Exhibit 13

FINANCIAL REVIEW
Avaya Inc. and Subsidiaries

Table of Contents

|Selected Financial Data                                                               |  | 1 
|------------------------------------------------------------------------------------- |  | --
|Management's Discussion and Analysis of Financial Condition and Results of Operations |  | 3 
|Report of Independent Auditors                                                        |  | 48
|Consolidated Statements of Operations                                                 |  | 49
|Consolidated Balance Sheets                                                           |  | 50
|Consolidated Statements of Changes in Stockholders' Equity and of Comprehensive Loss  |  | 51
|Consolidated Statements of Cash Flows                                                 |  | 52
|Notes to Consolidated Financial Statements                                            |  | 53

SELECTED FINANCIAL DATA

The following table sets forth selected financial information derived from our audited consolidated financial statements as of and for the fiscal years ended
September 30, 2003, 2002, 2001, 2000 and 1999. On September 30, 2000, we were spun off from Lucent Technologies Inc. The consolidated financial statements as of and for each of
the fiscal years ended prior to September 30, 2001 include allocations of certain Lucent corporate headquarters' assets, liabilities, and expenses relating to the businesses that were
transferred to us from Lucent. Therefore, the selected financial information for the fiscal years ended September 30, 2000 and 1999, during which time we were a business unit of Lucent, may not
be indicative of our future performance as an independent company. The selected financial information for all periods should be read in conjunction with "Management's Discussion and Analysis of
Financial Condition and Results of Operations," and the consolidated financial statements and the notes included elsewhere in this annual report.

In
reviewing the selected financial information, please note the following:



1

---



|                                                                     |                                                    | Year Ended September 30, |      
|-------------------------------------------------------------------- | -------------------------------------------------- | ------------------------ | -----
|
|
|Statement of operations information:                                 |                                                    |                          |      
|Revenue                                                              |                                                    | $                        | 4,338
|Business restructuring charges (reversals) and related expenses, net |                                                    |                          | (5   
|Goodwill and intangibles impairment charge                           |                                                    |                          |     
|Purchased in-process research and development                        |                                                    |                          |     
|Income (loss) before cumulative effect of accounting change          |                                                    |                          | (88  
|Cumulative effect of accounting change                               |                                                    |                          |     
|                                                                     |                                                    |                          |      
|Net income (loss)                                                    |                                                    | $                        | (88  
|                                                                     |                                                    |                          |      
|Earnings (loss) per common sharebasic:                              |                                                    |                          |      
|                                                                     | Income (loss) available to common stockholders     |                          | $    
|                                                                     | Cumulative effect of accounting change             |                          |      
|                                                                     |                                                    |                          |      
|                                                                     | Net income (loss) available to common stockholders |                          | $    
|                                                                     |                                                    |                          |      
|Earnings (loss) per common sharediluted:                            |                                                    |                          |      
|                                                                     | Income (loss) available to common stockholders     |                          | $    
|                                                                     | Cumulative effect of accounting change             |                          |      
|                                                                     |                                                    |                          |      
|                                                                     | Net income (loss) available to common stockholders |                          | $    
|                                                                     |                                                    |                          |      

|                                                   |  | As of September 30,
|-------------------------------------------------- |  | -------------------
|
|
|Balance sheet information:                         |  |                    
|Total assets                                       |  | $                  
|Total debt                                         |  |                    
|Series B convertible participating preferred stock |  |                    

2

---



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 annual report. The matters
discussed in "Management's Discussion and Analysis of Financial Condition and Results of Operations" contain certain forward-looking statements within the meaning of the Private Securities Litigation
Reform Act of 1995. Statements made that are not historical facts are forward-looking and are based on estimates, forecasts and assumptions involving risks and uncertainties that could cause actual
results or outcomes to differ materially from those expressed in the forward-looking statements. The risks and uncertainties referred to above include, but are not limited to those described under
"Forward-Looking Statements" in our fiscal 2003 Annual Report on Form 10-K.

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:



We
support our broad customer base with comprehensive global service offerings that help our customers plan, design, implement and manage their communications networks. We believe our
global service organization is an important consideration for customers purchasing our products and applications and is a source of significant revenue for us, primarily from maintenance contracts.

Our
revenue has declined significantly during the past several years. Revenue for the fiscal years ended September 30, 2001, 2002 and 2003 was $6,793 million,
$4,956 million and $4,338 million, respectively. The decline in revenue is attributable primarily to declines in the market for our traditional business, enterprise voice communications
systems, and the effect of general economic conditions on our customers' willingness to spend on enterprise communications technology during the last several years. Although revenue has declined over
this three year period, the quarterly revenue trend in fiscal 2003 generally stabilized. The stabilization of revenue can be attributed to our products and services that support the market for
converged communications. Specifically, revenue from the sale of our IP telephony systems increased throughout fiscal 2003, mitigating the decline in sales of our traditional voice systems. As
described in more detail below, however, we cannot provide assurance that our revenue will not decline in the future as we believe enterprises may continue to be reluctant to increase spending on
enterprise communications technology significantly in the near term.

The
decline in revenue from enterprise voice communications systems is attributable in part to the significant investments in these systems made by enterprises in the late 1990s in
anticipation of Year 2000. We believe enterprises have been reluctant to make additional investments in enterprise communications systems until their existing investments have been fully amortized
over their 7-10 year useful life. In addition, we believe many customers are hesitant to invest in traditional voice communication systems as they are anticipating the widespread
adoption of next-generation communications systems, such as IP telephony systems.

The
adverse effect of the decline in revenue from our traditional business has been exacerbated by the continuing effect of the economic slowdown that began in 2001. As a result of the
uncertain

3

---

economic
environment, we believe that enterprises continue to be concerned about their ability to increase revenues and thereby increase their profitability. Accordingly, they have tried to maintain
or improve profitability through cost reduction and reduced capital spending. Because it is not clear that enterprise communications spending will improve significantly in the near term, we expect
there to be continued pressure on our ability to generate revenue. Although we believe enterprises will ultimately invest in next-generation communications systems, we cannot predict the
nature, timing and extent of those investments and as a result, if and when our revenue will increase.

Operating Segments

The following table sets forth the allocation of our revenue among our operating segments, expressed as a percentage of total revenue:

Year Ended September 30,2003

2002

2001RevenueOperating Segments:Enterprise Communications Group

40.1
%
42.0
%
42.3
%Small and Medium Business Solutions

5.2

4.8

4.6Services

42.2

41.7

33.6Connectivity Solutions

12.5

11.5

19.5Total

100.0
%
100.0
%
100.0
%


Our
four operating segments include the Enterprise Communications Group, Small and Medium Business Solutions, Services and Connectivity Solutions. In the third quarter of fiscal 2003, we
changed the name of our Converged Systems and Applications segment to Enterprise Communications Group, or ECG. The ECG segment is focused on the sale of communications systems, products and
applications to our large enterprise customers. Our primary offerings for this segment include IP telephony systems and traditional voice communications systems, contact center infrastructure and
applications in support of customer relationship management, unified communications applications, and appliances, such as telephone sets. ECG's operating results also include our professional services
organization that provides services required to customize our communication application solutions for individual customer needs. The Small and Medium Business Solutions, or SMBS, segment develops,
markets and sells communications products and applications for small and medium-sized businesses including IP telephony systems, traditional voice communications systems, and unified communication and
contact center applications. Traditional voice communications systems designed for small and medium-sized businesses are also known as Key and hybrid telephony systems. 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, which we agreed to sell in
October 2003, provides structured cabling systems and electronic cabinets to our customers.

Collective Bargaining Agreements

Effective June 1, 2003, we renewed our collective bargaining agreements with the Communications Workers of America and the International Brotherhood of
Electrical Workers. The renewed agreements are for a term of three years, ending May 31, 2006. The agreements provide for a 3% per year wage increase for employees during the duration of the
agreements, and a 3% increase per year to employees' pension benefits for the duration of the agreements. The agreements also included additional cost-sharing by employees and retirees for
certain medical health benefit co-payments. The renewed collective bargaining agreements continue our variable workforce arrangement that gives eligible employees who retired from Lucent
as of September 30, 2000 the ability to continue working as

4

---

on-call
support service technicians at Avaya. This arrangement is intended to give us flexibility to match our workforce needs with our customers' cyclical service demands for the design,
installation and maintenance of their communications systems.

Goodwill and Intangible Assets

Effective October 1, 2001, we adopted Statement of Financial Accounting Standards, or SFAS, No. 142, "Goodwill and Other Intangible Assets," or
SFAS 142, which requires that goodwill and certain other intangible assets having indefinite lives no longer be amortized to earnings, but instead be subject to periodic testing for impairment.
Intangible assets determined to have definite lives will continue to be amortized over their remaining useful lives. In connection with the adoption of SFAS 142, we reviewed the classification
of our goodwill and other intangible assets, reassessed the useful lives previously assigned to other intangible assets, and discontinued amortization of goodwill. We also tested goodwill for
impairment by comparing the fair values of our reporting units to their carrying values as of October 1, 2001 and determined that there was no goodwill impairment at that time. Based on this
review, as of September 30, 2001, we classified $175 million as goodwill, $78 million as intangible assets, net and $2 million as other assets. We did not identify any
intangible assets having indefinite lives.

For
the fiscal year ended September 30, 2001, goodwill amortization, net of tax, amounted to $38 million. If we had adopted SFAS 142 at the beginning of fiscal 2001
and discontinued goodwill amortization, our net loss and loss per common share on a pro forma basis would have been as follows:

Year Ended
September 30,
2001Pro Forma Results
(dollars in millions, except per share amounts)Net loss, as reported

$
(352
)Goodwill amortization, net of tax


38Adjusted net loss


(314
)Accretion of Series B preferred stock


(27
)Adjusted loss available to common stockholders

$
(341
)Adjusted loss per common share:Basic and Diluted

$
(1.20
)


We
conducted the required annual impairment review during the fourth quarter of fiscal 2003 and 2002. Updated valuations were completed for all reporting units with goodwill as of
September 30, 2003 and 2002 using a discounted cash flow approach based on forward-looking information regarding market shares, revenues and costs for each reporting unit as well as appropriate
discount rates. For fiscal 2003, we did not identify a goodwill impairment. For fiscal 2002, due to a significant downward movement in the U.S. stock market and, in particular, communications
technology stocks, we experienced a decline in our market capitalization that negatively impacted the fair value of our reporting units. As a result, we recorded a goodwill impairment charge of
$44 million as an operating expense in fiscal 2002 related to our SMBS operating segment.

As
a result of the significant downturn in the communications technology industry, we noted a steep decline in the marketplace assumptions for virtual private networks in the fourth
quarter of fiscal 2002 as compared with the assumptions used when we acquired this existing technology through our acquisition of VPNet Technologies, Inc., or VPNet, in February 2001.
These circumstances caused us to review the recoverability of our acquired intellectual property and trademarks. We applied the provisions of SFAS No. 121, "Accounting for the Impairment of
Long-Lived Assets and for Long-Lived

5

---

Assets
to Be Disposed Of," or SFAS 121, to our intangible assets with definite lives and determined that the carrying value of these assets was impaired. Accordingly, we recorded a
$27 million intangibles impairment charge as an operating expense in fiscal 2002 to write-down the carrying value of these intangible assets to an amount representing their
discounted future cash flows. The $27 million impairment charge, which was recorded as accumulated amortization on the Consolidated Balance Sheet, was attributed $24 million to ECG and
$3 million to SMBS.

Acquired
intangible assets with definite lives are amortized over a period of three to six years. Amortization expense for such intangible assets was $12 million,
$35 million and $32 million for the fiscal years ended September 30, 2003, 2002 and 2001, respectively. As of September 30, 2003, we estimate remaining amortization expense
to be $4 million in 2004, and $2 million in 2005.

In
addition, included in other assets as of September 30, 2003 and 2002 is an intangible asset of $63 million and $35 million, respectively, representing
unrecognized prior service costs associated with the recording of a minimum pension liability in fiscal 2003 and 2002. This intangible asset may be eliminated or adjusted as necessary when the amount
of minimum pension liability is reassessed, which is conducted at least annually. Based on our fiscal 2003 annual assessment of our minimum pension liability, the intangible asset increased by
$28 million.

Internal Use Software

In the first quarter of fiscal 2003, we changed the estimated useful life of certain internal use software that is currently in service from seven to five years
since a newer version of the software is expected to be implemented in fiscal 2004, which is two years earlier than we originally anticipated. This change increased amortization expense, net of tax,
by approximately $9 million, equivalent to $0.02 per basic and diluted share, for the fiscal year ended September 30, 2003.

In
the second quarter of fiscal 2002, we changed the estimated useful life of certain internal use software from three to seven years to reflect actual experience as a stand-alone
company based on the utilization of such software. This change lowered amortization expense, net of tax, by approximately $8 million, equivalent to $0.02 per basic and diluted share, for the
fiscal year ended September 30, 2002.

6

---

Business Restructuring Reserve

The business restructuring reserve reflects the remaining balance associated with the business restructuring charges recorded in fiscal 2000 through 2002. The
following table summarizes the status of our business restructuring reserve and other related expenses during fiscal 2003, 2002 and 2001:

|                                                                        |  | Business Restructuring Reserve |      |   |   |     |   |   |    
|----------------------------------------------------------------------- |  | ------------------------------ | ---- | - | - | --- | - | - | ---
|
|
|
|
|FISCAL 2001:                                                            |  |                                |      |   |   |     |   |   |    
|Balance as of October 1, 2000                                           |  | $                              | 345  |   | $ | 127 |   | $ | 27 
|Charges                                                                 |  |                                | 650  |   |   | 24  |   |   |   
|Reversals                                                               |  |                                | (17  | ) |   | (7  | ) |   | (11
|Decrease in prepaid benefit costs/ increase in benefit obligations, net |  |                                | (577 | ) |   |    |   |   |   
|Cash payments                                                           |  |                                | (250 | ) |   | (66 | ) |   | (11
|Asset impairments                                                       |  |                                |     |   |   |    |   |   |   
|Reclassification                                                        |  |                                | (55  | ) |   |    |   |   |   
|                                                                        |  |                                |      |   |   |     |   |   |    
|Balance as of September 30, 2001                                        |  | $                              | 96   |   | $ | 78  |   | $ | 5  
|                                                                        |  |                                |      |   |   |     |   |   |    
|FISCAL 2002:                                                            |  |                                |      |   |   |     |   |   |    
|Charges                                                                 |  |                                | 116  |   |   | 84  |   |   | 1  
|Reversals                                                               |  |                                | (13  | ) |   | (4  | ) |   | (3 
|Net increase in benefit obligations                                     |  |                                | (3   | ) |   |    |   |   |   
|Cash payments                                                           |  |                                | (128 | ) |   | (56 | ) |   | (3 
|Asset impairments                                                       |  |                                |     |   |   |    |   |   |   
|                                                                        |  |                                |      |   |   |     |   |   |    
|Balance as of September 30, 2002                                        |  | $                              | 68   |   | $ | 102 |   | $ |   
|                                                                        |  |                                |      |   |   |     |   |   |    
|FISCAL 2003:                                                            |  |                                |      |   |   |     |   |   |    
|Charges                                                                 |  |                                |     |   |   |    |   |   |   
|Reversals                                                               |  |                                | (19  | ) |   | (2  | ) |   |   
|Cash payments                                                           |  |                                | (45  | ) |   | (38 | ) |   |   
|                                                                        |  |                                |      |   |   |     |   |   |    
|Balance as of September 30, 2003                                        |  | $                              | 4    |   | $ | 62  |   | $ |   
|                                                                        |  |                                |      |   |   |     |   |   |    

Fiscal 2003

During fiscal 2003, we recorded reversals to income of $21 million primarily attributable to fewer involuntary employee separations than originally
anticipated. Additionally, in fiscal 2003 we incurred $16 million in other related expenses associated with our fourth quarter of fiscal 2002 restructuring initiative. These expenses were
primarily attributable to information technology, or IT, costs incurred to relocate the development of certain IT applications to India.

Fiscal 2002

During fiscal 2002, we experienced a decrease in our revenue as a result of the continued decline in spending on IT by our customers, specifically for enterprise
communications products and services. Despite the unpredictability of the business environment, we remained focused on our strategy to return to profitability by focusing on sustainable cost and
expense reduction, among other things. To achieve that goal, we initiated restructuring actions in fiscal 2002 to enable us to reduce costs and expenses further in order to lower the amount of revenue
needed to reach our profitability break-even point. As a result, we recorded a pretax charge of $229 million in fiscal 2002 for business restructuring and related expenses. The
components of the charge included $116 million of employee separation

7

---

costs,
$84 million of lease termination costs, $1 million of other exit costs, and $28 million of other related expenses. This charge was partially offset by a $20 million
reversal to income primarily attributable to fewer involuntary employee separations than originally anticipated.

The
charge for employee separation costs was composed of $113 million for severance and other related costs and $3 million primarily related to the cost of curtailment in
accordance with SFAS No. 88, "Employers' Accounting for Settlements and Curtailments of Defined Benefit Pension Plans and for Termination Benefits," or SFAS 88. Lease termination costs included
approximately $72 million of real estate, net of sublease income that management believed was probable, and $12 million of IT lease
termination payments. The $28 million of other related expenses included relocation and consolidation costs, computer system transition expenditures, and asset impairments associated with our
ongoing restructuring initiatives.

The
employee separation costs were incurred in connection with the elimination of approximately 4,240 management and union-represented employee positions worldwide. As of
September 30, 2003, this workforce reduction had been completed. Employee separation payments included in the business restructuring reserve were made either through a lump sum or a series of
payments extending over a period of up to two years from the date of departure, which was an option available to certain union-represented employees. Payments to employees who elected to receive
severance through a series of payments will extend through fiscal 2004.

The
$72 million charge for real estate lease termination obligations includes approximately one million square feet of excess sales and services support, research and development,
call center and administrative offices located primarily in the U.S., which had been entirely vacated as of September 30, 2003. The real estate charge also included an adjustment to increase
the accrued amount for previously reserved sites due to a deterioration in the commercial real estate market. As a result, we extended our estimates as to when we will be able to begin subleasing
certain vacated sites and established an additional accrual for lease payments originally estimated to have been offset by sublease rental income. Payments on lease obligations, net of estimated
sublease income, will extend through 2011 because, in certain circumstances, the remaining lease payments were less than the termination fees.

