to maintain consolidated adjusted EBITDA of:



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If
our Connectivity Solutions Segment is sold, for purposes of these calculations, the minimum adjusted EBITDA amounts will be reduced (i) by $15 million for the fiscal
quarter in which our Connectivity Solutions segment is sold, (ii) by $30 million for the fiscal quarter following the fiscal quarter referred to in (i) above, (iii) by
$45 million for the fiscal quarter following the fiscal quarter referred to in (ii) above and (iv) by $60 million for each fiscal quarter thereafter.

While
we believe we will be able to continue to meet these financial covenants, our revenue has been declining and any further decline in revenue may affect our ability to meet these
financial covenants in the future.

Prior
to the amendment, our credit facility prohibited us from using more than $100 million in cash to redeem or repurchase the LYONs. However, under the amended credit facility,
this limitation may be increased, up to a maximum of $400 million, by an amount equal to 100% of the net cash proceeds of equity and debt issuances in the capital markets, including the
May 2003 issuance of the senior secured notes described below, and 50% of the net cash proceeds from the sale of our Connectivity Solutions segment and our corporate aircraft. As of
August 8, 2003, we have used approximately $156 million in cash to repurchase LYONs and, as a result of the amendments to the credit facility and the May 2003 public offering of
senior secured notes, have the ability under the amended credit facility to use an additional $154 million in cash to repurchase LYONs.

The
amended credit facility also requires us to maintain, as of each day in the period commencing September 30, 2004 until the later of (a) the date that the put obligation
under the LYONs is satisfied and (b) the date upon which we deliver to the lenders under the amended credit facility a certificate
certifying our compliance with the covenants included in the amended credit facility for the fiscal quarter ended September 30, 2004, liquidity of not less than $300 million on a pro
forma basis as if the put obligation under the LYONs had been satisfied as of such day. Holders of LYONs may require us to purchase all or a portion of their LYONs on October 31, 2004, 2006 and
2011 at a price per LYON of $542.95, $583.40 and $698.20, respectively. For purposes of this calculation, liquidity is defined as the sum of the unused commitments under our amended credit facility
plus domestic cash, to the extent free and clear of any liens other than liens under the collateral arrangements securing our obligations to the lenders under the amended credit facility, less our
obligations under our senior secured notes and the put obligation related to the LYONs had it been satisfied as of such day.

The
credit facility was also amended to permit us to issue up to $200 million in debt provided such debt is junior to the amended credit facility and matures not less than
90 days after the amended credit facility matures in September 2005. Pursuant to this provision of the amended credit facility, in May 2003, we issued $200 million
aggregate principal amount of senior secured notes as described below. In addition, the credit facility was amended to reduce our ability to incur other secured and unsecured debt, make investments,
and to prohibit us from prepaying long-term debt other than the LYONs.

LYONs Convertible Debt Exchange Offer

In December 2002, we, together with the Warburg Pincus Equity Partners L.P. and affiliated investment funds, or the Warburg Entities, commenced an exchange
offer to purchase up to approximately $661 million aggregate principal amount at maturity, or 70%, of our outstanding LYONs. Under the terms of the exchange offer, holders of LYONs could elect
to receive, for each $1,000 aggregate principal amount at maturity of LYONs exchanged, either (i) $389.61 in cash, which we refer to as cash consideration or (ii) a combination of
$208.40 in cash plus 77 shares of our common stock, which we refer to as mixed consideration.

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Avaya
and the Warburg Entities entered into a Backstop Agreement, as amended, which contains the terms relating to the Warburg Entities' participation in the exchange offer. Under the
terms of the backstop agreement, we granted the Warburg Entities series C warrants described below and reduced the exercise price of 5,581,101 of the 6,724,665 series A warrants held by
the Warburg Entities to $0.01 per share. The Warburg Entities exercised the 5,581,101 series A warrants and converted the LYONs they acquired in the exchange offer into shares of our common
stock, each as described below.

In
January 2003, the exchange offer expired and an aggregate principal amount at maturity of LYONs of $84,426,000, representing approximately 8.9% of the outstanding LYONs, or
approximately $43 million in accreted value, was tendered. Of these LYONs, $84,416,000 aggregate principal amount at maturity were tendered for the mixed consideration and $10,000 aggregate
principal amount at maturity were
tendered for the cash consideration. In exchange for the LYONs accepted in the exchange offer, the Warburg Entities paid an aggregate amount of approximately $18 million in cash and we
delivered 6,500,032 shares of our common stock. We delivered an additional 1,588,548 shares of our common stock to the Warburg Entities upon conversion of LYONs acquired by them in the exchange offer.