Fiscal 2001

In fiscal 2001, we outsourced certain manufacturing facilities and accelerated our restructuring plan that was originally adopted in September 2000 to
improve profitability and business performance as a stand-alone company. As a result, we recorded a pretax charge of $872 million in fiscal 2001 for business restructuring and related expenses.
This charge was partially offset by a $35 million reversal to income primarily attributable to fewer involuntary employee separations than originally anticipated and more favorable than
expected real estate lease termination costs.

The
components of the fiscal 2001 charge included $650 million of employee separation costs, $24 million of lease termination costs, and $198 million of other
related expenses. The charge for employee separation costs was composed of $577 million primarily related to enhanced pension and postretirement benefits, which represented the cost of
curtailment in accordance with SFAS 88, and $73 million for severance, special benefit payments and other employee separation costs. The $198 million of other related expenses was
composed of $178 million for incremental period expenses primarily to facilitate the separation from Lucent, including computer system transition costs, and $20 million for an asset
impairment charge related to buildings and equipment at the Shreveport manufacturing facility. Employee separation costs of $55 million established in fiscal 2000 for union-represented
employees at Shreveport were paid as enhanced severance benefits from existing pension and benefit assets and, accordingly, such amount was reclassified in fiscal 2001 out of the business
restructuring reserve and recorded as a reduction to prepaid benefit costs.

8

---

The
employee separation costs in fiscal 2001 were incurred in connection with the elimination of 6,810 employee positions of which 5,600 were through a combination of involuntary and
voluntary separations, including an early retirement program targeted at U.S. management employees, and a workforce reduction of 1,210 employees due to the outsourcing of certain of our manufacturing
operations. Employee separation payments included in the business restructuring reserve were made either through a lump sum or a series of payments extending over a period of up to two years from the
date of departure, which was an option available to certain union-represented employees. This workforce reduction was completed as of September 30, 2002.

Real
estate lease termination costs were incurred primarily in the U.S., Europe and Asia, and were reduced for sublease income that management believed was probable. Payments on lease
obligations, which consisted of real estate and equipment leases, will extend through fiscal 2005. In fiscal 2001, accrued costs for lease obligations represented approximately 666,000 square feet of
excess sales and services support offices, materials, stocking and logistics warehouses, and Connectivity Solutions facilities. As of September 30, 2002, we had entirely vacated this space.

Outsourcing of Certain Manufacturing Operations

We have outsourced all of the manufacturing operations related to our ECG and SMBS segments. Substantially all of these operations have been outsourced to
Celestica Inc. The remaining portions of our manufacturing operations, other than the manufacturing of our Connectivity Solutions product offerings, are outsourced to a number of other contract
manufacturers. We believe that outsourcing these operations will allow us to improve our cash flow over the next few years through a reduction of inventory and reduced capital expenditures.

We
are not obligated to purchase products from Celestica in any specific quantity, except as we outline in forecasts or orders for products. In addition, we may be obligated to purchase
certain excess inventory levels from Celestica that could result from our actual sales of product varying from forecast. Our outsourcing agreement with Celestica results in a concentration that, if
suddenly eliminated, could have an adverse effect on our operations. While we believe that alternative sources of supply would be available, disruption of our primary source of supply could create a
temporary, adverse effect on product shipments. There is no other significant concentration of business transacted with a particular supplier that could, if suddenly eliminated, have a material
adverse effect on our financial position, results of operations or cash flows.

Acquisitions and Divestiture

Acquisition of Expanets

In November 2003, we acquired substantially all of the assets and assumed certain liabilities of Expanets, Inc., a subsidiary of NorthWestern
Corporation. Expanets is a nationwide provider of networked communications and data products and services to small and mid-sized businesses and, prior to the acquisition, was one of our
largest dealers. Under the terms of the asset purchase agreement, we paid NorthWestern approximately $55 million in cash. In addition, we paid approximately $39 million to creditors of
Expanets to satisfy certain debt obligations of Expanets and deposited approximately $13.5 million into an escrow account to satisfy certain liabilities of Expanets. The purchase price is
subject to adjustment within 90 days after the closing. We will include Expanets in our consolidated results of operations and financial position beginning in November 2003.

A
substantial amount of Expanets' business was from Avaya-related product and service offerings. Since we do not expect to continue to sell other manufacturers' products that were
previously distributed by Expanets, we expect to divest or eliminate the portion of the business that focused on distributing these products. We plan to report this portion of Expanets' business as
discontinued operations beginning in our first quarter of fiscal 2004, and to have completely divested or eliminated

9

---

these
discontinued operations by the end of the second quarter of fiscal 2004. We anticipate the discontinued operations to have marginal cash requirements and operating losses during this
disposal period.

From
a continuing operations perspective, we expect during the first two quarters of fiscal 2004, Expanets will have only a marginally negative impact on our results of operations. We
expect that
Expanets will be neutral or accretive to our earnings by no later than the end of our third quarter of fiscal 2004.

Sale of Connectivity Solutions

In October 2003, we agreed to sell certain assets and liabilities of our Connectivity Solutions segment to CommScope, Inc. Under the terms of the
agreement, we will receive a purchase price of $263 million, subject to adjustment, consisting of approximately $210 million of cash, a note in the amount of $18 million that is
convertible into CommScope common stock one year after the closing, and CommScope common stock having a market value, at the time of the agreement, of $35 million. In addition, CommScope
assumed approximately $75 million of primarily employee-related liabilities of Connectivity Solutions. The waiting period applicable to the sale under the Hart-Scott-Rodino
Antitrust Improvements Act, as amended, has expired. We expect the sale of Connectivity Solutions to close no later than the second quarter of fiscal 2004. Because the products offered by Connectivity
Solutions do not fit strategically with the rest of our product portfolio, we believe the sale will enable us to strengthen our focus on our core product offerings.

The
carrying value of the net assets included in the disposal group was $293 million as of September 30, 2003. The final carrying values of the assets and liabilities to be
transferred to Commscope will be determined upon the closing date, with the exception of the benefit obligations noted below.

Based
upon an actuarial calculation using data as of September 30, 2003, we estimate that we will recognize a pension and postretirement curtailment loss of approximately
$26 million upon the closing of the transaction and a settlement loss of approximately $37 million upon the transfer of pension and postretirement benefit assets and liabilities to
Commscope. The estimated curtailment and settlement losses are subject to change based upon intervening events that may occur up to the closing date and the date on which the pension and
postretirement benefit assets and liabilities are transferred, respectively. These losses will be recorded as a loss from discontinued operations. Additionally, these losses will increase the benefit
obligation being transferred to Commscope by approximately $52 million and will remove an intangible asset of approximately $11 million that relates to unrecognized prior service costs
associated with the benefit obligation.

On
October 30, 2003, in exchange for the International Brotherhood of Electrical Worker's agreement to withdraw numerous pending and threatened grievances and arbitration demands
against us in connection with the Connectivity Solutions business, we agreed to provide a one-time payment of five thousand dollars to certain employees and offer an enhanced retirement
incentive for those employees who are pension eligible as of December 2, 2003. The settlement agreement is contingent upon the closing of the sale of Connectivity Solutions to CommScope. Total
payments, excluding the retirement incentive offer, are not expected to exceed $7 million. We expect to take a one-time charge in the first quarter of fiscal 2004 of approximately
$4 million related to the acceptance by 124 employees of the retirement incentive offer.

Other Acquisitions

As part of our continued efforts to broaden our portfolio of product offerings, we completed the following acquisitions during fiscal 2001. There were no material
acquisitions in fiscal 2003 and 2002.

April 2001Acquisition of substantially all of the assets, including $10 million of cash acquired, and the
assumption of $20 million of certain liabilities of Quintus Corporation, a provider of comprehensive electronic customer relationship management solutions. We paid $29 million in cash
for these assets. This transaction was accounted for as a purchase combination.

February 2001Acquisition of VPNet, a privately held distributor of virtual private network solutions and devices. The
total purchase price of $117 million was paid in cash and stock options. This transaction was accounted for as a purchase combination.

10

---

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:

Year Ended September 30,2003

2002

2001Revenue

100.0
%
100.0
%
100.0
%Costs

58.8

60.7

57.4Gross margin

41.2

39.3

42.6Operating expenses:Selling, general and administrative

30.3

31.4

30.3Business restructuring charges (reversals) and related expenses, net

(0.1
)
4.2

12.3Goodwill and intangibles impairment charge



1.4

Research and development

8.4

9.3

7.9Purchased in-process research and development





0.5Total operating expenses

38.6

46.3

51.0Operating income (loss)

2.6

(7.0
)
(8.4
)Other income (expense), net

(0.7
)
(0.1
)
0.5Interest expense

(1.8
)
(1.0
)
(0.5
)Provision (benefit) for income taxes

2.1

5.3

(3.2
)Net loss

(2.0
)%
(13.4
)%
(5.2
)%


Fiscal Year Ended September 30, 2003 Compared with Fiscal Year Ended September 30, 2002

Revenue

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

Year Ended
September 30,

Change2003

2002

$

%(dollars in millions)Revenue:U.S. revenue

$
3,204

$
3,647

$
(443
)
(12.2
)%Non-U.S. revenue


1,134


1,309


(175
)
(13.4
)%Total revenue

$
4,338

$
4,956

$
(618
)
(12.5
)%


Revenue
decreased 12.5%, or $618 million, to $4,338 million in fiscal 2003 from $4,956 million in fiscal 2002. Revenue decreased both in the U.S. and internationally
as well as 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. The protracted economic and business uncertainty resulted in hesitation by our customers to resume capital spending for telephony products and
services. The decline in our revenue also reflects widespread layoffs, high vacancy rates in commercial real estate, a lack of business start-ups and excess capacity within the
communications technology industry.

Although
revenue declined when comparing fiscal 2003 to fiscal 2002, the quarterly revenue trend in fiscal 2003 generally stabilized and was driven primarily by increases in our ECG and
Connectivity Solutions segments. The trends underlying this stabilization of revenue can be attributed to our

11

---

products
and services that support the market for converged communications products. Specifically, revenue from the sale of our IP hardware and software products had increased throughout fiscal 2003,
mitigating the decline in sales of our traditional voice systems. See "Overview" for a discussion of our outlook for revenue trends in the future.

Costs and Gross MarginOur costs of products consist primarily of materials and components, labor and manufacturing overhead.
Our costs of services consist primarily of labor, parts and service overhead. Total costs decreased 15.2%, or $458 million, to $2,552 million in fiscal 2003 from $3,010 million in
fiscal 2002. Gross margin percentage increased in fiscal 2003 to 41.2% as compared with 39.3% in fiscal 2002 attributable primarily to improvements in gross margin in our Connectivity Solutions and
SMBS operating segments. Gross margin on products increased to 42.8% in fiscal 2003 from 39.5% in fiscal 2002. Our ECG and Services segments were the significant contributors to gross margin. ECG's
gross margin percentage deteriorated slightly in fiscal 2003 from fiscal 2002, while Services' gross margin remained unchanged at 39.0% for both fiscal years. The overall improvement in gross margin
percentage was attributable to lower production costs of our SYSTIMAX cabling products, a favorable product mix, the impact of our continuing cost reductions and restructuring activities, and benefits
realized from our manufacturing outsourcing agreement with Celestica. In addition, gross margin was positively impacted by a curtailment gain of $15 million from freezing management pension
benefit and postretirement health benefit accruals. All segments were adversely impacted by the decline in U.S. sales, which typically have higher margins than sales made outside of the U.S.

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

Selling, General and AdministrativeOur selling, general and administrative expenses consist primarily of salaries,
commissions, benefits and other items. SG&A expenses decreased by 15.5%, or $241 million, to $1,314 million in fiscal 2003 from $1,555 million in fiscal 2002. The decrease was
primarily due to savings associated with our business restructuring initiatives, which contributed to a reduction of $62 million in compensation expense, $33 million in reduced IT
expenses, and a $7 million decrease in rental expense in connection with terminated real estate lease obligations. The reduction in IT expenses also reflects a favorable renegotiated agreement
related to the outsourcing of certain IT functions and lower networking costs. In addition, our provision for uncollectible receivables decreased by $43 million due, in part, 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, SG&A was positively impacted by a curtailment gain of $25 million from freezing management pension benefit and postretirement health
benefit accruals. We also had a reduction of $23 million in our current year's amortization expense for intangible assets due to a lower amount of intangible assets being amortized
as a result of both the write-down of intangibles recorded in the fourth quarter of fiscal 2002 and to the fact that certain assets became fully amortized at the end of fiscal 2002.

These
decreases in SG&A were partially offset by an increase in amortization expense of $9 million resulting from a decrease in the estimated useful life of certain internal use
software that occurred in the first quarter of fiscal 2003.

Business Restructuring Charges (Reversals) and Related Expenses, NetFor fiscal 2003, $5 million of business
restructuring reversals, net of related expenses, included reversals of $21 million of business restructuring liabilities established in prior periods, partially offset by $16 million of
other related expenses associated with our fourth quarter of fiscal 2002 business restructuring initiative. These expenses were primarily attributable to information technology costs incurred to
relocate the

12

---

development
of certain IT applications to India. The reversal was attributable primarily to fewer involuntary employee separations than originally anticipated.

Business
restructuring charges and related expenses of $209 million in fiscal 2002 included primarily (1) $116 million of charges related to employee separations,
(2) $84 million of real estate and IT lease terminations, (3) $21 million for incremental period costs, which included relocation and consolidation costs and computer
system transition expenditures, and (4) $7 million of asset impairments, partially offset by (5) a $20 million reversal of business restructuring liabilities primarily
related to fewer involuntary employee separations than originally anticipated.

Goodwill and Intangibles Impairment ChargeA $71 million impairment charge for goodwill and intangibles was recorded in
the fourth quarter of fiscal 2002 to write down the carrying value of goodwill and intangible assets to an amount representing their discounted future cash flows in accordance with SFAS 142 and
SFAS 121. The charge was composed of $44 million for goodwill attributed to SMBS, and $27 million for intangibles of which $24 million was attributed to ECG and
$3 million was attributed to SMBS. There was no impairment of goodwill or intangibles in fiscal 2003.

Research and DevelopmentOur research and development expenses consist primarily of salaries and benefits. R&D expenses
decreased 20.9%, or $96 million, to $363 million in fiscal 2003 from $459 million in fiscal 2002 attributed mainly to lower staffing levels in our R&D organization. In addition,
R&D was positively impacted by a curtailment gain of $6 million from freezing management pension benefit and postretirement health benefit accruals. 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.



Year Ended September 30,2003

2002(dollars in millions)Loss on foreign currency transactions

$
(2
)
$
(6
)Gain on assets sold


14


2Interest income(a)


15


20Impairment of investments(b)





(17
)Loss on long-term debt extinguishment, net(c)


(34
)

Lucent securities litigation charge(d)


(25
)

Miscellaneous, net


1


(1
)Total other income (expense), net

$
(31
)
$
(2
)


---

13

---

Interest ExpenseInterest expense increased by $27 million to $78 million in fiscal 2003 from $51 million
in fiscal 2002. Interest expense for fiscal 2003 includes $58 million of interest on $640 million aggregate principal amount of 111/8% Senior Secured Notes due
April 2009, or senior secured notes, $440 million of which were issued in March 2002 and $200 million of which were issued in May 2003. In addition, we recorded
interest expense of $20 million for the amortization of debt discount, premium and deferred financing costs related primarily to our LYONs, which were issued in October 2001, and
$3 million related to commitment and financing fees on our credit facility. Interest expense was partially offset by $3 million of income related to the amortization of a gain resulting
from the termination of our interest rate swaps in December 2002.

Interest
expense for fiscal 2002 included $25 million of interest expense on our senior secured notes, $21 million of amortization of both debt discount and deferred
financing costs related primarily to our LYONs, and $9 million for interest on commercial paper and other short-term borrowings. Interest expense was partially offset by
$4 million of income related to the hedging of the senior secured notes with our interest rate swaps.

Provision (Benefit) for Income TaxesIn fiscal 2003, we recorded a provision for income taxes of $93 million as
compared with $265 million for fiscal 2002. The provision for fiscal 2003 of $93 million included an $83 million provision to increase the deferred tax asset valuation allowance,
a
$22 million provision for state and foreign income taxes, a $4 million provision for other adjustments, a $10 million benefit related to the early extinguishment in
January 2003 of a portion of our LYONs, and a $6 million benefit related to a favorable audit settlement. 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.

The
provision for fiscal 2002 of $265 million included a $364 million provision related to the establishment of a deferred tax asset valuation allowance, a provision of
$57 million related to an unfavorable geographic distribution of earnings and losses, and a benefit of $156 million attributable to operational losses incurred for the year.

Fiscal Year Ended September 30, 2002 Compared with Fiscal Year Ended September 30, 2001

Revenue

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

Year Ended
September 30,

Change2002

2001

$

%(dollars in millions)Revenue:U.S. revenue

$
3,647

$
5,158

$
(1,511
)
(29.3
)%Non-U.S. revenue


1,309


1,635


(326
)
(19.9
)Total revenue

$
4,956

$
6,793

$
(1,837
)
(27.0
)%


Revenue
decreased 27.0%, or $1,837 million, to $4,956 million for fiscal 2002 from $6,793 million in fiscal 2001, due to decreases across each of our operating
segments. Revenue declines in our core business, which is made up of ECG, SMBS, and Services, reflects a continued decline in spending on enterprise information technology in general, and on
communications products and services in particular. In fiscal 1999 and 2000, the communications technology industry experienced strong economic growth and significant investing by enterprises in
related products and services. In fiscal 2001, growth within this industry began to slow particularly in the U.S. as our customers' focus changed from building new networks to limiting capital
spending and concentrating on extracting maximum value from existing systems. This trend continued in fiscal 2002 as the protracted economic and business

14

---

uncertainty
led to reluctance by our customers to resume capital spending for telephony products and services. In addition, widespread layoffs, high vacancy rates in commercial real estate, a lack of
business start-ups and excess capacity within the communications technology industry adversely impacted our revenues.

Costs and Gross MarginTotal costs decreased 22.8%, or $887 million, to $3,010 million in fiscal 2002 from
$3,897 million in fiscal 2001. Gross margin percentage decreased to 39.3% in fiscal 2002 from 42.6% in fiscal 2001. The decrease in gross margin was attributable to ECG, Connectivity Solutions,
and SMBS, partially offset by an increase in Services' gross margin. Because sales within the U.S., including both direct and indirect channels, typically have higher margins than those sales made
internationally, the drop 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SG&A expenses decreased 24.3%, or $500 million, to $1,555 million in fiscal
2002 from $2,055 million in fiscal 2001. The decrease was primarily due to savings associated with our business restructuring initiatives, including a reduction of $301 million in
salaries and other employee related expenses as a result of lower staffing levels and a $49 million decrease in rental expense in connection with terminated real estate lease obligations. The
decline was also due to higher costs incurred during fiscal 2001 including higher incentive compensation expense of $16 million related to performance bonuses and higher marketing and
promotional costs of $103 million related to
enhancing awareness of the Avaya brand. During fiscal 2001, we also incurred start-up expenses of $48 million related to launching our brand in the marketplace.

The
decrease in SG&A is also attributable to our adoption of SFAS 142. Accordingly, we did not record any goodwill amortization in fiscal 2002 as compared with $40 million
in fiscal 2001. In addition, we increased the estimated useful life of certain internal use software during the second quarter of fiscal 2002, which lowered depreciation expense by $13 million
in fiscal 2002.

The
reduction in SG&A expenses were partially offset by an increase of $16 million of IT related expenses primarily attributable to higher telecommunication expenses.

Business Restructuring Charges (Reversals) and Related Expenses, NetBusiness restructuring charges and related expenses of
$209 million in fiscal 2002 included primarily (1) $116 million of charges related to employee separations, (2) $84 million of real estate and IT lease terminations,
(3) $21 million for incremental period costs, which included relocation and consolidation costs and computer system transition expenditures, and (4) $7 million of asset
impairments, partially offset by (5) a $20 million reversal of business restructuring liabilities primarily related to fewer involuntary employee separations than originally anticipated.

The
$837 million of business restructuring charges and related expenses in fiscal 2001 included (1) $540 million for our accelerated restructuring plan, which was
composed primarily of enhanced pension and healthcare benefits that were offered through an early retirement program, severance and terminated lease obligations, (2) $134 million
primarily for employee separation costs associated with the outsourcing of certain manufacturing operations to Celestica, (3) $178 million representing incremental period costs largely
associated with our separation from Lucent including computer system transition costs such as data conversion activities, asset transfers and training, and (4) a $20 million asset
impairment charge related to assets to be disposed of in connection with our manufacturing outsourcing initiative, partially offset by (5) a $35 million reversal of business
restructuring liabilities originally recorded in September 2000, primarily related to fewer involuntary employee separations than originally anticipated.

Goodwill and Intangibles Impairment ChargeA $71 million impairment charge for goodwill and intangibles was recorded in
the fourth quarter of fiscal 2002 to write down the carrying value of

15

---

goodwill
and intangible assets to an amount representing their discounted future cash flows in accordance with SFAS 142 and SFAS 121. The charge was composed of $44 million for
goodwill attributed to SMBS, and $27 million for intangibles of which $24 million was attributed to ECG and $3 million was attributed to SMBS.

Research and DevelopmentR&D expenses decreased 14.4%, or $77 million, to $459 million in fiscal 2002 from
$536 million in fiscal 2001. Although R&D spending decreased, our R&D expense as a percentage of total revenue increased from 7.9% in fiscal 2001 to 9.3% in fiscal 2002 due to a greater rate of
decline in our revenue than in R&D spending.

Purchased In-Process Research and DevelopmentThe $32 million expense recorded in fiscal 2001 reflects
charges associated with our acquisitions of VPNet in February 2001, and the purchase of substantially all of the assets and certain liabilities of Quintus in April 2001. The purchase
price for these acquisitions included certain technologies that had not reached technological feasibility and had no future alternative use and, accordingly, the value allocated to these technologies
was capitalized and immediately expensed at acquisition. There was no charge in fiscal 2002 for purchased in-process research and development.

Other Income (Expense), Net

Year Ended September 30,2002

2001(dollars in millions)Loss on foreign currency transactions

$
(6
)
$
(5
)Gain on assets sold


2


6Interest income(a)


20


27Impairment of investments(b)


(17
)

Miscellaneous, net


(1
)

3Total other income (expense), net

$
(2
)
$
31


---

Interest ExpenseInterest expense increased 37.8%, or $14 million, to $51 million in fiscal 2002 from
$37 million in fiscal 2001. The increase in interest expense is largely attributed to a higher amount of weighted average debt outstanding. During the first and second quarters of fiscal 2002,
we replaced our commercial paper with long-term debt, which carried a higher rate of interest. During fiscal 2002, we recorded interest expense of $41 million relating to our LYONs
and senior secured notes. In addition, we incurred $22 million of issuance costs in fiscal 2002 related to these debt issuances, which have been deferred and $5 million had been
amortized to interest expense in fiscal 2002. The increase in interest expense was partially offset by a $4 million favorable impact resulting from the hedging of our senior secured notes with
interest rate swaps.

Provision (Benefit) for Income TaxesThe effective tax provision rate for fiscal 2002 was higher than the U.S. statutory rate
due to an increase in the net deferred tax asset valuation allowance of $364 million. The effective tax benefit rate excluding this charge would have been 24.7%, which was substantially lower
than the U.S. statutory rate primarily due to an unfavorable geographic distribution of earnings and losses.

16

---

The
effective tax benefit rate of 38.3% in fiscal 2001 was higher than the U.S. statutory rate primarily due to acquisition related costs.

Results of Operations by Segment

Operating Segments

We manage our operations in four segments including ECG, SMBS, Services and Connectivity Solutions. Other expenses that are not identified with the operating
segments such as business restructuring charges and related expenses and costs incurred to maintain vacant real estate facilities are included in corporate.

Fiscal Year Ended September 30, 2003 Compared with Fiscal Year Ended September 30, 2002

Year Ended
September 30,

Change2003

2002

$

%(dollars in millions)Revenue:Enterprise Communications Group

$
1,738

$
2,080

$
(342
)
(16.4
)%Small and Medium Business Solutions


225


236


(11
)
(4.7
)Services


1,833


2,068


(235
)
(11.4
)Connectivity Solutions


542


572


(30
)
(5.2
)Total revenue

$
4,338

$
4,956

$
(618
)
(12.5
)%


Year Ended September 30,2003

2002

$ Change(dollars in millions)Operating Income (Loss):Enterprise Communications Group

$
(62
)
$
(205
)
$
143Small and Medium Business Solutions


(3
)

(24
)

21Services


157


271


(114
)Connectivity Solutions


3


(72
)

75Total segment operating income (loss)


95


(30
)

125Corporate:Business restructuring (charges) reversals and related expenses, net


5


(209
)

214Other unallocated amounts


14


(109
)

123Total operating income (loss)

$
114

$
(348
)
$
462


ECG

ECG's revenue, which represented 40.1% and 42.0% of our total revenue in fiscal 2003 and 2002, respectively, decreased by $342 million, or 16.4%, from
fiscal 2002 due primarily to declines of $287 million in our converged systems and communication appliances division and $66 million in applications. During the fourth quarter of fiscal
2003, we realigned the components of our ECG operating segment. As a result, we merged most of our multi-media contact center, which we formerly referred to as customer relationship management, or
CRM, and unified communications and formed a new division referred to as applications. We also formed a division referred to as communications appliances, which consists mainly of hardware such as
telephone sets and software that resides on alternative endpoints, such as our IP Softphone which provides the functionality of a digital telephone

17

---

on
a personal computer or handheld device. The appliances division now includes portions of the divisions formerly referred to as converged enterprise systems and CRM. To date, our communication
appliances have typically been sold as components of a larger sale of a converged system.

The
reduction in this segment's revenue was due primarily to the restraint on capital spending by our customers, which resulted in lower sales volumes compounded by increased pricing
pressures. Although total revenue declined when comparing fiscal 2003 to fiscal 2002, the quarterly revenue trend in fiscal 2003 steadily improved, with the exception of the third quarter in which
revenues dipped to their lowest level for the year. Upon our introduction of next generation enterprise class IP telephony solutions in February 2002, we initially saw cautiousness among our
customers to transition to these IP-based telecommunications systems. In fiscal 2003, however, we saw an increased willingness by our customers to invest in IP telephony systems as revenue
from our IP portfolio grew as a percentage of our overall revenue. Our IP portfolio is made up of hardware and software and includes mainly gateways, servers, Avaya Communication Manager software and
IP phones. Sales of gateways have increased at a faster rate than sales of communications servers which we believe indicates that customers who have already deployed our IP systems are now adding
additional sites to their IP networks, and larger customers are beginning larger deployments of our IP offerings across their businesses. This trend is partially attributable to our ability to migrate
our customers to IP telephony while preserving their existing telecommunications investments. In fiscal 2003, ECG's sales through the indirect channel increased to 47.9% of total ECG revenue from
46.8% in fiscal 2002.

Despite
the decrease in revenue, ECG's operating loss in fiscal 2003 improved by $143 million as compared with 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 related to headcount. Additionally, our continued focus on productivity and effectiveness led to less,
but more targeted spending on advertising and marketing. R&D expenses also declined due to the shift away from investing in mature product lines and focusing investments primarily on strategic and
higher growth areas of our business. These expense reductions were partially offset by a slight decline in gross margin percentage. This decline was primarily due to increased discounts resulting from
pricing pressures and a higher mix of indirect sales, partially offset by efficiencies gained in our manufacturing process through our outsourcing agreement with Celestica.

SMBS

SMBS' revenue represented 5.2% and 4.8% of our total revenue in fiscal 2003 and 2002, respectively. Revenue in this segment declined by $11 million from
fiscal 2002, of which a significant portion occurred in the U.S. This 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 22% of total SMBS' revenue in fiscal 2003 compared to 10% in fiscal 2002. Sales from our SMBS segment were
generated almost entirely through the indirect channel.

SMBS'
operating loss in fiscal 2003 improved by $21 million compared with fiscal 2002. This improvement 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 due to a favorable product mix, which included an increase in sales of IP Office, and operational
efficiencies gained through outsourcing of manufacturing.

Services

Services' revenue, which represented 42.2% and 41.7% of our total revenue in fiscal 2003 and 2002, respectively, decreased by $235 million, of which a
large portion occurred within the U.S. This decline was largely due to a decline in maintenance contract renewals caused by the softened economy,

18

---

customer
cost cutting initiatives and the decline in fiscal 2002 product sales. Because maintenance contracts take effect after a one-year warranty period ends, declines in product sales
have a direct effect on maintenance contract revenue in the year following the product sales. The decline in Services' revenue also reflects the full effect in fiscal 2003 of the loss of a major
services contract in our Europe/Middle East/Africa region in the second quarter of fiscal 2002, and the renegotiation of a maintenance contract with Expanets, in March 2002, which extended the
term of the agreement but lowered the monthly revenue. In addition, we saw a decline in our maintenance services billed on a time and materials basis due also to customer cost reduction initiatives
and 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 primarily due to reduced pricing on renewal contracts, the consolidation of call centers by our customers and fewer active ports. While revenue in our Services segment
declined on a year over year basis, revenue on a quarterly basis in fiscal 2003 remained steady and primarily reflects a stabilization of our contract-based revenue. Services revenue generated through
our direct channel represented 84.6% of this segment's revenue in fiscal 2003 as compared with 83.1% in fiscal 2002.

Services'
operating income in fiscal 2003 decreased by $114 million compared with fiscal 2002 driven primarily by revenue erosion. Despite this revenue decline, gross margin
percentage remained unchanged in fiscal 2003 versus fiscal 2002 and reflects our cost reduction initiatives including headcount reductions associated with business restructuring activities and
improved utilization of our technician workforce. R&D expenses increased primarily from investments in the enhancement and further development of service diagnostic tools. Additionally, a small
increase in SG&A was primarily due to the creation of a dedicated sales organization in the first quarter of fiscal 2003. This increase is net of a reduction in fiscal 2003 in bad debt expense
resulting from billing and collection process improvements.

Connectivity Solutions

Connectivity Solutions' revenue, which represented 12.5% and 11.5% of our total revenue in fiscal 2003 and 2002, respectively, decreased by $30 million due
to declines of $34 million in sales of ExchangeMAX® cabling for telecommunications services providers and $16 million in sales related to electronic cabinets, a service
provider offering, partially offset by an increase of $20 million in sales of SYSTIMAX® structured cabling systems for enterprises. These revenue declines, which occurred
predominantly in the U.S., were due to a continued constraint on the capital budgets of telecommunications service providers. Revenue generated from SYSTIMAX represented $434 million, or 80.1%,
and $414 million, or 72.4%, of Connectivity Solutions' total revenue
in fiscal 2003 and 2002, respectively. The $20 million increase in SYSTIMAX revenue, which reflects a $15 million increase internationally, was a result of our strategy implemented at
the beginning of the market recession to redesign our product and reduce standard pricing. While Connectivity Solutions' revenue declined in fiscal 2003 as compared with fiscal 2002, revenue on a
quarterly basis steadily increased throughout fiscal 2003. Sales through our indirect channel increased to 85.0% of Connectivity Solutions' revenue in fiscal 2003 from 78.6% in fiscal 2002.

Despite
the decline in revenue, Connectivity Solutions' operating income in fiscal 2003 improved by $75 million compared with fiscal 2002 due primarily to an increase in gross
margin percentage, which more than doubled year over year. The increase in gross margin percentage was primarily attributable 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
negotiating more favorable pricing terms with vendors.

19

---

Fiscal Year Ended September 30, 2002 Compared with Fiscal Year Ended September 30, 2001

Year Ended
September 30,

Change2002

2001

$

%(dollars in millions)Revenue:Enterprise Communications Group

$
2,080

$
2,871

$
(791
)
(27.6
)%Small and Medium Business Solutions


236


313


(77
)
(24.6
)Services


2,068


2,286


(218
)
(9.5
)Connectivity Solutions


572


1,323


(751
)
(56.8
)Total Revenue

$
4,956

$
6,793

$
(1,837
)
(27.0
)%


Year Ended September 30,2002

2001

$ Change(dollars in millions)Operating Income (Loss):Enterprise Communications Group

$
(205
)
$
10

$
(215
)Small and Medium Business Solutions


(24
)

(13
)

(11
)Services


271


168


103Connectivity Solutions


(72
)

257


(329
)Total segment operating income (loss)


(30
)

422


(452
)Business restructuring (charges) reversals and related (expenses), net


(209
)

(885
)

676Other unallocated amounts


(109
)

(101
)

(8
)Total operating loss

$
(348
)
$
(564
)
$
216


ECG

ECG's revenue, which represented 42.0% and 42.3% of our total revenue in fiscal 2002 and 2001, respectively, declined by $791 million in fiscal 2002
predominantly due to declines of $551 million in converged systems, $158 million in CRM, and $63 million in unified communications. Although revenue in regions outside of the U.S.
declined, the majority of the reduction was seen in the U.S. This was consistent with the industry trend occurring in the U.S. at the time as enterprises restrained capital spending due to economic
uncertainty. In addition, enterprises were hesitant to commit to investments in next-generation products as they evaluated technological advances made in the industry and several new IP
telephony products introduced by us and certain competitors in fiscal 2002. In particular, in February 2002, we introduced our next generation enterprise class IP telephony solutions. This
trend was compounded by the continued decline in demand for our traditional, more mature product lines. Sales through our indirect channel increased to 46.8% of total ECG revenue in fiscal 2002 from
43.0% in fiscal 2001.

ECG's
operating loss worsened by $215 million, to $205 million of operating loss in fiscal 2002 from $10 million of operating income in fiscal 2001. This change was
primarily attributable to a lower gross margin associated with the decline in revenue in fiscal 2002. Gross margin percentage declined due to an unfavorable geographic sales mix, which was
attributable to a decline in sales in the U.S., and an unfavorable channel mix as sales from our indirect channel increased. The declines in revenue and gross margin percentage were partially offset
by lower SG&A and R&D expenses. The decreases in SG&A and R&D expenses were primarily due to savings associated with our business restructuring

20

---

initiatives.
Sales and marketing costs within SG&A expenses decreased due to a stronger concentration of sales through the indirect channel.

SMBS

Although revenue in this segment declined by $77 million from fiscal 2001, the reduction was mitigated partially 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. More than half of the revenue decline was seen in the U.S. Sales from the SMBS
segment, which were almost entirely indirect, represented 4.8% and 4.6% of our total revenue in fiscal 2002 and 2001, respectively.

SMBS'
operating loss worsened by $11 million to $24 million in fiscal 2002 from $13 million in fiscal 2001. This decline was primarily attributable to a lower gross
margin percentage due to a reduction in
revenue, along with increases in standard material costs. This decline was partially offset by a reduction in SG&A expenses due to cost savings associated with our business restructuring initiatives
predominantly associated with headcount reductions.

Services

Services' revenue, which represented 41.7% and 33.6% of our total revenue in fiscal 2002 and 2001, respectively, decreased by $218 million from fiscal 2001
largely as a result of the renegotiation of a maintenance contract with Expanets in March 2002, which extended the term of the agreement but lowered the monthly revenues, and the loss of a
major services contract in our Europe/Middle East/Africa region during the second quarter of fiscal 2002. In addition, the economic constraint on discretionary spending resulted in a depressed demand
for maintenance billed on a time and materials basis, and cuts in capital expenditures resulted in lower demand for equipment adds, moves and changes. Lower product sales and financial difficulties of
certain service providers resulted in fewer installations as well as less training and consulting services delivered to our customers. Sales through our indirect channel decreased to 16.8% of total
Services' revenue in fiscal 2002 from 20.1% in fiscal 2001. The $218 million decline in this segment's revenue was seen almost entirely in the U.S.