In
the second quarter of fiscal 2003, we recognized in our Consolidated Statement of Operations a pre-tax charge of $36 million in loss on long-term debt
extinguishment, net related to the exchange offer. This charge reflects a $26 million loss related to the retirement of LYONs and $10 million of expenses related to
(a) series C warrants issued to the Warburg Entities; (b) common stock issued to the Warburg Entities; (c) estimated transaction costs; and (d) the unamortized
deferred financing costs from the original issuance of LYONs that were retired.

In
the first quarter of fiscal 2003, we recorded a deferred income tax valuation allowance through a non-cash income tax charge of $83 million in the Consolidated
Statement of Operations. This amount increased the deferred tax asset valuation allowance to reflect the difference between the actual and expected tax gain associated with the LYONs exchange offer.

Repurchases of LYONs

During the second and third quarters of fiscal 2003, we repurchased $232 million aggregate principal amount at maturity of LYONs, or $119 million in
accreted value, in a series of open market transactions. We used a total of approximately $115 million in cash to repurchase these LYONs of which $7 million has been recorded as a
component of accounts payable as of June 30, 2003 since the cash settlement occurred in July 2003. We recognized a pre-tax gain of approximately $1 million and
$2 million, net of the write-off of deferred financing costs related to the LYONs repurchased for the three and nine months ended June 30, 2003, respectively.

Interest
expense related to the amortization of the discount on the LYONs of $4 million and $12 million was recorded for the three and nine months ended June 30,
2003, respectively. In addition, interest expense related to the amortization of deferred financing costs on the LYONs of $1 million and $3 million was recorded for the three and nine
months ended June 30, 2003, respectively.

In
July and August 2003, we repurchased $78 million aggregate principal amount at maturity of LYONs, or $41 million in accreted value, in a series of open market
transactions. We used a total of approximately $41 million in cash to repurchase these LYONs.

Add-On Public Offering of Senior Secured Notes

In May 2003, we sold $200 million aggregate principal amount of 111/8% Senior Secured Notes due April 2009, at a price of 108%
of par, resulting in net proceeds of approximately $212 million, which includes approximately $2 million in accrued interest and a $16 million premium, partially offset by
$6 million of issuance costs. The issuance costs, which were recorded as deferred financing costs, and

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premium
are being amortized to interest expense over the term of the notes. These notes constitute a further issuance of, and form a single series with, the senior secured notes that we issued
in the second quarter of fiscal 2002.

Interest
on the senior secured notes is payable on April 1 and October 1 of each year. We recorded interest expense related to the senior secured notes of
$15 million and $40 million for the three and nine months ended June 30, 2003, respectively. In addition, we recorded interest expense related to the amortization of discount,
premium and deferred financing costs on the senior secured notes of $1 million and $2 million for the three and nine months ended June 30, 2003, respectively.

Fair Value of Long-Term Debt

The estimated aggregate fair market value of the senior secured notes increased from September 30, 2002 by $425 million to $704 million as of
June 30, 2003, which reflects an increase in the fair market value of the initial senior secured note offering and the fair market value of the add-on public offering which was
$220 million. With regard to the LYONs, the estimated aggregate fair value as of June 30, 2003 increased from September 30, 2002 by $130 million to $323 million,
which reflects an increase in the fair market value per LYON, partially offset by a reduction in the aggregate fair market value of LYONs extinguished in connection with the exchange offer and
repurchases during the second and third quarters of fiscal 2003. The fair market values are based upon quoted market prices and yields obtained through independent pricing sources for the same or
similar types of borrowing arrangements taking into consideration the underlying terms of the debt. The following table summarizes the number of outstanding LYONs and senior secured notes, their
aggregate accreted value and their related fair market value as of June 30, 2003 and September 30, 2002:

|                     |  | As of June 30, 2003 |  | As of September 30, 2002
|-------------------- |  | ------------------- |  | ------------------------
|
|
|LYONs                |  | 627,740             |  | $                       
|Senior Secured Notes |  | 640,000             |  | $                       

Interest Rate Swap Agreements

In December 2002, we cancelled two interest rate swap agreements under which the difference between fixed and floating rate interest amounts, calculated on
a $200 million notional principal amount which correlated to a like amount of fixed rate senior secured notes, was exchanged at specified intervals. The cancellation resulted in a reduction to
other assets for the removal of the fair market value of the interest rate swaps and cash proceeds of $19 million representing a deferred gain, which is being recognized as a reduction to
interest expense over the remaining term to maturity of the senior secured notes. For the three and nine months ended June 30, 2003, we recognized $1 million and $2 million,
respectively, as a reduction to interest expense related to this deferred gain. The unamortized balance of the deferred gain is included in long-term debt on the Consolidated Balance Sheet
and amounted to $17 million as of June 30, 2003.