Services'
operating income increased by $103 million, to $271 million in fiscal 2002 from $168 million in fiscal 2001. This increase was primarily attributed to
improved gross margin percentage due to efficiencies gained from reducing headcount and employing a variable workforce approach to meet periods of high demand.

Connectivity Solutions

Connectivity Solutions' revenue, which represented 11.5% and 19.5% of our total revenue in fiscal 2002 and 2001, respectively, decreased by $751 million
due to declines of $303 million in sales of ExchangeMAX® cabling for service providers, $283 million in sales of SYSTIMAX® structured cabling systems for
enterprises, and $165 million in sales related to electronic cabinets. ExchangeMAX sales, which accounted for $87 million of total Connectivity Solutions' revenue in fiscal 2002, dropped
significantly due to a decline in sales volumes caused by a lack of capital spending by telecommunications service providers. The main contributors to the decline in SYSTIMAX revenue, which
represented $414 million of total Connectivity Solutions' revenue in fiscal 2002, were a constraint on spending by our customers on large infrastructure projects, combined with the
implementation of our strategic initiative that began in the first half of fiscal 2002 to lower cable prices. Pricing pressure resulting from excess cable manufacturing capacity was another
contributing factor. Revenue from electronic cabinets, a service provider offering, was $71 million in fiscal 2002. In response to a decline in DSL (Digital Subscriber Line) and wireless site
installations, which are two main drivers behind sales of electronic cabinets, service providers reduced spending related to electronic cabinets. Sales through our indirect channel increased to 78.6%
of total Connectivity Solutions' revenue in fiscal 2002 from 60.9% in fiscal 2001. The majority of the decline in this segment's revenue occurred within the U.S.

21

---

Connectivity
Solutions' operating loss worsened by $329 million, from $257 million of operating income in fiscal 2001, to $72 million of operating loss in fiscal
2002. This change was driven by a lower gross margin predominantly attributable to the sharp decline in sales volume while factory costs remained relatively fixed. The decline in gross margin was
partially offset by lower SG&A and R&D expenses, which were due to savings associated with lower staffing levels as a result of our business restructuring initiatives.

Liquidity and Capital Resources

Our cash and cash equivalents increased to $1,192 million at September 30, 2003 from $597 million at September 30, 2002. The
$595 million increase resulted primarily from an increase in net cash provided by financing and operating activities of $421 million and $197 million, respectively, partially
offset by $34 million of cash used for investing activities. In fiscal 2002, cash and cash equivalents increased to $597 million as of September 30, 2002 from $250 million
at September 30, 2001. The $347 million increase resulted primarily from $255 million and $198 million of net cash provided by financing and operating activities,
respectively, partially offset by $109 million of net cash used for investing activities.

Operating Activities

Our net cash provided by operating activities was $197 million in fiscal 2003 compared with $198 million in fiscal 2002. In fiscal 2003, net cash
provided by operating activities was comprised of a net loss of $88 million adjusted for non-cash items of $310 million and net cash used for changes in operating assets and
liabilities of $25 million. Included in the non-cash items was $418 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 to our deferred tax asset valuation allowance, the loss on the extinguishment of a portion of our LYONs, amortization of restricted stock units,
and a charge for our estimated liability related to the Lucent securities litigation. Also included in such non-cash items was $108 million of amounts that generated net income, but
did not provide cash from operations including a gain on curtailment of our pension and postretirement plans, an increase in our deferred income taxes, and a reversal of certain business restructuring
reserves. Net cash used for operating assets and liabilities was attributed mainly to a $105 million voluntary pension contribution made during the fourth quarter of fiscal 2003, as well as
payments made for business restructuring activities and accounts payable. These usages of cash were partially offset by receipts of cash on amounts due from our customers, which included proceeds of
$26 million from a third party financial institution for the sale of a term loan due from Expanets and a decrease in our inventory balance.

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 fourth quarter
of fiscal 2003 was 57 days versus 69 days for the same period in fiscal 2002. 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

22

---

one-point
method, days sales of inventory on-hand for the fourth quarter of fiscal 2003 was 56 days versus 59 days for the same quarter of fiscal 2002.

In
fiscal 2002, our net cash provided by operating activities was $198 million compared with net cash used for operating activities of $133 million in fiscal 2001. Net cash
provided by operating activities in
fiscal 2002 was comprised of a net loss of $666 million adjusted for non-cash items of $878 million, and net cash used for changes in operating assets and liabilities of
$14 million. Included in the non-cash items are $999 million of charges that increased our net loss, but did not result in the usage of cash. These charges consisted mainly
of the establishment of a deferred tax asset valuation allowance, depreciation and amortization, business restructuring charges, the impairment of certain assets, and a provision for uncollectible
receivables. Also included in such non-cash items is a $121 million increase to our deferred income taxes 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 mostly offset by receipts of cash on amounts due from our customers and a decrease in our inventory balance, as well as $82 million of installment
payments of principal and interest received from Expanets pursuant to a credit line.

Days
sales outstanding in accounts receivable for the fourth quarter of fiscal 2002, excluding the effect of the securitization transaction discussed below, was 69 days versus
95 days for the same period in fiscal 2001. The improvement in the level of days sales outstanding is primarily attributable to the implementation of process improvements that resulted in
increased collections on past due amounts and lower sales. Days sales of inventory on-hand for the fourth quarter of fiscal 2002 was 59 days versus 68 days for the same
period in fiscal 2001. This decrease is primarily due to improved inventory management as a result of outsourcing our contract manufacturing, as well as a decrease in unit costs.

Investing Activities

Our net cash used for investing activities was $34 million in fiscal 2003 compared with $109 million in fiscal 2002. The usage of cash in each year
resulted primarily from capital expenditures, which amounted to $60 million and $111 million in fiscal 2003 and 2002, respectively. Capital expenditures in fiscal 2003 related primarily
to IT investments. This was partially offset by the receipt of $21 million in proceeds from the sale of property, plant and equipment. Capital expenditures in fiscal 2002 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 IT
systems, including the purchase of internal use software. In addition, in the third quarter of fiscal 2002, we used $6 million of cash for our acquisition of Conita Technologies, a leading
supplier of voice-driven software applications for business. The reduction in capital expenditures in fiscal 2003 as compared to fiscal 2002 was due to a continuing effort to limit spending as a
result of declines in our revenue.

Financing Activities

Net cash provided by financing activities was $421 million in fiscal 2003 compared with $255 million in fiscal 2002. Cash flows from financing
activities in the current year were mainly attributed to the issuance of common stock and long-term debt. During fiscal 2003, we received cash proceeds from the issuance of common stock
amounting to $368 million in connection with (i) the sale of 34.5 million shares for $10.20 per share in a public offering, resulting in gross proceeds of approximately
$352 million and (ii) $16 million primarily in connection with the sale of shares under our employee stock purchase plan. In addition, we received gross proceeds of
$216 million from the issuance of senior secured notes. The receipt of cash from these debt and equity offerings was partially offset by the payment of $9 million of issuance costs. In
addition, we made cash payments of $156 million related to the repurchase of LYONs during fiscal 2003.

23

---

In
fiscal 2002, net cash provided by financing activities was $255 million compared with $483 million in fiscal 2001. Cash flows from financing activities in fiscal 2002
were mainly attributed to the issuance of long-term debt and common stock. During fiscal 2002, we received gross proceeds of $460 million from the issuance of LYONs, and
$435 million from the issuance of senior secured notes. Cash proceeds received from the issuance of common stock amounted to $235 million in connection with (i) the sale of
19.55 million shares for $5.90 per share in a public offering, resulting in gross proceeds of approximately $115 million, (ii) the equity transactions entered into with the
Warburg Entities described below, resulting in gross proceeds of $100 million, and (iii) $20 million primarily in connection with the sale of shares under our employee stock
purchase plan. The receipt of cash from these debt and equity offerings was partially offset by the payment of $29 million of issuance costs. In addition, we made net payments of
$432 million for the retirement of commercial paper, $200 million towards the repayment of borrowings under our five-year credit facility, and $13 million for the
repayment of other short-term borrowings. In connection with our election to terminate an accounts receivable securitization in March 2002, $200 million of collections of
qualified trade accounts receivable were used to liquidate the financial institution's investment as described below in "Securitization of Accounts Receivable."

Securitization of Accounts Receivable

In June 2001, we entered into a receivables purchase agreement and transferred a designated pool of qualified trade accounts receivable to a special
purpose entity, or SPE, which in turn sold an undivided ownership interest in the pool of receivables to an unaffiliated financial institution for cash proceeds of $200 million. The receivables
purchase agreement was terminated in March 2002 as described below. The designated pool of qualified receivables held by the SPE was pledged as collateral to secure the obligations to the
financial institution. During the term of the receivables purchase agreement, we, through the SPE, had a retained interest in the designated pool of receivables, representing collateral for the sale,
to the extent the value of the receivables exceeded the outstanding amount of the financial institution's investment. The fair value of our retained interest, which approximated its carrying amount
because of the short-term nature of the receivables, was recorded in other current assets.

In
March 2002, we elected to terminate the receivables purchase agreement, which was scheduled to expire in June 2002. As a result of the early termination, purchases of
interests in receivables by the financial institution ceased, and collections on receivables that constituted the designated pool of trade accounts receivable were used to repay the financial
institution's $200 million investment, which had been entirely liquidated as of September 30, 2002. No portion of the retained interest was used to liquidate the financial institution's
investment. Upon liquidation in full in April 2002, we had reclassified the remaining $109 million retained interest to receivables.

Expanets Arrangements

Following the sale by Lucent in March 2000 of the primary distribution function for our voice communications systems for small and mid-sized
enterprises to Expanets, 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 us 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
Agreement with Expanets and its parent company, NorthWestern, 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 agreed in December 2002, because of the importance of our relationship
with Expanets and the

24

---

customer
base served by Expanets, 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:



In
the fourth quarter of fiscal 2003, we sold the $27 million term loan due from Expanets to a third party financial institution for $26 million.

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, our long-term debt ratings were downgraded. Debt ratings and outlooks as of September 30, 2003 and 2002 are as follows:

As of September 30,2003

2002Debt Ratings

Outlook

Debt Ratings

OutlookMoody's:Long-term senior unsecured debt

B3

Negative

Ba3

NegativeSenior secured notes

B2

Stable

Ba2

NegativeCorporate credit

B3

Stable

No RatingStandard & Poor's:Long-term senior unsecured debt

B

Stable

B

NegativeSenior secured notes

B+

Stable

B+

NegativeCorporate credit

B+

Stable

BB-

Negative


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.

25

---

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 September 30, 2003 and 2002, 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.

For
the four quarter period ending September 30, 2003, we were required to maintain a minimum adjusted EBITDA of $220 million and a ratio of adjusted EBITDA to interest
expense of 2.70 to 1. We were in compliance with all required covenants as of September 30, 2003.

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



Upon
the sale of our Connectivity Solutions segment, 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:



Upon
the sale of our Connectivity Solutions segment, 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.

Prior
to the amendment, our credit facility prohibited us from using more than $100 million in cash to redeem or repurchase the LYONs, prior to the October 31, 2004 put
date described under "Conversion of 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 and 50% of the net cash proceeds from the sale of our Connectivity Solutions segment and our corporate aircraft. The
$216 million issuance of senior secured

26

---

notes
in May 2003 and the $349 million of net proceeds resulting from the equity offering in September 2003 increased the amount of cash we may use to repurchase LYONs to the
$400 million maximum amount allowable under the credit facility. As of September 30, 2003, we had used approximately $156 million in cash to repurchase LYONs and, as a result of
the amendments to the credit facility, the May 2003 public offering of senior secured notes and the September 2003 equity offering, we have the ability under the amended credit facility
to use an additional $244 million in cash to repurchase LYONs.

In
connection with the October 31, 2004 put obligation described under "Conversion of 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. 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. To the extent we
can satisfy this liquidity test, we may use cash to satisfy any put obligation with respect to the LYONs.

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.

In
October 2003, the credit facility was amended to increase the amount allowed for external investments from $50 million, by an additional $100 million, if the
increased amount is to be used for the purchase of the stock or substantially all of the assets and certain liabilities of Expanets prior to December 31, 2003.

LYONs Convertible Debt

In the first quarter of fiscal 2002, we sold through an underwritten public offering under a shelf registration statement an aggregate principal amount at
maturity of approximately $944 million of LYONs. The proceeds of approximately $448 million, net of a $484 million discount and $12 million of underwriting fees, were used
to refinance a portion of our outstanding commercial paper. The underwriting fees of $12 million were recorded as deferred financing costs and are being amortized to interest expense over a
three-year period through October 31, 2004, which represents the first date holders may require us to purchase all or a portion of their LYONs.

The
original issue discount of $484 million accretes daily at a rate of 3.625% per year calculated on a semiannual bond equivalent basis. We do not make periodic cash payments of
interest on the LYONs. Instead, the amortization of the discount is recorded as interest expense and represents the accretion of the LYONs issue price to their maturity value. The discount will cease
to accrete on the LYONs upon maturity, conversion, purchase by us at the option of the holder, or redemption by us. The LYONs are unsecured obligations that rank equally in right of payment with all
our existing and future unsecured and unsubordinated indebtedness.

27

---

Interest
expense related to the amortization of the discount on the LYONs amounted to $14 million and $16 million for fiscal 2003 and 2002, respectively. In addition,
interest expense related to the amortization of deferred financing costs on the LYONs amounted to $4 million in each of the fiscal years ended September 30, 2003 and 2002.

LYONs Exchange Offer

In December 2002, we, together with 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.

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. In January 2003, following the completion of the exchange offer, the Warburg Entities exercised the 5,581,101 series A warrants for aggregate cash consideration of $55,811 and
converted the LYONs they acquired in the exchange offer into shares of our common stock, 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 the Consolidated Statement of Operations a pre-tax charge of $36 million for the loss on long-term
debt extinguishment related to the exchange offer, which was included in other income (expense), net. This charge reflects a $26 million loss related to the retirement of LYONs and
$10 million of expenses related to (i) series C warrants issued to the Warburg Entities; (ii) common stock issued to the Warburg Entities; (iii) transaction costs;
and (iv) 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.

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 and was 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 which is a component of other income (expense), net.

28

---

As of September 30, 2003, the Warburg Entities hold warrants to purchase the following additional shares of our 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


Repurchases of LYONs

During fiscal 2003, we repurchased $310 million aggregate principal amount at maturity of LYONs, or $160 million in accreted value, in a series of
open market transactions. We used a total of approximately $156 million in cash to repurchase these LYONs. We recognized a pre-tax gain of approximately $2 million, net of
the write-off of deferred financing costs related to the LYONs repurchased.

Conversion of LYONs

As of September 30, 2003, the 549,022 of outstanding LYONs are convertible into 20,557,415 shares of our common stock at any time on or before the maturity
date. The conversion rate of 37.4437 will not be adjusted for accrued original issue discount. Upon conversion, the holder will not receive any cash payment representing accrued original issue
discount. Accrued original issue discount will be considered paid by the shares of common stock received by the holder of the LYONs upon conversion.

We
will adjust the conversion rate for:



We
and the trustee under the indenture governing the LYONs may modify or amend the LYONs or the indenture with the consent of the holders of not less than a majority in aggregate
principal amount at maturity of the LYONs then outstanding. However, the consent of the holders of each outstanding LYON would be required to make certain changes to the terms of the indenture and the
LYONs, including any change that adversely affects the rights of a holder to convert a LYON.

We
may redeem all or a portion of the LYONs for cash at any time on or after October 31, 2004 at a price equal to the sum of the issue price and accrued original issue discount on
the LYONs as of the applicable redemption date. Conversely, holders 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. We may, at our option, elect to pay the purchase price in cash or shares of our common stock, or any combination thereof. If we were to purchase all of the 549,022
LYONs outstanding as of

29

---

September 30,
2003 at the option of the holders, the aggregate purchase price would be approximately $298 million on October 31, 2004, $320 million on October 31,
2006, and $383 million on October 31, 2011. If we elected to pay the purchase price in shares of our common stock, the number of shares would be equal to the purchase price divided by
the average of the market prices of our common stock for the five trading day period ending on the third business day prior to the applicable purchase date.

The
indenture governing the LYONs includes certain covenants, including a limitation on our ability to grant liens on significant domestic real estate properties or the stock of our
subsidiaries holding such properties.

Senior Secured Notes

In March 2002, we issued through an underwritten public offering $440 million aggregate principal amount of 111/8% Senior Secured
Notes due April 2009, or senior secured notes, and received net proceeds of approximately $425 million, net of a $5 million discount and $10 million of issuance costs.
Interest on the senior secured notes is payable on April 1 and October 1 of each year beginning on October 1, 2002. The $5 million discount is being amortized to interest
expense over the seven-year term to maturity. The $10 million of issuance costs were recorded as deferred financing costs and are also being amortized to interest expense over the
term of the senior secured notes. The proceeds from the issuance were used to repay amounts outstanding under the five-year credit facility and for general corporate purposes.

We
may redeem the senior secured notes, in whole or from time to time in part, at the redemption prices expressed as a percentage of the principal amount plus accrued and unpaid interest
to the applicable redemption date, if redeemed during the twelve-month period beginning on April 1 of the following years: (i) 2006 at 105.563%; (ii) 2007 at 102.781%; and
(iii) 2008 at 100.0%.

The
senior secured notes are secured by a second priority security interest in the collateral securing our obligations under the five-year credit facility. In the event that
(i) our corporate credit is rated at least BBB by Standard & Poor's and our long-term senior unsecured debt is rated at least Baa2 by Moody's, each without a negative outlook
or its equivalent, or (ii) subject to certain conditions, at least $400 million of unsecured indebtedness is outstanding or available under the
credit facilities or a bona fide successor credit facility, the security interest in the collateral securing the senior secured notes will terminate. The indenture governing the senior secured notes
includes negative covenants that limit our ability to incur secured debt and enter into sale/leaseback transactions. In addition, the indenture also includes conditional covenants that limit our
ability to incur debt, enter into affiliate transactions, or make restricted payments or investments and advances. These conditional covenants will apply to us until such time that the senior secured
notes are rated at least BBB- by Standard & Poor's and Baa3 by Moody's, in each case without a negative outlook or its equivalent.