Stock Options and Restricted Stock Units Grants

During the nine months ended June 30, 2003, we granted to eligible employees approximately 13.7 million stock options at a weighted average exercise
price of $3.09 per option and 5.8 million restricted stock units at a weighted average market price of $3.01 per unit.

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Warrants to Purchase Common Stock

In consideration of their agreement to participate in the LYONs exchange offer, in December 2002, we granted the Warburg Entities series C warrants
that have a four-year term and are exercisable for an aggregate of 7,355,824 shares of our common stock at an exercise price of $3.50 per share. The fair value of these warrants was
estimated to be $5 million using a Black-Scholes securities-pricing model and has been included in additional paid-in capital. During the second quarter of fiscal 2003, upon
completion of the exchange offer, we recognized the cost of these warrants as a commitment fee and recorded the amount in loss on long-term debt extinguishment, net.

Following
completion of the exchange offer, in January 2003 the Warburg Entities exercised 5,581,101 of the series A warrants for an aggregate cash consideration of
$55,811.

As
of June 30, 2003, the Warburg Entities hold warrants to purchase the following additional shares of our common stock:

|Warrants |       | Number of Shares |            | Exercise Price |       | Expiration Date
|-------- | ----- | ---------------- | ---------- | -------------- | ----- | ---------------
|Series A |       | 1,143,564        |            | $              | 34.73 |                
|Series B |       | 5,379,732        |            | $              | 34.73 |                
|Series C |       | 7,355,824        |            | $              | 3.50  |                
|         |       |                  |            |                |       |                
|         | Total |                  | 13,879,120 |                |       |                
|         |       |                  |            |                |       |                

Future Cash Needs

Our primary future cash needs will be to fund working capital, capital expenditures, debt service, employee benefit obligations and our business restructuring
charges and related expenses. We foresee a further reduction in cash usage on capital expenditures in the remainder of fiscal 2003 as compared with fiscal 2002 as we continue to limit our spending as
a result of the continued economic and business uncertainty. In fiscal 2004, we will make two semi-annual interest payments on the fixed interest rate senior secured notes each amounting
to approximately $36 million. Based on the value of the assets in our pension plans as of June 30, 2003, we are required to contribute an additional $35 million to the plans in
the fourth quarter of fiscal 2003. We estimate that we will also be required to fund approximately $44 million in fiscal 2004. Furthermore, we may elect to make an additional contribution
during the fourth quarter of fiscal 2003 to fund our pension obligation. If we make an optional contribution to our pension plan in the fourth quarter of fiscal 2003, it may reduce in whole or in
part, our funding obligation for fiscal 2004. We also expect to make cash payments related to our business restructuring initiatives of approximately $15 million during the remainder of fiscal
2003 and approximately $34 million in fiscal 2004. These total restructuring related payments of $49 million are expected to be composed of $8 million for employee separation
costs, $36 million for lease obligations, and $5 million for incremental period expenses, including IT transition related expenses. We believe that our existing cash and cash flows from
operations will be sufficient to meet these needs. If we do not generate sufficient cash from operations, we may need to incur additional debt or issue equity.

In
order to meet our cash needs, we may from time to time, borrow under our credit facility, issue other long- or short-term debt or equity securities, if the
market permits. In May 2003, we completed the sale of $200 million aggregate principal amount of senior secured notes referred to above in "Add-On Public Offering of Senior
Secured Notes." We intend to use the net proceeds of this offering for general corporate purposes, which may include the repurchase of LYONs in the open market or otherwise. We cannot assure you that
any other financings will be available to us on acceptable terms or at all. Our ability to make payments on and to refinance our indebtedness, and to fund working capital, capital expenditures,
strategic acquisitions, and our business restructuring will depend on our ability to generate cash in the future, which is subject to general economic, financial, competitive,

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legislative,
regulatory and other factors that are beyond our control. Our credit facility and the indentures governing the LYONs and the senior secured notes impose, and any future indebtedness may
impose, various restrictions and covenants which could limit our ability to respond to market conditions, to provide for unanticipated capital investments or to take advantage of business
opportunities.

We
may from time to time seek to retire additional amounts of our outstanding debt through cash purchases and/or exchanges for equity securities, in open market purchases, privately
negotiated transactions or otherwise. Such repurchases or exchanges, if any, will depend on the prevailing market conditions, our liquidity requirements, contractual restrictions and other factors.
The amounts involved may be material.

Guarantees of Indebtedness

Irrevocable Letters of Credit and Other Arrangements

We have entered into several uncommitted credit facilities totaling $44 million and other arrangements similar to irrevocable letters of credit that vary
in term, of which an aggregate of $32 million in irrevocable letters of credit and other arrangements were outstanding as of June 30, 2003. Letters of credit are purchased guarantees
that ensure our performance or payment to third parties in accordance with specified terms and conditions.

Purchase Commitments and Termination Fees

We have commitment contracts with certain suppliers in which we are obligated to purchase a specified amount of inventory based on our forecasts, or pay a charge
in the event we do not meet our designated purchase commitments. Additionally, certain agreements call for an early termination fee, obligating us to make a payment to the supplier. As of
June 30, 2003, the maximum potential payment under these commitments was approximately $82 million, of which we recorded $3 million in other current liabilities and
$5 million in other liabilities.

Product Financing Arrangements

We sell products to various resellers that may obtain financing from certain unaffiliated third party lending institutions.

For
our U.S. product financing arrangement with resellers, in the event the lending institution repossesses the reseller's inventory of our products, we are obligated under certain
circumstances to repurchase such inventory from the lending institution. Our obligation to repurchase inventory from the lending institution terminates 180 days from the date of invoicing by us
to the reseller. The repurchase amount is equal to the price originally paid to us by the lending institution for the inventory. During the third quarter of fiscal 2003, one of our resellers that
previously participated in this type of arrangement established a direct line of credit with us. The remaining reseller has financed inventory purchases under this arrangement of approximately
$35 million as of June 30, 2003. There have not been any repurchases made by us since we entered into this agreement in March 2001. We have estimated the fair value of this
guarantee as of June 30, 2003 and have adequately provided for this guarantee in our financial statements at June 30, 2003. The fair value of the guarantee is not significant. There can
be no assurance that we will not be obligated to repurchase inventory under this arrangement in the future.

For
our product financing arrangement with resellers outside the U.S., in the event participating resellers default on their payment obligation to the lending institution, we are
obligated under certain circumstances to guarantee repayment to the lending institution. The repayment amount fluctuates with the level of product financing activity. The guarantee repayment amount
reported to us from the

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lending
institution was approximately $17 million as of June 30, 2003. We review and set the maximum credit limit for each reseller participating in this financing arrangement. There
have not been any guarantee repayments made by us since we entered into this arrangement in October 2000. We have estimated the fair value of this guarantee as of June 30, 2003 and have
adequately provided for this guarantee in our financial statements at June 30, 2003. The fair value of the guarantee is not significant. There can be no assurance that we will not be obligated
to repurchase inventory under this arrangement in the future.

Credit Facility Indemnification

In connection with our obligations under the amended credit facility described previously under "Credit Facility," we have agreed to indemnify the third party
lending institutions for costs incurred by the institutions related to changes in tax law or other legal requirements. While there have been no amounts paid to the lenders pursuant to this indemnity
in the past, there can be no assurance that we will not be obligated to indemnify the lenders under this arrangement in the future.

Transactions with Lucent

In connection with our spin-off from Lucent in September 2000, we and Lucent executed and delivered the Contribution and Distribution Agreement
and certain related agreements.

Pursuant
to the Contribution and Distribution Agreement, Lucent contributed to us substantially all of the assets, liabilities and operations associated with its enterprise networking
businesses (our "Businesses"). The Contribution and Distribution Agreement, among other things, provides that, in general, we will indemnify Lucent for all liabilities including certain
pre-Distribution tax obligations of Lucent relating to our Businesses and all contingent liabilities primarily relating to our Businesses or otherwise assigned to us. In addition, the
Contribution and Distribution Agreement provides that certain contingent liabilities not allocated to one of the parties will be shared by Lucent and us in prescribed percentages. The Contribution and
Distribution Agreement also provides that each party will share specified portions of contingent liabilities based upon agreed percentages related to the business of the other party that exceed
$50 million. In the second quarter of fiscal 2003, we recorded a charge of $25 million representing our estimate of the amount of our liability associated with the settlement by Lucent
of the litigation described under "Legal Proceedings-Lucent Securities Litigation." We cannot at this time determine the maximum amount of our liability for this matter, however, because we are not
responsible for all of the cases, which are the subject of Lucent's $420 million settlement. The maximum amount of our liability will be less than $42 million, or 10% of the total Lucent
settlement. We are unable to determine the maximum potential amount of our future payments, if any, that we could be required to make under this agreement.