In
May 2003, we sold an additional $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 included 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 we issued in March 2002.

We
recorded interest expense related to the senior secured notes of $58 million and $25 million for the fiscal years ended September 30, 2003 and 2002, respectively.
In addition, we recorded interest expense related to the amortization of discount, premium and deferred financing costs on the senior secured notes of $2 million and $1 million for the
fiscal years ended September 30, 2003 and 2002, respectively.

30

---

Fair Value of Financial Instruments

The estimated aggregate fair market value of the senior secured notes increased from September 30, 2002 by $463 million to $742 million as of
September 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
$232 million. With regard to the LYONs, the estimated aggregate fair value as of September 30, 2003 increased from September 30, 2002 by $112 million to
$305 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 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 values as of September 30, 2003 and 2002:

As of September 30, 2003

As of September 30, 2002Number of
Notes
Outstanding

Accreted
Value

Fair
Value

Number of
Notes
Outstanding

Accreted
Value

Fair
Value(dollars in millions)LYONs

549,022

$
287

$
305

943,632

$
476

$
193111/8% Senior Secured Notes

640,000

$
650

$
742

440,000

$
435

$
279


The
carrying amounts of cash and cash equivalents, accounts receivable, accounts payable and accrued liabilities approximate fair value because of their short-term maturity
and variable rates of interest.

As
of September 30, 2003 and 2002, the estimated fair values of our foreign currency forward contracts and options were $11 million and $10 million, respectively,
and were included in other current assets. The estimated fair values of these forward contracts and options were based on market quotes obtained through independent pricing sources.

Grants of Stock Option and Restricted Stock Units

During the period from October 1, 2003 through December 1, 2003, we granted to eligible employees approximately 8 million stock options at a
weighted average exercise price of $13.24 and approximately 401 thousand restricted stock units at a weighted average market value of $13.28.

Public Offerings of Common Stock

In September 2003, we sold 34.5 million shares of common stock for $10.20 per share in a public offering. We received proceeds of approximately
$349 million, which was net of approximately $3 million of underwriting discounts and commissions reflected as a reduction to additional paid-in capital.

In
March 2002, we sold 19.55 million shares of common stock for $5.90 per share in a public offering. We received proceeds of approximately $112 million, which was
net of approximately $3 million of underwriting fees reflected as a reduction to additional paid-in capital.

Warburg Transactions

In October 2000, we sold to the Warburg Entities four million shares of our Series B convertible participating preferred stock and series A
and series B warrants to purchase our common stock for an aggregate purchase price of $400 million. The Series B preferred stock had an aggregate initial liquidation value of
$400 million and accreted at an annual rate of 6.5%, compounded quarterly. The

31

---

$400 million
of proceeds were initially allocated between the Series B preferred stock and warrants based upon the relative fair market value of each security. The fair value allocated
to the Series B preferred stock of $368 million was recorded in the mezzanine section of the Consolidated Balance Sheet and the fair value allocated to the warrants of $32 million
was included in additional paid-in capital.

In
March 2002, we completed a series of transactions pursuant to which the Warburg Entities acquired 53 million shares of our common stock by (i) converting all four
million shares of the Series B preferred stock into 38,329,365 shares of our common stock based on a conversion price of $11.31 per share, which was reduced from the original conversion price
of $26.71 per share, (ii) exercising 286,682 warrants at an exercise price of $34.73 per share resulting in gross proceeds of approximately $10 million, and (iii) purchasing
14,383,953 shares of our common stock for $6.26 per share, which was
the reported closing price of our common stock on the New York Stock Exchange on March 8, 2002, resulting in gross proceeds of approximately $90 million. In connection with these
transactions, we incurred approximately $4 million of transaction costs, which were recorded as a reduction to additional paid-in capital. Following these transactions, there were
no shares of Series B preferred stock outstanding.

The
conversion of the Series B preferred stock and the exercise of the warrants resulted in a charge to accumulated deficit of approximately $125 million, which primarily
represented the impact of reducing the preferred stock conversion price from $26.71 per share to $11.31 per share. We also recorded as a reduction to accumulated deficit a total of $12 million
and $27 million of accretion for the period from October 1, 2001 through the date of conversion and for fiscal 2001, respectively.

Future Cash Needs

Our primary future cash needs will be to fund working capital, capital expenditures, debt service, employee benefit obligations, strategic acquisitions, and our
business restructuring liabilities. We foresee an increase in cash usage for capital expenditures in fiscal 2004 as compared with fiscal 2003. We expect to make cash payments of approximately
$100 million for capital expenditures in fiscal 2004, of which more than half will be related to IT investments. In fiscal 2004, we will make two semi-annual interest payments on
our fixed interest rate senior secured notes each amounting to approximately $36 million. Since we have made a $105 million voluntary contribution to our pension plan in the fourth
quarter of fiscal 2003, we will not be required to make any contributions in fiscal 2004. We made payments in the first quarter of fiscal 2004 of $55 million in cash for the acquisition of
substantially all of the assets and the assumption of certain liabilities of Expanets. In addition, we paid approximately $39 million to creditors of Expanets to satisfy certain debt
obligations of Expanets and deposited approximately $13.5 million into an escrow account to satisfy certain liabilities of Expanets. The purchase price is subject to adjustment within
90 days after the closing. We also expect to make cash payments related to our business restructuring initiatives of approximately $29 million in fiscal 2004. These restructuring related
payments are expected to be composed of $4 million for employee separation costs and $25 million for lease obligations.

In
conjunction with our agreement in October 2003 to sell certain assets and liabilities of our Connectivity Solutions segment to CommScope, we expect to receive a purchase price
of $263 million, subject to adjustment, consisting of approximately $210 million of cash, a note in the amount of $18 million that is convertible into CommScope common stock one
year after the closing, and CommScope common stock having a market value, at the time of the agreement, of $35 million.

We
believe that our existing cash and cash flows from operations will be sufficient to meet our future cash 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 or issue other long- or short-term debt or
equity securities, if the market

32

---

permits.
In May 2003, we completed the sale of $200 million aggregate principal amount 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. In September 2003, we received net proceeds of $349 million relating to the sale of common stock. We
used $105 million of these net proceeds to fund a voluntary contribution to our pension plan and the remainder of the net proceeds will be used for general corporate purposes. 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, debt service, employee benefit obligations, strategic acquisitions, and our business restructuring liabilities will depend on our ability to generate cash in the future, which is subject
to general economic, financial, competitive, legislative, regulatory and other factors that are beyond our control. 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. Discussion regarding the restrictions and covenants for the credit facility, LYONs and senior secured notes can be found in the respective sections
above.

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 and Other Off-Balance Sheet Arrangements

Irrevocable Letters of Credit and Other Arrangements

We have entered into several uncommitted credit facilities totaling $53 million and other arrangements similar to irrevocable letters of credit that vary
in term totaling $10 million, of which an aggregate of $29 million in irrevocable letters of credit and other arrangements were outstanding as of September 30, 2003. Letters of
credit are purchased guarantees that ensure our performance or payment to third parties in accordance with specified terms and conditions.

Surety Bonds

We acquire various types of surety bonds, such as license, permit, bid and performance bonds, which are irrevocable undertakings by us to make payment in the
event we fail to perform our obligations. These bonds vary in duration although most are issued and outstanding from one to three years. As of September 30, 2003, the maximum potential payment
under these surety bonds is approximately $7 million. Historically, no surety bonds have been drawn upon and there is no future expectation that these surety bonds will be drawn upon.

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
September 30, 2003, the maximum potential payment under these commitments was approximately $82 million, of which we recorded a liability in the amount of $8 million. We
classified this liability as $3 million in other current liabilities and $5 million in other liabilities.

33

---

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 the 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 agreement of approximately
$35 million as of September 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 September 30, 2003 and have adequately provided for this guarantee in our financial statements at September 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 lending institution was approximately $8 million as of September 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 by us since we entered in this arrangement in October 2000. We have estimated the fair value of this guarantee as of
September 30, 2003 and have adequately provided for this guarantee in our financial statements at September 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 above, 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 our enterprise networking
businesses, or 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

34

---

of
$25 million representing our estimate of the amount of our liability associated with the settlement by Lucent of the securities litigation described below. We recently reached agreement with
Lucent to pay $24 million in shares of our common stock in full satisfaction of our obligations under the settlement. The terms of the settlement will be subject to a fairness hearing scheduled
for December 2003. We are unable to determine the maximum potential amount of other 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.

Purchased In-Process Research and Development

In connection with our acquisitions in fiscal 2001, a portion of the purchase price, $31 million for VPNet and $1 million for Quintus, was allocated
to purchased in-process research and development, or IPR&D. As part of the process of analyzing these acquisitions, we made a decision to buy technology that had not yet been
commercialized rather than develop the technology internally. We based this decision on a number of factors including the amount of time it would take to bring the technology to market. We also
considered our internal research resource allocation and our progress on comparable technology, if any. We expect to use a similar decision process in the future.

At
the date of each acquisition, the IPR&D projects had not yet reached technological feasibility and had no future alternative use. Accordingly, the value allocated to these projects
was capitalized and immediately expensed at acquisition.

The
value allocated to purchased IPR&D for the acquisitions was determined using an income approach. This involved estimating the fair value of the IPR&D, using the present value of the
estimated after-tax cash flows expected to be generated by the purchased IPR&D, using
risk-adjusted discount rates and revenue forecasts as appropriate. Where appropriate, we deducted an amount reflecting the contribution of the core technology from the anticipated cash
flows from an IPR&D project. The selection of the discount rate was based on consideration of our weighted average cost of capital, as well as other factors, including the useful life of each
technology, profitability levels of each technology, the uncertainty of technological advances that were known at the time, and the stage of completion of each technology. We believe that the
estimated IPR&D amounts so determined represent the fair value and do not exceed the amount a third party would have paid for the projects.

Revenue
forecasts were estimated based on relevant market size and growth factors, expected industry trends, individual product sales cycles and the estimated life of each product's
underlying technology. Estimated operating expenses, income taxes, and charges for the use of contributory assets were deducted from estimated revenue to determine estimated after-tax cash
flows for each project. Estimated operating expenses include cost of goods sold, selling, general and administrative expenses, and research and development expenses. The research and development
expenses include estimated costs to maintain the products once they have been introduced into the market and generate revenue and costs to complete the purchased IPR&D.

The
actual results to date have been consistent, in all material respects, with our assumptions at the time of the acquisition, except as noted below.

Set
forth below are descriptions of the significant acquired IPR&D projects related to our acquisition of VPNet.

In
February 2001, we completed the purchase of VPNet and allocated approximately $31 million to IPR&D projects, using the income approach described above, to the following
projects: low-end technologies for $5 million and high-end technologies for $26 million. These projects under

35

---

development
at the valuation date represent next-generation technologies that are expected to address emerging market demands for low- and high-end network data
security needs.

At
the acquisition date, the low-end technologies under development were approximately 80% complete based on engineering data and technological progress. Revenue attributable
to the developmental low-end VPNet technologies was estimated to be $8 million in 2002 and $13 million in 2003. Revenue was estimated to grow at a compounded annual growth
rate of approximately 60% for the six years following introduction, assuming the successful completion and market acceptance of the major research and development programs. Revenue was
expected to peak in 2004 and decline thereafter through the end of the technologies' life in 2007 as new product technologies were expected to be introduced.

At
the acquisition date, the high-end technologies under development were approximately 60% complete, based on engineering data and technological progress. Revenue
attributable to the developmental high-end VPNet technologies was estimated to be $52 million in 2002 and $86 million in 2003. Revenue was estimated to grow at a compounded
annual growth rate of approximately 50% for the seven years following introduction, assuming the successful completion and market acceptance of the major research and development programs. Revenue was
expected to peak in 2004 and decline thereafter through the end of the technologies' life in 2008 as new product technologies were expected to be introduced.

VPNet
had spent approximately $4 million on these in-process technology projects, and expected to spend approximately $4 million to complete all phases of
research and development. The rates utilized to discount the net cash flows to their present value were based on estimated cost of capital calculations. Due to the nature of the forecasts and the
risks associated with the successful development of the projects, a discount rate of 25% was used to value the IPR&D. The discount rate utilized was higher than our weighted average cost of capital
due to the inherent uncertainties surrounding the successful development of the purchased in-process technology, the useful life of such technology, the profitability levels of the
technology, and the uncertainty of technological advances that were unknown at that time.

During
fiscal 2002, the business environment in which the acquired VPNet technologies were to be commercialized changed and the marketplace assumptions originally utilized in the
acquisition models were updated accordingly. Consequently, we did not realize all of the original forecasted revenues in fiscal 2002, and we do not expect to realize all of the forecasted revenues in
subsequent fiscal years from these acquired technologies. As a result, during fiscal 2002, we wrote off $21 million of net acquired intangible assets related to the purchase of VPNet, which was
included in the $71 million goodwill and intangibles impairment charge included in our Consolidated Statement of Operations.

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 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 voluntarily or pursuant to government directives. None of the sites are reasonably likely to generate environmental costs that will be individually
material nor will environmental costs for all sites in the aggregate be 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, we have

36

---

not
assumed that we will recover amounts from any third party, including under any insurance coverage or indemnification arrangement. Although we do not separately track recurring costs of managing
hazardous substances and pollutants in ongoing operations, we 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 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
assesses the adequacy of environmental reserves on a quarterly basis. For the fiscal years ended September 30, 2003 and 2002, respectively, no amounts were charged to our
Statements of Operations for environmental costs as reserves were deemed to be adequate. Expenditures for environmental matters for the fiscal years ended September 30, 2003 and 2002 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.

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.

Year 2000 Actions

Three separate purported class action lawsuits are pending against Lucent, our 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 us 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, as described in "Transactions
with Lucent" above 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 free 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

37

---

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 of 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, we are
responsible for 10% of our liabilities attributable to those cases, including 10% of the legal costs associated with the portion of the litigation for which we share liability. In the second quarter
of fiscal 2003, we recorded a charge of $25 million representing an estimate of our liability in this matter. We recently reached agreement with Lucent to pay $24 million in shares of
our common stock in full satisfaction of our obligations under the settlement. The terms of the settlement will be subject to a fairness hearing scheduled for December 2003.

Commissions Arbitration Demand

In July 2002, Communications Development Corporation, or CDC, 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. In
April 2003, CDC initiated the arbitration before the American Arbitration Association. The plaintiff 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, CDC may likely increase its commission demand. The parties are in the process of selecting arbitrators.

38

---

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 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.

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. We recently agreed with Lucent to pay $6 million in satisfaction of our
liability in this matter, although Lucent has notified us that we may be responsible for some additional costs that may be incurred in connection with the conclusion of the claims administration.
Based on our discussions with Lucent, we do not expect those additional costs to be material.

Patent Infringement Claim

AudioFAX IP, LLC has filed an action against us in the U.S. District Court for the Northern District of Georgia, alleging that we have infringed five of its
patents relating to facsimile products in violation of federal patent laws. This matter is in the early stages of litigation and we cannot determine whether the outcome of this action will have a
material adverse effect on our financial position, results of operations or cash flows.

Financial Instruments

We conduct our business on a multi-national basis in a wide variety of foreign currencies. We are, therefore, subject to the risk associated with foreign currency
exchange rates and interest rates that could affect our results of operations, financial position or cash flows. We manage our exposure to
these market risks through our regular operating and financing activities and, when deemed appropriate, through the use of derivative financial instruments. We use derivative financial instruments to
reduce earnings and cash flow volatility associated with foreign exchange rate changes. Specifically, we utilize foreign currency forward contracts, and to a lesser extent, foreign currency options to
mitigate the effects of fluctuations of exchange rates associated with certain existing assets and liabilities that are denominated in non-functional currencies, and periodically to reduce
anticipated net foreign currency cash flows resulting from normal business operations. In addition, we use interest rate swap agreements to manage our proportion of fixed and floating rate debt and to
reduce interest expense. Derivative financial instruments are used as risk management tools and not for speculative or trading purposes.

We
engage in foreign currency hedging activities to reduce our risk that changes in exchange rates will adversely affect the eventual net cash flows resulting from the sale of products
to foreign customers and purchases from foreign suppliers. We believe that we have achieved risk reduction and hedge effectiveness because the gains and losses on our derivative instruments
substantially offset the losses and gains on the assets, liabilities and transactions being hedged. Hedge effectiveness is periodically measured by comparing the change in fair value of each hedged
foreign currency exposure at the applicable market rate with the change in market value of the corresponding derivative instrument.

39

---

Foreign Currency Transactions

Recorded TransactionsWe utilize foreign currency forward contracts primarily to manage
short-term exchange rate exposures on certain receivables, payables and loans residing on foreign subsidiaries' books, which are denominated in currencies other than the subsidiary's
functional currency. When these items are revalued into the subsidiary's functional currency at the month-end exchange rates, the fluctuations in the exchange rates are recognized in
earnings as other income or expense. Changes in the fair value of our foreign currency forward and option contracts used to offset these exposed items are also recognized in earnings as other income
or expense in the period in which the exchange rates change. For the fiscal years ended September 30, 2003 and 2002, the changes in the fair value of the foreign currency forward and option
contracts were substantially offset by changes resulting from the revaluation of the hedged items.

The
fair value of foreign currency forward contracts is sensitive to changes in foreign currency exchange rates. As of September 30, 2003 and 2002, a 10% appreciation in foreign
currency exchange rates from the prevailing market rates would have increased our related net unrealized gain for fiscal 2003 and 2002 by $19 million and $6 million, respectively.
Conversely, a 10% depreciation in these currencies from the prevailing market rates would have decreased our related net gain for fiscal 2003 and 2002 by $19 million and $6 million,
respectively. Consistent with the nature of the economic hedge of such foreign currency forward contracts, such unrealized gains or losses would be offset by corresponding decreases or increases,
respectively, of the underlying asset, liability or transaction being hedged.

Forecasted TransactionsFrom time to time, we use foreign currency forward and option contracts to offset certain forecasted
foreign currency transactions primarily related to the purchase or sale of product expected to occur during the ensuing twelve months. The change in the fair value of foreign currency forward and
option contracts is recognized as other income or expense in the period in which the exchange rates change. For the fiscal year ended September 30, 2003, these gains and losses were not
material to our results of operations. We did not use any foreign currency forward or option contracts for forecasted transactions in fiscal 2002. As permitted under SFAS 133, we have elected
not to designate our forward and option contracts as hedges thereby precluding the use of hedge accounting for these instruments. Such treatment could result in a gain or loss from fluctuations in
exchange rates related to a derivative contract that is different from the loss or gain recognized from the underlying forecasted transaction. However, we have procedures to manage the risks
associated with our derivative instruments, which include limiting the duration of the contracts, typically six months or less, and the amount of the underlying exposures that can be economically
hedged. Historically, the gains and losses on these transactions have not been significant.

By
their nature, all derivative instruments involve, to varying degrees, elements of market risk and credit risk not recognized in our financial statements. The market risk associated
with these instruments resulting from currency exchange rate movements is expected to offset the market risk of the underlying transactions, assets and liabilities being economically hedged. The
counterparties to the agreements relating to our foreign exchange instruments consist of a diversified group of major financial institutions. We do not believe that there is significant risk of loss
in the event of non-performance of the counterparties because we control our exposure to credit risk through credit approvals and limits, and continual monitoring of the credit ratings of
such counterparties. In addition, we limit the financial exposure and the amount of agreements entered into with any one financial institution.

Interest Rate Swap Agreements

In April 2002, we entered into two interest rate swap agreements with a total notional amount of $200 million that were to mature in
April 2009 and were executed in order to: (i) convert a portion of

40

---

the
senior secured notes fixed-rate debt into floating-rate debt; (ii) maintain a capital structure containing appropriate amounts of fixed and floating-rate
debt; and (iii) reduce net interest payments and expense in the near-term.

In
December 2002, we cancelled both interest rate swap agreements. 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. We recognized $3 million in fiscal 2003, 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 $16 million as of September 30, 2003.

Under
these agreements, we received a fixed interest rate of 111/8% and paid a floating interest rate based on the six-month LIBOR (in arrears) plus an
agreed-upon spread, which was equal to a weighted average interest rate of 6.8% as of September 30, 2002. The amounts paid and received were calculated based on the total notional
amount of $200 million. Since the relevant terms of the swap agreements matched the corresponding terms of the senior secured notes, there was no hedge ineffectiveness. Accordingly, as required
by SFAS 133, gains and losses on the swap agreements fully offset the losses and gains on the hedged portion of the senior secured notes, which were marked to market at each reporting date. As
of September 30, 2002, we recorded the fair market value of the swaps of $22 million as other assets along with a corresponding increase to the hedged debt with equal and offsetting
unrealized gains and losses included in other income (expense), net.

Interest
payments were recognized through interest expense and were to be made and received on the first day of each April and October, commencing on October 1, 2002 and ending on
the maturity date. On the last day of each semi-annual interest payment period, the interest payment for the previous six months was to be made based upon the six-month LIBOR
rate (in arrears) on that day, plus the applicable spread, as shown in the table below. Since the interest rate was not known until the end of each semi-annual interest period, estimates
were used during such period based upon published forward-looking LIBOR rates. Any differences between the estimated interest expense and the actual interest payment were recorded to interest expense
at the end of each semi-annual interest period. These interest rate swaps resulted in a reduction to actual interest expense in fiscal 2002 of $4 million.

The
following table outlines the terms of the swap agreements:

|Maturity Date |       | Notional Amount |     | Receive Fixed Interest Rate |       | Pay Variable Interest Rate
|------------- | ----- | --------------- | --- | --------------------------- | ----- | --------------------------
|
|April 2009    |       | $               | 150 |                             | 111/8 | %                         
|April 2009    |       |                 | 50  |                             | 111/8 | %                         
|              |       |                 |     |                             |       |                           
|              | Total |                 | $   | 200                         |       |                           
|              |       |                 |     |                             |       |                           

Each
counterparty to the swap agreements was a lender under our five-year credit facility. Our obligations under these swap agreements was secured on the same basis as our
obligations under the five-year credit facility.

During
the period from October 1, 2003 through December 11, 2003, we entered into three interest rate swap agreements each having a notional amount of $50 million
and a maturity date of April 2009. These interest rate swap agreements have the same terms as the interest rate swap agreements entered into in April 2002, with the exception of the
agreed upon spread of 6.55%, 6.8575% and 6.94%, respectively, that is added to the six month LIBOR (in arrears) used to calculate the variable interest rate that we will pay.

41

---

Recent Accounting Pronouncement

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," or FIN 46. FIN 46 requires certain variable interest entities to be consolidated by the primary beneficiary of the entity if the other 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 and consolidation requirements of FIN 46 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 created or acquired prior to February 1, 2003, the consolidation requirements of FIN 46
become effective for us in the first quarter of fiscal 2004. The adoption of FIN 46 did not have a material effect on our consolidated results of operations, financial position or cash flows.

The Application of Critical Accounting Policies

Our consolidated financial statements are based on the selection and application of accounting principles generally accepted in the United States of America,
which require us to make estimates and assumptions about future events that affect the amounts reported in our financial statements and the accompanying notes. Future events and their effects cannot
be determined with absolute certainty. Therefore, the determination of estimates requires the exercise of judgment. Actual results could differ from those estimates, and any such differences may be
material to the financial statements. We believe that the following policies may involve a higher degree of judgment and complexity in their application and represent the critical accounting policies
used in the preparation of our financial statements. If different assumptions or conditions were to prevail, the results could be materially different from our reported results.

Revenue Recognition

We derive revenue primarily from the sale and service of communication systems and applications. In accordance with SEC Staff Accounting Bulletin No. 101,
"Revenue Recognition in Financial Statements," revenue is recognized when persuasive evidence of an arrangement exists, delivery has occurred, the fee is fixed and determinable, collectibility is
reasonably assured, contractual obligations have been satisfied, and title and risk of loss have been transferred to the customer.

Our
products are sold directly through our worldwide sales force and indirectly through our global network of distributors, dealers, value-added resellers and system integrators. The
purchase price of our systems and applications typically includes installation and a warranty of up to one year. Revenue from the direct sales of products that include installation services is
recognized at the time the products are installed, after satisfaction of all the terms and conditions of the underlying customer contract. When we provide a combination of products and services to
customers, the arrangement is evaluated under Emerging Issues Task Force Issue No. 00-21, "Revenue Arrangements with Multiple Deliverables," or EITF 00-21, which is
effective for us for transactions entered into after July 1, 2003. EITF 00-21 addresses certain aspects of accounting by a vendor for arrangements under which the vendor will
perform multiple revenue generating activities. The application of EITF 00-21 did not have a material effect on our consolidated results of operations, financial position or cash flows.
Our indirect sales to distribution partners are generally recognized at the time of shipment if all contractual obligations have been satisfied. We accrue a provision for estimated sales returns and
other allowances and deferrals as a reduction of revenue at the time of revenue recognition, as required.

We
also derive revenue from: (i) maintenance services, including services provided under contracts and on a time and materials basis; (ii) professional services for
customer relationship management,

42

---

converged
voice and data networks, network security, and unified communications; and (iii) outsourcing services for messaging and other parts of communication systems. Maintenance contracts
typically have terms that range from one to five years. Contracts for professional services typically have terms that range from two to four weeks for standard solutions and from six months to one
year for customized solutions. Contracts for outsourcing services typically have terms that range from one to seven years. Revenue from services performed under outsourcing services arrangements,
professional services and services performed under maintenance contracts is deferred and recognized ratably over the term of the underlying customer contract or at the end of the contract, when
obligations have been satisfied. For services performed on a time and materials basis, revenue is recognized upon performance.

Most
of our sales require judgments principally in the areas of customer acceptance, returns assessments and collectibility. The assessment of collectibility is particularly critical in
determining whether or not revenue should be recognized. We assess collectibility based primarily on the creditworthiness of the customer as determined by credit checks and analysis, as well as the
customer's payment history. In addition, a significant amount of our revenue is generated from sales of product to distributors. As such, our provision for estimated sales returns and other allowances
and deferrals requires significant judgment. We provide for estimated sales returns and other allowances and deferrals as a reduction of revenue at the time of revenue recognition, as required. If
these estimates, which are based on historical experience, are significantly below the actual amounts, our revenue could be adversely affected.

Collectibility of Accounts Receivable

In order to record our accounts receivable at their net realizable value, we must assess their collectibility. A considerable amount of judgment is required in
order to make this assessment including an analysis of historical bad debts and other adjustments, a review of the aging of our receivables and the current creditworthiness of our customers. We have
recorded allowances for receivables which we feel are uncollectible, including amounts for the resolution of potential credit and other collection issues such as disputed invoices, customer
satisfaction claims and pricing discrepancies. However, depending on how such potential issues are resolved, or if the financial condition of any of our customers was to deteriorate and their ability
to make required payments became impaired, increases in these allowances may be required. We actively manage our accounts receivable to minimize credit risk and as of September 30, 2003, we
have no individual customer that constitutes more than 10% of our accounts receivable.

Inventories

In order to record our inventory at its lower of cost or market, we regularly assess the ultimate realizability of our inventory. We adjust our inventory balance
based on historical usage, inventory turnover and product life cycles through the recording of a provision which we include in cost of sales. In certain circumstances such as the introduction of a new
product, we may make judgments as to future demand and compare that with the current or committed inventory levels. Where we have determined that the future demand is lower than our current inventory
levels, we adjust our inventory balance accordingly. In addition, we have outsourced the manufacturing of substantially all of our ECG and SMBS products. We are not obligated to purchase products from
our outsourced manufacturer in any specific quantity, except as we outline in forecasts or orders for products required to be manufactured by the outsourced manufacturer. We may be obligated to
purchase certain excess inventory levels from our outsourced manufacturer that could result from our actual sales of product varying from forecast, in which case we may need to record additional
inventory provisions in the future.

43

---

Deferred Tax Assets

As of September 30, 2003, we had $439 million in net deferred tax assets resulting from tax credit carryforwards, net operating losses and other
deductible temporary differences, which are available to reduce taxable income in future periods. We recorded an increase of $202 million to our net deferred tax assets valuation allowance
during 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, a $93 million reduction in accumulated other comprehensive loss associated with the minimum pension liability recorded in accordance with SFAS
No. 87, "Employers' Accounting for Pensions," and a $3 million adjustment related to the exercise of stock options which served to decrease taxable income for the year. In addition, the
valuation allowance balance increased by $32 million related to the reversal of certain deferred tax liabilities related to pre-spin federal income tax audits. The increase in the
valuation allowance was partially offset by a $9 million benefit included in the tax provision as a result of having positive book taxable income for the year including certain other tax
adjustments. 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 September 30, 2003 will be realized based on the scheduling of deferred tax liabilities and on 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.

Long-Lived Assets

We have recorded property, plant and equipment, intangible assets, and capitalized software costs at cost less accumulated depreciation or amortization. The
determination of useful lives and whether or not these assets are impaired involves significant judgment. Goodwill impairment is determined using a two-step approach. The first step of the
goodwill test is used to identify potential impairment by comparing the fair value of a reporting unit, which is one level below our operating segments, with its carrying amount, including goodwill.
The second step of the goodwill impairment test compares the implied fair value of the reporting unit's goodwill with the carrying amount of that goodwill. If the carrying amount of the reporting
unit's goodwill exceeds the implied fair value of that goodwill, an impairment loss is recognized in an amount equal to that excess.

We
conducted the required annual goodwill impairment review during the fourth quarter of fiscal 2003. Due to upward movement in our stock value we experienced an increase in our market
capitalization that positively impacted the fair value of our reporting units as determined in accordance with the provisions of SFAS 142. Updated valuations were completed for all reporting
units with goodwill as of September 30, 2003 using a discounted cash flow approach based on forward-looking information regarding market share, revenues and costs for each reporting unit as
well as appropriate discount rates. As a result, no goodwill impairment charge was recorded in fiscal 2003. A considerable amount of judgment is required in calculating this impairment charge,
principally in determining discount rates, market premiums, financial forecasts, and allocation methodology.

44

---

Business Restructuring Charges

During each of fiscal 2002 and 2001, we recorded $201 million and $674 million, respectively, of charges and established related business
restructuring reserves related to the outsourcing of certain manufacturing facilities, the acceleration of our restructuring plan originally adopted in September 2000, and our efforts to
improve our business performance in response to the continued industry-wide slowdown. These reserves include estimates related to employee separation costs, lease termination obligations
and other exit costs. In fiscal years 2003, 2002 and 2001, we reversed $21 million, $20 million and $35 million, respectively, of business restructuring reserves primarily related
to fewer involuntary employee separations than originally anticipated.

Estimates
used to establish reserves related to real estate lease obligations have been reduced for sublease income that we believe is probable. Because certain of our real estate lease
obligations extend for many years past fiscal 2003, assumptions were made as to the timing, availability and amount of sublease income that we expect to receive. In making these assumptions, we
considered many variables such as the vacancy rates of commercial real estate in the local markets and the market rate for sublease rentals. Because we are required to project sublease income for many
years into the future, our estimates and assumptions regarding the commercial real estate market that we used to calculate future sublease income may be materially different from actual sublease
income. If our sublease income estimates were too high, we would incur additional real estate lease obligation charges. Conversely, if our sublease income estimates were too low, we would be required
to reverse charges and recognize income.

Pension and Postretirement Benefit Costs

We maintain defined benefit pension plans covering the majority of our employees and retirees, and postretirement benefit plans for retirees that include
healthcare benefits and life insurance coverage. In fiscal 2003, we adopted amendments to our pension and postretirement plans. Effective December 31, 2003, we froze the benefit accruals and
additional participation in our plans for our management employees. We also enhanced our 401(k) savings plan for our management employees effective January 1, 2004. The changes in the pension
and postretirement plans were accounted for as curtailments in accordance with SFAS No. 88, "Employers' Accounting for Settlements and Curtailments of Defined Benefit Pension Plans and for
Termination Benefits." Effective June 1, 2003, we entered into new collective bargaining agreements with the Communications Workers of America and the International Brotherhood of Electrical
Workers, which included pension increases and postretirement healthcare limitation increases over the term of the 3 year agreements. Additionally, we provided current retirees of the management
pension plan with a one-time opportunity to take a full or partial lump sum distribution from the plan with a payout date of December 1, 2003.

Our
pension and postretirement benefit costs are developed from actuarial valuations. Inherent in these valuations are key assumptions, including the discount rate and expected
long-term rate of return on plan assets. Material changes in our pension and postretirement benefit costs may occur in the future due to changes in these assumptions, changes in the number
of plan participants, changes in the level of benefits provided, and changes in asset levels.

The
discount rate is subject to change each year, consistent with changes in applicable high-quality, long-term corporate bond indices. Based on the expected
duration of the benefit payments for our pension plans, we refer to applicable indices such as the Moody's AA Corporate Bond Index and the Salomon Brothers Pension Discount Curve to select a rate at
which we believe the pension benefits could be effectively settled. Based on the published rates as of September 30, 2003, we used a discount rate of 6.0%, a decline of 50 basis points from the
6.5% rate used in fiscal year 2002. This had the effect of increasing our accumulated pension benefit obligation by approximately $178 million for the

45

---

fiscal
year ended September 30, 2003, and increasing our estimated pension expense for fiscal 2004 by $10 million.

The
expected long-term rate of return on pension plan assets is selected by taking into account the expected duration of the projected benefit obligation for the plans, the
asset mix of the plans, and the fact that the plan assets are actively managed. The forward-looking assumptions underlying our expected long-term rate of return are developed by our
investment adviser and reviewed by us for reasonableness. The return and risk assumptions consider such factors as expected future earnings growth, dividend yields and inflation rates. The returns are
reviewed for reasonableness by comparison to published long-term historical market returns. Based on these factors, our expected long-term rate of return as of
September 30, 2003 is 9%, consistent with the prior year. A 25 basis point change in the expected long-term rate of return would result in approximately a $7 million change
in our pension expense.

Avaya
employs an asset allocation strategy whereby the assets in our portfolio are periodically rebalanced to maintain the desired target asset mix. Therefore, the actual asset
allocation does not stray significantly from the targeted asset allocation. Based on our asset allocation strategy, and the correlation of the asset classes in our portfolio, the variability of
returns around the mean, as measured by standard deviation, is approximately 9 percentage points. Therefore, in a normal probability distribution, about two-thirds of our returns
will fall between plus and minus one standard deviation (9 percentage points) from the mean.

The
market-related value of our plan assets is developed using a 5-year smoothing technique. The market-related value as of the measurement date is calculated as follows:
(1) A preliminary market-related value is calculated by adjusting the market-related value at the beginning of the year for payments to and from plan assets and the expected return on assets
during the year. The expected return on assets represents the expected long-term rate of return on plan assets adjusted plus or minus 2% based on the actual 10-year average
rate of return on plan assets. (2) The final market-related value is determined as the preliminary market-related value from (1) above, plus 20% of the difference between the actual
return and expected return for each of the past five years.

For
the fiscal year ended September 30, 2003, we recorded a net pension credit of $8 million, which included a $31 million curtailment gain from freezing management
pension benefit accruals, and a $7 million charge for special termination benefits offered to represented employees as a result of the new collective bargaining agreements. We also recorded a
net postretirement benefit expense of $18 million, which included a $15 million gain related to the curtailment. During fiscal 2003, the projected benefit obligation decreased by
$55 million as a result of the amendments to our pension plan for the curtailment of benefit accruals, the new collective bargaining agreements, and the lump sum distribution for our retirees.
The projected postretirement benefit obligation increased by $98 million as a result of the amendment to our postretirement plan for the collective bargaining agreements.