In
addition, if the separation from Lucent fails to qualify as a tax-free distribution under Section 355 of the Internal Revenue Code because of an acquisition of our
stock or assets, or some other actions of ours, then we will be solely liable for any resulting corporate taxes.

Environmental, Health and Safety Matters

We are subject to a wide range of governmental requirements relating to employee safety and health and to the handling and emission into the environment of
various substances used in our operations. We are subject to certain provisions of environmental laws, particularly in the United States, governing the cleanup of soil and groundwater contamination.
Such provisions impose liability for the costs of investigating and remediating releases of hazardous materials at our currently or formerly owned or operated sites. In certain circumstances, this
liability may also include the cost of cleaning up historical contamination, whether or not caused by us. We are currently conducting investigation and/or cleanup of known contamination at
approximately seven of our facilities either

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voluntarily
or pursuant to government directives. None of the sites is reasonably likely to generate environmental costs that will be individually material. There are no known third parties who may be
responsible for investigation and/or cleanup at these sites and therefore, for purposes of assessing the adequacy of our financial reserves for these liabilities, we have not assumed that we will
recover amounts from any third party, including under any insurance coverage or indemnification arrangement. We do not separately track recurring costs of managing hazardous substances and pollutants
in ongoing operations, but do not believe them to be material.

It
is often difficult to estimate the future impact of environmental matters, including potential liabilities. We have established financial reserves to cover environmental liabilities
where they are probable and reasonably estimable. Reserves for estimated losses from environmental matters are undiscounted and consist primarily of estimated remediation and monitoring costs and are,
depending on the site, based primarily upon internal or third-party environmental studies and the extent of contamination and the type of required cleanup. We are not aware of, and have not included
in our reserves any provision for, any unasserted environmental claims.

The
reliability and precision of estimates of our environmental costs may be affected by a variety of factors, including whether the remediation treatment will be effective,
contamination sources have been accurately identified and assumptions regarding the movement of contaminants are accurate. In addition, estimates of environmental costs may be affected by changes in
law and regulation, including the willingness of regulatory authorities to conclude that remediation and/or monitoring performed by us is adequate.

We
assess the adequacy of our environmental reserves on a quarterly basis. For the three and nine months ended June 30, 2003 and 2002, respectively, no amounts were charged to the
Statements of Operations for environmental costs as reserves were deemed to be adequate. Expenditures for environmental for the three and nine months ended June 30, 2003 were not material to
our financial position, results of operations or cash flows. Payment for the environmental costs covered by the reserves may be made over a 30-year period. Although we believe that our
current reserves are adequate to cover known environmental liabilities, due to the uncertainties described above, there can be no assurance that the actual amount of environmental liabilities will not
exceed the
amount of reserves for such matters or will not have a material adverse effect on our consolidated financial position, results of operations or cash flows.

Legal Proceedings

From time to time, we are involved in legal proceedings arising in the ordinary course of business. Other than as described below, we believe there is no
litigation pending against us that could have, individually or in the aggregate, a material adverse effect on our financial position, results of operations or cash flows.

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Year 2000 Actions

Three separate purported class action lawsuits are pending against Lucent, one in state court in West Virginia, one in federal court in the Southern District of
New York and another in federal court in the Southern District of California. The case in New York was filed in January 1999 and, after being dismissed, was refiled in September 2000.
The case in West Virginia was filed in April 1999 and the case in California was filed in June 1999, and amended in 2000 to include Avaya as a defendant. We may also be named a party to
the other actions and, in any event, have assumed the obligations of Lucent for all of these cases under the Contribution and Distribution Agreement between us and Lucent. All three actions are based
upon claims that Lucent sold products that were not Year 2000 compliant, meaning that the products were designed and developed without considering the possible impact of the change in the calendar
from December 31, 1999 to January 1, 2000. The complaints allege that the sale of these products violated statutory consumer protection laws and constituted breaches of implied
warranties.

A
class has been certified in the West Virginia state court matter. The certified class in the West Virginia matter includes those persons or entities that purchased, leased or financed
the products in question. In addition, the court also certified as a subclass all class members who had service protection plans or other service or extended warranty contracts with Lucent in effect
as of April 1, 1998, as to which Lucent failed to offer a Year 2000-compliant solution. The Fourth Circuit Court of Appeals recently denied the defendant's attempt to have the
Federal District Court in West Virginia retain jurisdiction in this matter. This matter is now in West Virginia state court. The federal court in the New York action has issued a decision and order
denying class certification, dismissing all but certain fraud claims by one representative plaintiff. No class claims remain in this case at this time. The federal court in the California action has
issued an opinion and order granting class certification. The class includes any entities that purchased or leased certain products on or after January 1, 1990, excluding those entities who did
not have a New Jersey choice of law provision in their contracts and those who did not purchase equipment directly from defendants. The federal court in the California action has issued an order
staying the action pending the outcome of the West Virginia matter. The complaints seek, among other remedies, compensatory damages, punitive damages and counsel fees in amounts that have not yet been
specified. At this time, we cannot determine whether the outcome of these actions will have a material adverse effect on our financial position, results of operations or cash flows. These cases have
required in the past, and may require in the future, expenditure of significant legal costs related to their defense.