On
September 30, 2003, our annual measurement date, the accumulated benefit obligation related to our pension plans exceeded the fair value of the pension plan assets (such excess
is referred to as an unfunded accumulated benefit obligation). This difference reflects an increase in the accumulated benefit obligation that resulted from a decrease in the interest rate used to
discount the projected benefit obligation to its present settlement amount. The unfunded accumulated benefit obligation exceeded our accrued pension liability by $813 million, an increase of
$265 million from September 30, 2002. As a result, in accordance with SFAS 87, we recorded an adjustment to increase the additional minimum pension liability from $548 million at
September 30, 2002 to $813 million at September 30, 2003. This resulted in a $237 million increase to accumulated other comprehensive loss from $513 million at
September 30, 2002 to $750 million at September 30, 2003, and a $28 million increase

46

---

to
intangible assets from $35 million at September 30, 2002 to $63 million at September 30, 2003. The charge to stockholders' equity represents a net loss not yet
recognized as pension expense.

Commitments and Contingencies

We are subject to legal proceedings related to environmental, product, employment, intellectual property, licensing and other matters. In addition, we are subject
to indemnification and liability sharing claims by Lucent under the terms of the Contribution and Distribution Agreement. In order to determine the amount of reserves required, we assess the
likelihood of any adverse judgments or outcomes to these matters as well as potential ranges of probable losses. A determination of the amount of reserves required for these contingencies is made
after analysis of each individual issue. The required reserves may change in the future due to new developments in each matter or changes in approach such as a change in settlement strategy. Assessing
the adequacy of any reserve for matters for which we may have to indemnify Lucent is especially difficult, as we do not control the defense of those matters. In addition, estimates are made for our
repurchase obligations related to products sold to various distributors who obtain financing from certain third party lending institutions.

47

---



REPORT OF INDEPENDENT AUDITORS

To the Board of Directors and Stockholders of
Avaya Inc.:

In
our opinion, the accompanying consolidated balance sheets and the related consolidated statements of operations, of changes in stockholders' equity and of comprehensive loss, and of
cash flows present fairly, in all material respects, the financial position of Avaya Inc. and its subsidiaries (the "Company") at September 30, 2003 and 2002, and the results of their
operations and their cash flows for each of the three years in the period ended September 30, 2003, in conformity with accounting principles generally accepted in the United States of America.
These financial statements are the responsibility of the Company's management; our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits of
these statements in accordance with auditing standards generally accepted in the United States of America, which require that we plan and perform the audit to obtain reasonable assurance about whether
the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the
accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our
opinion.

As
discussed in Note 2 to the consolidated financial statements, on October 1, 2001, the Company adopted the provisions of Statement of Financial Accounting Standards
No. 142, "Goodwill and Other Intangible Assets."

/s/
PricewaterhouseCoopers LLP
PricewaterhouseCoopers LLP
Florham Park, New Jersey
October 21, 2003, except
for Note 20 as to which the
date is December 11, 2003

48

---



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

|                                                                   |                                                                      | Year Ended September 30, |      
|------------------------------------------------------------------ | -------------------------------------------------------------------- | ------------------------ | -----
|
|REVENUE                                                            |                                                                      |                          |      
|                                                                   | Products                                                             |                          | $    
|                                                                   | Services                                                             |                          |      
|                                                                   |                                                                      |                          |      
|                                                                   |                                                                      |                          | 4,338
|                                                                   |                                                                      |                          |      
|COSTS                                                              |                                                                      |                          |      
|                                                                   | Products                                                             |                          |      
|                                                                   | Services                                                             |                          |      
|                                                                   |                                                                      |                          |      
|                                                                   |                                                                      |                          | 2,552
|                                                                   |                                                                      |                          |      
|GROSS MARGIN                                                       |                                                                      |                          | 1,786
|                                                                   |                                                                      |                          |      
|OPERATING EXPENSES                                                 |                                                                      |                          |      
|                                                                   | Selling, general and administrative                                  |                          |      
|                                                                   | Business restructuring charges (reversals) and related expenses, net |                          |      
|                                                                   | Goodwill and intangibles impairment charge                           |                          |      
|                                                                   | Research and development                                             |                          |      
|                                                                   | Purchased in-process research and development                        |                          |      
|                                                                   |                                                                      |                          |      
|                                                                   | TOTAL OPERATING EXPENSES                                             |                          |      
|                                                                   |                                                                      |                          |      
|OPERATING INCOME (LOSS)                                            |                                                                      |                          | 114  
|                                                                   | Other income (expense), net                                          |                          |      
|                                                                   | Interest expense                                                     |                          |      
|                                                                   |                                                                      |                          |      
|INCOME (LOSS) BEFORE INCOME TAXES                                  |                                                                      |                          | 5    
|                                                                   | Provision (benefit) for income taxes                                 |                          |      
|                                                                   |                                                                      |                          |      
|NET LOSS                                                           |                                                                      | $                        | (88  
|                                                                   |                                                                      |                          |      
|Net Loss Available to Common Stockholders:                         |                                                                      |                          |      
|Net loss                                                           |                                                                      | $                        | (88  
|Accretion of Series B preferred stock                              |                                                                      |                          |     
|Conversion charge related to Series B preferred stock and warrants |                                                                      |                          |     
|                                                                   |                                                                      |                          |      
|Net loss available to common stockholders                          |                                                                      | $                        | (88  
|                                                                   |                                                                      |                          |      
|Loss Per Common Share:                                             |                                                                      |                          |      
|                                                                   | Basic and Diluted                                                    |                          | $    
|                                                                   |                                                                      |                          |      

See
Notes to Consolidated Financial Statements.

49

---



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

|                                           |                                                                                                                                                                                                            | As of September 30, |      
|------------------------------------------ | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- | ------------------- | -----
|
|ASSETS                                     |                                                                                                                                                                                                            |                     |      
|Current assets:                            |                                                                                                                                                                                                            |                     |      
|                                           | Cash and cash equivalents                                                                                                                                                                                  |                     | $    
|                                           | Receivables, less allowances of $87 and $121 as of September 30, 2003 and 2002, respectively                                                                                                               |                     |      
|                                           | Inventory                                                                                                                                                                                                  |                     |      
|                                           | Deferred income taxes, net                                                                                                                                                                                 |                     |      
|                                           | Other current assets                                                                                                                                                                                       |                     |      
|                                           |                                                                                                                                                                                                            |                     |      
|TOTAL CURRENT ASSETS                       |                                                                                                                                                                                                            |                     | 2,569
|                                           |                                                                                                                                                                                                            |                     |      
|                                           | Property, plant and equipment, net                                                                                                                                                                         |                     |      
|                                           | Deferred income taxes, net                                                                                                                                                                                 |                     |      
|                                           | Goodwill                                                                                                                                                                                                   |                     |      
|                                           | Other assets                                                                                                                                                                                               |                     |      
|                                           |                                                                                                                                                                                                            |                     |      
|TOTAL ASSETS                               |                                                                                                                                                                                                            | $                   | 4,057
|                                           |                                                                                                                                                                                                            |                     |      
|LIABILITIES AND STOCKHOLDERS' EQUITY       |                                                                                                                                                                                                            |                     |      
|Current liabilities:                       |                                                                                                                                                                                                            |                     |      
|                                           | Accounts payable                                                                                                                                                                                           |                     | $    
|                                           | Business restructuring reserve                                                                                                                                                                             |                     |      
|                                           | Payroll and benefit obligations                                                                                                                                                                            |                     |      
|                                           | Deferred revenue                                                                                                                                                                                           |                     |      
|                                           | Other current liabilities                                                                                                                                                                                  |                     |      
|                                           |                                                                                                                                                                                                            |                     |      
|TOTAL CURRENT LIABILITIES                  |                                                                                                                                                                                                            |                     | 1,168
|                                           |                                                                                                                                                                                                            |                     |      
|                                           | Long-term debt                                                                                                                                                                                             |                     |      
|                                           | Benefit obligations                                                                                                                                                                                        |                     |      
|                                           | Other liabilities                                                                                                                                                                                          |                     |      
|                                           |                                                                                                                                                                                                            |                     |      
|TOTAL NON-CURRENT LIABILITIES              |                                                                                                                                                                                                            |                     | 2,689
|                                           |                                                                                                                                                                                                            |                     |      
|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, 419,434,414 and 364,752,178 issued (including 878,254 and 557,353 treasury shares) as of September 30, 2003 and 2002, respectively |                     |      
|                                           | Additional paid-in capital                                                                                                                                                                                 |                     |      
|                                           | Accumulated deficit                                                                                                                                                                                        |                     |      
|                                           | Accumulated other comprehensive loss                                                                                                                                                                       |                     |      
|                                           | Less treasury stock at cost                                                                                                                                                                                |                     |      
|                                           |                                                                                                                                                                                                            |                     |      
|TOTAL STOCKHOLDERS' EQUITY                 |                                                                                                                                                                                                            |                     | 200  
|                                           |                                                                                                                                                                                                            |                     |      
|TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY |                                                                                                                                                                                                            | $                   | 4,057
|                                           |                                                                                                                                                                                                            |                     |      

See
Notes to Consolidated Financial Statements.

50

---



AVAYA INC. AND SUBSIDIARIES        CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY AND OF COMPREHENSIVE LOSS        (dollars in millions)

|                                                                                 |  | Year Ended September 30, |       
|-------------------------------------------------------------------------------- |  | ------------------------ | ------
|
|COMMON STOCK:                                                                    |  |                          |       
|Beginning balance                                                                |  | $                        | 4     
|Issuance of stock                                                                |  |                          |      
|                                                                                 |  |                          |       
|Ending balance                                                                   |  | $                        | 4     
|                                                                                 |  |                          |       
|ADDITIONAL PAID-IN CAPITAL:                                                      |  |                          |       
|Beginning balance                                                                |  | $                        | 1,693 
|Issuance of warrants                                                             |  |                          | 5     
|Issuance of common stock for options exercised                                   |  |                          |      
|Issuance of common stock to employees under the stock purchase plan              |  |                          | 16    
|Issuance of other stock unit awards                                              |  |                          | 31    
|Issuance of common stock in connection with Warburg transactions                 |  |                          |      
|Issuance of common stock in connection with the LYONs Exchange Offer, net of tax |  |                          | 57    
|Issuance of common stock through public offering                                 |  |                          | 349   
|Other stock transactions                                                         |  |                          |      
|Adjustment to Lucent capital contribution                                        |  |                          |      
|                                                                                 |  |                          |       
|Ending balance                                                                   |  | $                        | 2,151 
|                                                                                 |  |                          |       
|ACCUMULATED DEFICIT:                                                             |  |                          |       
|Beginning balance                                                                |  | $                        | (1,182
|Preferred stock accretion                                                        |  |                          |      
|Preferred stock conversion and exercise of warrants charge                       |  |                          |      
|Net loss                                                                         |  |                          | (88   
|                                                                                 |  |                          |       
|Ending balance                                                                   |  | $                        | (1,270
|                                                                                 |  |                          |       
|ACCUMULATED OTHER COMPREHENSIVE LOSS:                                            |  |                          |       
|Beginning balance                                                                |  | $                        | (512  
|Foreign currency translation                                                     |  |                          | 70    
|Minimum pension liability                                                        |  |                          | (237  
|Tax effect of minimum pension liability                                          |  |                          | 93    
|Valuation allowance related to minimum pension liability                         |  |                          | (93   
|                                                                                 |  |                          |       
|Ending balance                                                                   |  | $                        | (679  
|                                                                                 |  |                          |       
|TREASURY STOCK:                                                                  |  |                          |       
|Beginning balance                                                                |  | $                        | (3    
|Purchase of treasury stock at cost                                               |  |                          | (3    
|                                                                                 |  |                          |       
|Ending balance                                                                   |  | $                        | (6    
|                                                                                 |  |                          |       
|TOTAL STOCKHOLDERS' EQUITY                                                       |  | $                        | 200   
|                                                                                 |  |                          |       
|COMPREHENSIVE LOSS:                                                              |  |                          |       
|Net loss                                                                         |  | $                        | (88   
|Minimum pension liability, net of tax and valuation allowance                    |  |                          | (237  
|Foreign currency translations                                                    |  |                          | 70    
|                                                                                 |  |                          |       
|Comprehensive loss                                                               |  | $                        | (255  
|                                                                                 |  |                          |       

See
Notes to Consolidated Financial Statements.

51

---



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

|                                                             |                                                                                            | Year Ended September 30,                                                            |                               
|------------------------------------------------------------ | ------------------------------------------------------------------------------------------ | ----------------------------------------------------------------------------------- | ------------------------------
|
|OPERATING ACTIVITIES:                                        |                                                                                            |                                                                                     |                               
|                                                             | Net loss                                                                                   |                                                                                     | $                             
|                                                             | Adjustments to reconcile net loss to net cash provided by (used for) operating activities: |                                                                                     |                               
|                                                             |                                                                                            | Business restructuring charges, net of reversals                                    |                               
|                                                             |                                                                                            | Depreciation and amortization                                                       |                               
|                                                             |                                                                                            | Provision for uncollectible receivables                                             |                               
|                                                             |                                                                                            | Deferred income taxes                                                               |                               
|                                                             |                                                                                            | Deferred tax asset valuation allowance                                              |                               
|                                                             |                                                                                            | Gain on curtailment of pension and postretirement plans                             |                               
|                                                             |                                                                                            | Loss on extinguishment of debt, net                                                 |                               
|                                                             |                                                                                            | Lucent securities litigation charge                                                 |                               
|                                                             |                                                                                            | Amortization of restricted stock units                                              |                               
|                                                             |                                                                                            | Impairment of goodwill, intangible assets and investments                           |                               
|                                                             |                                                                                            | Purchased in-process research and development                                       |                               
|                                                             |                                                                                            | Adjustments for other non-cash items, net                                           |                               
|                                                             |                                                                                            | Changes in operating assets and liabilities, net of effects of acquired businesses: |                               
|                                                             |                                                                                            |                                                                                     | Receivables                   
|                                                             |                                                                                            |                                                                                     | Inventory                     
|                                                             |                                                                                            |                                                                                     | Accounts payable              
|                                                             |                                                                                            |                                                                                     | Payroll and benefits, net     
|                                                             |                                                                                            |                                                                                     | Voluntary pension contribution
|                                                             |                                                                                            |                                                                                     | Business restructuring reserve
|                                                             |                                                                                            |                                                                                     | Deferred revenue              
|                                                             |                                                                                            |                                                                                     | Other assets and liabilities  
|                                                             |                                                                                            |                                                                                     |                               
|NET CASH PROVIDED BY (USED FOR) OPERATING ACTIVITIES         |                                                                                            |                                                                                     | 197                           
|                                                             |                                                                                            |                                                                                     |                               
|INVESTING ACTIVITIES:                                        |                                                                                            |                                                                                     |                               
|                                                             | Capital expenditures                                                                       |                                                                                     |                               
|                                                             | Proceeds from the sale of property, plant and equipment                                    |                                                                                     |                               
|                                                             | Acquisition of businesses, net of cash acquired                                            |                                                                                     |                               
|                                                             | Other investing activities, net                                                            |                                                                                     |                               
|                                                             |                                                                                            |                                                                                     |                               
|NET CASH USED FOR INVESTING ACTIVITIES                       |                                                                                            |                                                                                     | (34                           
|                                                             |                                                                                            |                                                                                     |                               
|FINANCING ACTIVITIES:                                        |                                                                                            |                                                                                     |                               
|                                                             | Issuance of convertible participating preferred stock                                      |                                                                                     |                               
|                                                             | Issuance of warrants                                                                       |                                                                                     |                               
|                                                             | Issuance of common stock                                                                   |                                                                                     |                               
|                                                             | Net decrease in commercial paper                                                           |                                                                                     |                               
|                                                             | Issuance of long-term borrowings                                                           |                                                                                     |                               
|                                                             | Repayment of long-term borrowings                                                          |                                                                                     |                               
|                                                             | Payment of issuance costs related to debt and equity offerings                             |                                                                                     |                               
|                                                             | Borrowings (repayments) under the credit facility                                          |                                                                                     |                               
|                                                             | Proceeds from (termination of) accounts receivable securitization                          |                                                                                     |                               
|                                                             | Other financing activities, net                                                            |                                                                                     |                               
|                                                             |                                                                                            |                                                                                     |                               
|NET CASH PROVIDED BY FINANCING ACTIVITIES                    |                                                                                            |                                                                                     | 421                           
|                                                             |                                                                                            |                                                                                     |                               
|Effect of exchange rate changes on cash and cash equivalents |                                                                                            |                                                                                     | 11                            
|                                                             |                                                                                            |                                                                                     |                               
|Net increase (decrease) in cash and cash equivalents         |                                                                                            |                                                                                     | 595                           
|Cash and cash equivalents at beginning of fiscal year        |                                                                                            |                                                                                     | 597                           
|                                                             |                                                                                            |                                                                                     |                               
|Cash and cash equivalents at end of fiscal year              |                                                                                            | $                                                                                   | 1,192                         
|                                                             |                                                                                            |                                                                                     |                               

See Notes to Consolidated Financial Statements.

52

---



AVAYA INC. AND SUBSIDIARIES        NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

1. Description of Business

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 Internet Protocol ("IP") telephony systems that converge voice, data and other traffic across a single unified network, traditional
voice communication systems, contact center infrastructure and applications in support of customer relationship management, 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.

2. Summary of Significant Accounting Policies

Principles of Consolidation

The consolidated financial statements include the accounts of Avaya and its subsidiaries. All intercompany transactions and balances have been eliminated.

Use of Estimates

The consolidated financial statements and related disclosures are prepared in conformity with accounting principles generally accepted in the United States of
America. Management is required to make estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities at the date of the
financial statements and revenue and expenses during the period reported. These estimates include assessing the collectibility of accounts receivable, the use and recoverability of inventory, the
realization of deferred tax assets, restructuring reserves, pension and postretirement obligations, and useful lives and impairment of tangible and intangible assets, among others. The markets for the
Company's products are characterized by intense competition, rapid technological development and frequent new product introductions, all of which could affect the future realizability of the Company's
assets. Estimates and assumptions are reviewed periodically and the effects of revisions are reflected in the consolidated financial statements in the period they are determined to be necessary.
Actual results could differ from these estimates.