Lucent Securities Litigation

In November 2000, three purported class actions were filed against Lucent in the Federal District Court for the District of New Jersey alleging violations
of the federal securities laws as a result of the facts disclosed in Lucent's announcement on November 21, 2000 that it had identified a revenue recognition issue affecting its financial
results for the fourth quarter of fiscal 2000. The actions purport to be filed on behalf of purchasers of Lucent common stock during the period from October 10, 2000 (the date Lucent originally
reported these financial results) through November 21, 2000.

The
above actions have been consolidated with other purported class actions filed against Lucent on behalf of its stockholders in January 2000 and are pending in the Federal
District Court for the District of New Jersey. The consolidated cases were initially filed on behalf of stockholders of Lucent who bought Lucent common stock between October 26, 1999 and
January 6, 2000, but the consolidated complaint was amended to include purported class members who purchased Lucent common stock up to December 20, 2000. A class has not yet been
certified in the consolidated actions. The plaintiffs in all these stockholder class actions seek compensatory damages plus interest and attorneys' fees.

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In
March 2003, Lucent announced that it had entered into a $420 million settlement of all pending shareholder and related litigation. Certain cases which are the subject of
the settlement are shared contingent liabilities under the Contribution and Distribution Agreement and accordingly, we are responsible for 10% of the liabilities attributable to those cases, including
10% of the legal costs associated with the portion of the litigation for which we share liability. The amount of our portion of this liability has not yet been finally determined, however, in the
second quarter of fiscal of 2003, we recorded a charge of $25 million, representing our estimate of our liability in this matter. The liability may be settled, at our option, in any combination
of cash and our equity securities. Upon settlement, the amount of this liability will be adjusted to reflect our actual obligation in this matter.

Licensing Arbitration

In March 2001, Voxem, Inc. made formal demand for alleged royalty payments which it claims we owe as a result of a contract between it and our
predecessors, initially entered into in 1995, and renewed in 1997. Voxem claims that we owe royalty payments for software integrated into certain of our products. Voxem also alleges that we have
breached the governing contract by not honoring a right of first refusal related to development of fax software for next generation products. In May 2003, the arbitrator awarded Voxem
approximately $650,000 in total damages, including interest and certain legal costs.

Commissions Arbitration Demand

In July 2002, Communications Development Corporation, a British Virgin Islands corporation, made formal demand for arbitration for alleged unpaid
commissions in an amount in excess of $10 million, stemming from the sale of products from our businesses that were formerly owned by Lucent involving the Ministry of Russian Railways. The
plantiff alleges that as a result of agreements entered into between the plaintiff and us, it is owed commissions on sales by us to the Ministry of Russian Railways on a continuing basis. We believe
that the agreements relating to their claim have expired or do not apply to the products in question. As the sales of products continue, Communications Development Corporation may likely increase its
commission demand. The claimant recently filed its arbitration demand with the American Arbitration Association.

Lucent Consumer Products Class Actions

In several class action cases (the first of which was filed on June 24, 1996), plaintiffs claim that AT&T and Lucent engaged in fraud and deceit in
continuing to lease residential telephones to consumers without adequate notice that the consumers would pay well in excess of the purchase price of a telephone by continuing to lease. The cases were
removed and consolidated in federal court in Alabama, and were subsequently remanded to their respective state courts (Illinois, Alabama, New Jersey, New York and California). In July 2001, the
Illinois state court certified a nationwide class of plaintiffs. The case in Illinois was scheduled for trial on August 5, 2002. Prior to commencement of trial, however, we were advised that
the parties agreed to a settlement of the claims on a class-wide basis. The settlement was approved by the court on November 4, 2002. Claims from class members were required to be
filed on or about January 15, 2003. The amount of Avaya's portion of the liability has not yet been determined.

Any
liability incurred by Lucent in connection with these class action cases will be considered an exclusive Lucent liability under the Contribution and Distribution Agreement between
Lucent and us and, as a result, we are responsible for 10% of any such liability in excess of $50 million.

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Recent Accounting Pronouncements

FASB Interpretation No. 45

In November 2002, the Financial Accounting Standards Board issued Interpretation No. 45, "Guarantor's Accounting and Disclosure Requirements for
Guarantees, Including Indirect Guarantees of Indebtedness of Others." FIN 45 expands the existing disclosure requirements for most guarantees, including loan guarantees such as standby letters of
credit. It also requires that at the time a company issues a guarantee, the company must recognize an initial liability for the fair market value of the obligation it assumes under that guarantee and
must disclose that information in its interim and annual financial statements. The initial recognition and measurement provisions of FIN 45 apply on a prospective basis to guarantees issued or
modified after December 31, 2002. We adopted the recognition and measurement provisions of FIN 45 beginning in the second quarter of fiscal 2003. The applicable disclosures are reflected in
Note 12-Commitments and Contingencies to the unaudited interim consolidated financial statements included elsewhere in this Quarterly Report on Form 10-Q.

EITF Issue No. 00-21

In November 2002, the Emerging Issues Task Force reached a consensus on Issue No. 00-21, "Accounting for Revenue Arrangements with
Multiple Deliverables." EITF 00-21 addresses certain aspects of the accounting by a vendor for arrangements that involve the delivery or performance of multiple revenue generating
activities, including the sale of products combined with initial installation, initiation, or activation services, that may occur at different points in time or over different periods of time. This
consensus addresses when and, if so, how an arrangement with multiple deliverables should be divided into separate units of accounting. EITF 00-21 will apply to revenue arrangements
entered into by us beginning in the fourth quarter of fiscal 2003. The adoption of EITF 00-21 is not expected to have a material impact on our consolidated results of operations, financial
position or cash flows.

SFAS 148

In December 2002, the FASB issued SFAS 148, "Accounting for Stock-Based Compensation-Transition and Disclosure," which amends SFAS No. 123,
"Accounting for Stock-Based Compensation." SFAS 148 provides alternative methods of transition for a voluntary change to the fair value based method of accounting for stock-based employee
compensation. SFAS 148 also amends the disclosure provisions of SFAS 123 to require prominent disclosure about the effects on reported net income of an entity's accounting policy
decisions with respect to stock-based employee compensation, and requires disclosure about those effects in both annual and interim financial statements. We have elected to continue to account for our
stock compensation plans under the recognition and measurement principles of Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees," and related interpretations.
The applicable disclosures are reflected in Note 2-Recent Accounting Pronouncements to the unaudited interim consolidated financial statements included elsewhere in this Quarterly
Report on Form 10-Q.

FASB Interpretation No. 46

In January 2003, the FASB issued Interpretation No. 46, "Consolidation of Variable Interest Entities, an interpretation of Accounting Research
Bulletin No. 51." FIN 46 requires certain variable interest entities to be consolidated by the primary beneficiary of the entity if the equity investors in the entity do not have the
characteristics of a controlling financial interest or do not have sufficient equity at risk for the entity to finance its activities without additional subordinated financial support from other
parties. The disclosure requirements of FIN 46 and the consolidation requirements for variable interest entities created or acquired subsequent to January 31, 2003 became effective for
financial statements issued by us beginning in the second quarter of fiscal 2003. For variable interest entities

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created
or acquired prior to February 1, 2003, the consolidation requirements of FIN 46 become effective in our fourth quarter of fiscal 2003. We currently have no significant contractual
relationship or other business relationship with a variable interest entity and therefore the adoption of FIN 46 did not have a material effect on our consolidated results of operations, financial
position or cash flows.

SFAS 149

In April 2003, the FASB issued SFAS No. 149, "Amendment of Statement 133 on Derivative Instruments and Hedging Activities." SFAS 149 amends
and clarifies financial accounting and reporting for derivative instruments, including certain derivative instruments embedded in other contracts and for hedging activities under SFAS No. 133,
"Accounting for Derivative Instruments and Hedging Activities." The changes are intended to improve financial reporting by requiring that contracts with comparable characteristics be accounted for
similarly. Additionally, those changes are expected to result in more consistent reporting of contracts as either derivatives or hybrid instruments. The requirements of SFAS 149 become
effective for us for contracts entered into or modified after June 30, 2003, with the exception of Implementation Issues that have been cleared by the FASB and have been effective for fiscal
quarters that began prior to June 15, 2003, and for hedging relationships designated after June 30, 2003. The provisions of this statement are applied on a prospective basis. The
adoption of SFAS 149 is not expected to have a material effect on our consolidated results of operations, financial position or cash flows.

SFAS 150

In May 2003, the FASB issued SFAS No. 150, "Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity."
SFAS 150 establishes standards for the classification and measurement of certain financial instruments with characteristics of both liabilities and equity. The changes are intended to result in
a more complete representation of an entity's liabilities and equity and will, thereby, assist investors and creditors in assessing the amount, timing, and likelihood of
potential future cash outflows and equity share issuances. This Statement also requires that certain obligations that could be settled by issuance of equity, but lack other characteristics of equity,
be reported as liabilities even though the obligation does not meet the definition of a liability. The requirements of SFAS 150 become effective for us for financial instruments entered into or
modified after May 31, 2003, or at the beginning of the fourth quarter of fiscal 2003 for financial instruments entered into on or prior to May 31, 2003. The adoption of SFAS 150
is not expected to have a material effect on our consolidated results of operations, financial position or cash flows.

The Application of Critical Accounting Policies

Deferred Tax Assets

As of June 30, 2003, we had $443 million in net deferred tax assets resulting from tax credit carryforwards, net operating losses, and other
deductible temporary differences that are available to reduce taxable income in the future. We recorded an increase of approximately $119 million to our deferred tax assets valuation allowance
in the first nine months of fiscal 2003. The increase in the valuation allowance is comprised of an $83 million provision for income taxes to reflect the difference between the actual and
expected tax gain associated with the LYONs exchange offer, and other adjustments that were fully offset with a valuation allowance. The valuation allowance was calculated in accordance with the
provisions of SFAS No. 109, "Accounting for Income Taxes," which place primary importance on a company's cumulative operating results for the current and preceding years.

We
intend to maintain a valuation allowance until sufficient positive evidence exists to support its reversal. Although realization is not assured, we have concluded that the remaining
net deferred tax assets as of June 30, 2003 will be realized based on the scheduling of deferred tax liabilities and on

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certain
distinct tax planning strategies that we intend to implement in a timely manner, if necessary, which will allow us to recognize the future tax attributes. The amount of net deferred tax assets
determined to be realizable was measured by calculating the tax effect of the planning strategies, which include the potential sale of assets and liabilities. The amount of the deferred tax assets
actually realized, however, could vary if there are differences in the timing or amount of future reversals of existing deferred tax liabilities or in future income. If we determine that we will not
be able to realize all or part of our deferred tax assets in the future, an adjustment to the deferred tax assets valuation allowance would be charged to income in the period such determination was
made.

Item 3.Quantitative and Qualitative Disclosures About Market Risk.

See Avaya's Annual Report filed on Form 10-K for the fiscal year ended September 30, 2002 (Item 7A). As of June 30, 2003, there
had been no material change in this information other than the termination of the interest rate swap agreements disclosed in Note 7-Long-Term Debt and Derivative
Financial Instruments to the unaudited interim consolidated financial statements included elsewhere in this Quarterly Report on Form 10-Q.

Item 4.Controls and Procedures.

We have established disclosure controls and procedures to ensure that material information relating to us, including our consolidated subsidiaries, is made known
to the officers who certify our financial reports and to other members of senior management and the Board of Directors.

Based
on their evaluation as of the end of the period covered by this Quarterly Report on Form 10-Q, the principal executive officer and principal financial officer of
Avaya Inc. have concluded that our disclosure controls and procedures (as defined in Rules 13a-15e and 15d-15e under the Securities Exchange Act of 1934) are
effective to ensure that the information required to be disclosed by us in reports that it files or submits under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported
within the time periods specified in SEC rules and forms.

There
were no significant changes in our internal control over financial reporting during our most recent fiscal quarter that has materially affected, or is reasonably likely to
materially affect, our ability to record, process, summarize and report financial information.

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PART II

Item 1.Legal Proceedings.

See Note 12Commitments and Contingencies to the unaudited interim consolidated financial statements included elsewhere in this Quarterly
Report on Form 10-Q.

Item 2.Changes in Securities and Use of Proceeds.

See Note 7Long-Term Debt and Derivative Financial Instruments to the unaudited interim consolidated financial statements included
elsewhere in this Quarterly Report on Form 10-Q.

Item 3.Defaults Upon Senior Securities.

None.

Item 4.Submission of Matters to a Vote of Security Holders.

None.

Item 5.Other Information.

We make available free of charge, through our investor relations' website, investors.Avaya.com, our Form 10-K,
Form 10-Q and Form 8-K reports and all amendments to those reports as soon as reasonably practicable after such material is electronically filed with or furnished
to the Securities and Exchange Commission.

Item 6.Exhibits and Reports on Form 8-K



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SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned,
thereunto duly authorized.

|                |  | AVAYA INC.
|--------------- |  | ----------
|                |  | By:       
|August 12, 2003 |  |           

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