Foreign Currency Translation

Balance sheet accounts of the Company's foreign operations are translated from foreign currencies into U.S. dollars at period-end exchange rates while
income and expenses are translated at average exchange rates during the period. Translation gains or losses related to net assets located outside the U.S. are shown as a component of accumulated other
comprehensive loss in stockholders' equity. Gains and losses resulting from foreign currency transactions, which are denominated in currencies other than the entity's functional currency, are included
in the Consolidated Statements of Operations.

Revenue Recognition

The Company derives revenue primarily from the sale and service of communication systems and applications. In accordance with SEC Staff Accounting Bulletin
No. 101, "Revenue Recognition in Financial Statements," revenue is recognized when persuasive evidence of an arrangement exists, delivery has occurred, the fee is fixed and determinable,
collectibility is reasonably assured, contractual obligations have been satisfied, and title and risk of loss have been transferred to the customer.

53

---

The
Company's products are sold directly through our worldwide sales force and indirectly through our global network of distributors, dealers, value-added resellers and system
integrators. The purchase price of the Company's systems and applications typically includes installation and a warranty for up to one year. Revenue from the direct sales of products that include
installation services is recognized at the
time the products are installed, after satisfaction of all the terms and conditions of the underlying customer contract. When the Company provides a combination of products and services to customers,
the arrangement is evaluated under Emerging Issues Task Force Issue ("EITF") No. 00-21, "Revenue Arrangements with Multiple Deliverables," ("EITF 00-21"), which is
effective for the Company for transactions entered into after July 1, 2003. EITF 00-21 addresses certain aspects of accounting by a vendor for arrangements under which the vendor
will perform multiple revenue generating activities. The application of EITF 00-21 did not have a material effect on the Company's consolidated results of operations, financial position or
cash flows. The Company's indirect sales to distribution partners are generally recognized at the time of shipment if all contractual obligations have been satisfied. The Company accrues a provision
for estimated sales returns and other allowances and deferrals as a reduction of revenue at the time of revenue recognition, as required.

The
Company also derives revenue from: (i) maintenance services, including services provided under contracts and on a time and materials basis; (ii) professional services
for customer relationship management, converged voice and data networks, network security, and unified communications; and (iii) outsourcing services for messaging and other parts of
communication systems. Maintenance contracts typically have terms that range from one to five years. Contracts for professional services typically have terms that range from two to four weeks for
standard solutions and from six months to one year for customized solutions. Contracts for outsourcing services typically have terms that range from one to seven years. Revenue from services performed
under outsourcing services arrangements, professional services and services performed under maintenance contracts is deferred and recognized ratably over the term of the underlying customer contract
or at the end of the contract, when obligations have been satisfied. For services performed on a time and materials basis, revenue is recognized upon performance.

Research and Development Costs and Software Development Costs

Research and development costs are charged to expense as incurred. The costs incurred for the development of computer software that will be sold, leased or
otherwise marketed, however, are capitalized when technological feasibility has been established. These capitalized costs are subject to an ongoing assessment of recoverability based on anticipated
future revenues and changes in hardware and software technologies. Costs that are capitalized include direct labor and related overhead.

Amortization
of capitalized software development costs begins when the product is available for general release to customers. Amortization is recognized on a
product-by-product basis on the greater of either the ratio of current gross revenues to the total of current and anticipated future gross revenues, or the
straight-line method over a period of up to three years. Unamortized capitalized software development costs determined to be in excess of net realizable value of the product are expensed
immediately. As of September 30, 2003 and 2002, the Company had unamortized software development costs of $43 million and $47 million, respectively.

54

---

Cash and Cash Equivalents

All highly liquid investments with original maturities of three months or less are considered to be cash equivalents. These short-term investments are
stated at cost, which approximates market value. The Company's cash and cash equivalents are invested in various investment grade institutional money market accounts.

Inventory

Inventory is stated at the lower of cost, determined on a first-in, first-out basis, or market.

Property, Plant and Equipment

Property, plant and equipment are stated at cost less accumulated depreciation. Depreciation is determined using a straight-line method over the
estimated useful lives of the various asset classes. Estimated lives range from three to 10 years for machinery and equipment, and up to 40 years for buildings.

Major
improvements are capitalized and minor replacements, maintenance and repairs are charged to expense as incurred. Upon retirement or disposal of assets, the cost and related
accumulated depreciation are removed from the Consolidated Balance Sheets and any gain or loss is reflected in the Consolidated Statements of Operations.

Certain
costs of computer software developed or obtained for internal use are capitalized and amortized on a straight-line basis over three to seven years. Costs for general
and administrative, overhead, maintenance and training, as well as the cost of software that does not add functionality to the existing system, are expensed as incurred. As of September 30,
2003 and 2002, the Company had unamortized internal use software costs of $95 million and $71 million, respectively.

In
the first quarter of fiscal 2003, the Company changed the estimated useful life of certain internal use software that is currently in service from seven to five years since a newer
version of the software is expected to be implemented in fiscal 2004, which is two years earlier than originally anticipated. This change increased amortization expense, net of tax, by approximately
$9 million, equivalent to $0.02 per basic and diluted share, for the fiscal year ended September 30, 2003.

In
the second quarter of fiscal 2002, the Company changed the estimated useful life of certain internal use software from three to seven years to reflect actual experience as a
stand-alone company based on the utilization of such software. This change lowered amortization expense, net of tax, by approximately $8 million, equivalent to $0.02 per basic and diluted
share, for the fiscal year ended September 30, 2002.

Goodwill, Other Intangible and Long-lived Assets

Goodwill is the excess of the purchase price over the fair value of identifiable net assets acquired in business combinations accounted for as purchases. The
Company adopted Statement of Financial Accounting Standards ("SFAS") No. 142, "Goodwill and Other Intangible Assets" ("SFAS 142") in October 2001. Goodwill and certain other
intangible assets having indefinite lives, which were previously amortized on a straight-line basis over the periods benefited, are no longer being amortized to earnings, but instead are
subject to periodic testing for impairment. Intangible assets determined to

55

---

have
definite lives are amortized over their remaining useful lives. Goodwill of a reporting unit, which is one level below the Company's operating segments, is tested for impairment on an annual
basis or between annual tests if an event occurs or circumstances change that would reduce the fair value of a reporting unit below its carrying amount.

Goodwill
impairment is determined using a two-step approach. The first step of the goodwill test is used to identify potential impairment by comparing the fair value of a
reporting unit with its carrying amount, including goodwill. If the fair value of a reporting unit exceeds its carrying amount, goodwill of the reporting unit is not considered impaired and the second
step of the impairment test is unnecessary. However, if the carrying amount of a reporting unit exceeds its fair value, the second step of the goodwill impairment test is performed to measure the
amount of impairment, if any. The second step of the goodwill impairment test compares the implied fair value of the reporting unit's goodwill with the carrying amount of that goodwill. If the
carrying amount of the reporting unit's goodwill exceeds the implied fair value of that goodwill, an impairment loss is recognized in an amount equal to that excess.

Intangible
and other long-lived assets are reviewed for impairment whenever events such as product discontinuance, plant closures, product dispositions or other changes in
circumstances indicate that the carrying amount may not be recoverable. In reviewing for impairment, the Company compares the carrying value of such assets to the estimated undiscounted future cash
flows expected from the use of the assets and their eventual disposition. When the estimated undiscounted future cash flows are less than their carrying amount, an impairment loss is recognized equal
to the difference between the assets' fair value and their carrying value.

Investments

The Company's investment portfolio consists primarily of investments accounted for under the cost and equity methods that are generally concentrated in the
emerging communications technology industry. The carrying value of these investments is included in other assets. The Company's share of earnings or losses from equity method investments is recorded
in other income (expense), net. All investments are periodically reviewed for impairment and a write down is recorded whenever declines in fair value below carrying value are considered to be other
than temporary. In making this determination, the Company considers, among other factors, sustained decreases in quoted market prices and a series of historic and projected operating losses by the
investee. If the decline in fair value is determined to be other than temporary, an impairment loss is recorded and the respective investment is written down to an adjusted carrying value. As of
September 30, 2003 and 2002, the Company had investments of $10 million and $12 million, respectively. In fiscal 2002, the Company recorded impairment charges of
$17 million in other income (expense), net related to investments accounted for under the cost method, after the Company determined the investments were permanently impaired.

Financial Instruments

The Company uses various financial instruments, including interest rate swap agreements and foreign currency forward and option contracts, to manage and reduce
risk to the Company by generating cash flows which offset the cash flows of certain transactions in foreign currencies or underlying financial instruments in relation to their amount and timing. The
Company's derivative

56

---

financial
instruments are used as risk management tools and not for speculative or trading purposes. Although not material, these derivatives represent assets and liabilities and are classified as
other current assets or other current liabilities on the accompanying Consolidated Balance Sheets, except for the interest rate swaps discussed below. Gains and losses on the changes in the fair
values of the Company's derivative instruments are included in other income (expense), net.

As
permitted under SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities," ("SFAS 133"), the Company has elected not to designate its forward and
option contracts as hedges thereby precluding the use of hedge accounting for these instruments. Such treatment could result in a gain or loss from fluctuations in exchange rates related to a
derivative contract which is different from the loss or gain recognized from the underlying forecasted transaction. However, the Company has procedures to manage risks associated with its derivative
instruments, which include limiting the duration of the contracts, typically six months or less, and the amount of the underlying exposures that can be economically hedged. Historically, the gains and
losses on these transactions have not been significant.

In
April 2002, the Company entered into two interest rate swap agreements with a total notional amount of $200 million that qualify and are designated as fair value hedges
in accordance with SFAS 133. These arrangements generally involve the exchange of fixed and floating rate interest payments without the exchange of the underlying principal. Net amounts paid or
received are reflected as adjustments to interest expense. The Company records the fair market value of the swaps as other assets along with a corresponding increase to the hedged debt, both of which
are recorded through other income (expense), net. In December 2002, the Company cancelled the interest rate swap agreements. The cancellation resulted in a $19 million deferred gain,
which is being recognized as a reduction to interest expense over the remaining term to maturity of the Senior Secured Notes. See Note 10Derivatives and Other Financial Instruments
for a further discussion.

The
Company also utilizes non-derivative financial instruments including letters of credit and commitments to extend credit.

Business Restructuring Charges and Related Expenses

The Company accounts for exit or disposal activities initiated after December 31, 2002, in accordance with SFAS No. 146, "Accounting For Costs
Associated With Exit Or Disposal Activities" ("SFAS 146"). Prior to December 31, 2002, the Company accounted for its restructuring activities in accordance with EITF
No. 94-3, "Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred in a Restructuring)" ("EITF
94-3"). The principle difference between SFAS 146 and EITF 94-3 is that SFAS 146 requires that a liability for exit or disposal activities be recognized when the
liability is incurred, whereas under EITF 94-3, a liability was recognized at the date an entity committed to an exit plan.

In
accordance with SFAS 146, a business restructuring is defined as a program that is planned and controlled by management, and materially changes either the scope of a business
or the manner in which that business is conducted. Business restructuring charges include (i) one-time termination benefits related to employee separations, (ii) contract
termination costs, and (iii) other associated costs such as consolidating or closing facilities and relocating employees.

57

---

A
liability is recognized and measured at its fair value for one-time termination benefits once the plan of termination is communicated to employees and it meets all of the
following criteria: (i) management commits to a plan of termination, (ii) the plan identifies the number of employees to be terminated, their job classifications or functions, locations
and the expected completion date, (iii) the plan establishes the terms of the benefit arrangement, and (iv) it is unlikely that significant changes to the plan will be made or the plan
will be withdrawn. Contract termination costs include costs to terminate a contract or costs that will continue to be incurred under the contract without benefit to the
Company. A liability is recognized and measured at its fair value when the Company either terminates the contract or ceases using the rights conveyed by the contract. A liability is recognized and
measured at its fair value for other associated costs in the period in which the liability is incurred.

The
Company periodically evaluates its business restructuring reserve to ensure that any accrued amount no longer needed for its originally intended purpose is reversed in a timely
manner. A reversal of the liability, if any, is recorded through the same statement of operations line item that was used when the liability was initially recorded.

Pension and Postretirement Benefit Obligations

The Company maintains defined benefit pension plans covering the majority of its employees, which provide benefit payments to vested participants upon retirement.
The Company also provides certain postretirement healthcare and life insurance benefits to eligible employees. The plans use different factors, including age, years of service, and eligible
compensation, to determine the benefit amount for eligible participants. The Company funds its pension plans in compliance with applicable law. See Note 14Benefit Obligations, for
a discussion of amendments made to the Company's pension and postretirement plans which froze benefits accruals and additional participation in the plans for its management employees, effective
December 31, 2003.

Stock Compensation

The Company's employees participate in stock option plans, which are described more fully in Note 15Stock Compensation Plans. The Company
applies the recognition and measurement principles of Accounting Principles Board ("APB") Opinion No. 25, "Accounting for Stock Issued to Employees" ("APB 25") and related interpretations in
accounting for such stock compensation. Accordingly, 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 or greater than 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 based on the fair market value of the restricted stock units at the date of grant over the vesting period, which is typically three years. The following
table illustrates the effect on net loss available to common stockholders and loss per share as if the Company had applied the fair value

58

---

recognition
provisions of SFAS No. 123, "Accounting for Stock-Based Compensation" as amended by SFAS No. 148, "Accounting for Stock-Based CompensationTransition and
Disclosure."

Year Ended September 30,2003

2002

2001(dollars in millions, except per share amounts)Net loss available to common stockholders, as reported

$
(88
)
$
(803
)
$
(379
)Total stock-based employee compensation income (expense) determined under fair value based method, net of related tax effect


39


(35
)

(77
)Pro forma net loss available to common stockholders

$
(49
)
$
(838
)
$
(456
)Loss per shareBasic and DilutedAs reported

$
(0.23
)
$
(2.44
)
$
(1.33
)Pro forma

$
(0.13
)
$
(2.54
)
$
(1.60
)


The
fair value of stock options used to compute pro forma net loss resulted in additional income in fiscal 2003 because a substantial number of previously granted options had been
forfeited/expired and the cumulative reversal of pro forma expense related to these options exceeded the pro forma expense related to the remaining outstanding options.

The
fair value of stock options used to compute pro forma net loss disclosures is the estimated fair value at grant date using the Black-Scholes option-pricing model with the following
assumptions:

Year Ended September 30,2003

2002

2001WEIGHTED AVERAGE ASSUMPTIONSDividend yield

0
%
0
%
0
%Expected volatility

75.0
%
61.5
%
50.4
%Risk-free interest rate

2.7
%
4.3
%
5.7
%Expected holding period (in years)

3.8

3.9

3.3


Income Taxes

Income taxes are accounted for under the asset and liability method. Under this method, deferred tax assets and liabilities are recognized for the estimated
future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases, and operating loss and tax
credit carryforwards. Deferred tax assets and liabilities are measured using enacted tax rates in effect for the year in which those temporary differences are expected to be recovered or settled. The
effect on deferred tax assets and liabilities of a change in tax rates is recognized in the Consolidated Statement of Operations in the period that includes the enactment date. A valuation allowance
is recorded to reduce the carrying amounts of deferred tax assets if it is more likely than not that such assets will not be realized.

59

---

Other Comprehensive Income (Loss)

Other comprehensive income (loss) is recorded directly to a separate section of stockholders' equity in accumulated other comprehensive loss and includes
unrealized gains and losses excluded from the Consolidated Statements of Operations. These unrealized gains and losses consist of adjustments to the minimum pension liability, net of income taxes, and
foreign currency translation, which are not adjusted for income taxes since they primarily relate to indefinite investments in non-U.S. subsidiaries. The minimum pension liability
adjustment represents the excess of the additional pension liability over the unrecognized prior service cost.

Reclassifications

Certain prior year amounts have been reclassified to conform to the current year presentation.

3. Recent Accounting Pronouncement

FASB Interpretation No. 46

In January 2003, the Financial Accounting Standards Board ("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 other
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 and consolidation requirements of FIN 46 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 first quarter of fiscal 2004. The adoption of FIN 46 did not have a material effect on the Company's consolidated results
of operations, financial position or cash flows.

4. Goodwill and Intangible Assets

In connection with the Company's adoption of SFAS 142 on October 1, 2001, the Company reviewed the classification of its goodwill and other
intangible assets, reassessed the useful lives previously assigned
to other intangible assets, and discontinued amortization of goodwill. The Company also tested goodwill for impairment by comparing the fair values of the Company's reporting units to their carrying
values as of October 1, 2001 and determined that there was no goodwill impairment at that time. Based on this review, as of September 30, 2001, the Company classified $175 million
as goodwill, $78 million as intangible assets, net and $2 million as other assets. The Company did not identify any intangible assets having indefinite lives.

The
Company conducted the required annual impairment review during the fourth quarter of fiscal 2003 and 2002. Updated valuations were completed for all reporting units with goodwill as
of September 30, 2003 and 2002 using a discounted cash flow approach based on forward-looking information regarding market shares, revenues and costs for each reporting unit as well as
appropriate discount rates. For fiscal 2003, the Company did not identify any goodwill impairment. For fiscal 2002, due to a significant downward movement in the U.S. stock market and, in particular,
communications

60

---

technology
stocks, the Company experienced a decline in its market capitalization that negatively impacted the fair value of its reporting units. As a result, the Company recorded a goodwill
impairment charge of $44 million as an operating expense in fiscal 2002 related to its Small and Medium Business Solutions ("SMBS") operating segment.

The
changes in the carrying value of goodwill for fiscal 2003 and 2002 by operating segment are as follows:

Enterprise
Communications
Group

Small and Medium
Business Solutions

Total(dollars in millions)Balance as of September 30, 2001

$
108

$
67

$
175Goodwill acquired


6





6Purchase accounting adjustment


5





5Impact of foreign currency exchange rate fluctuations


(1
)

3


2Impairment loss





(44
)

(44
)Balance as of September 30, 2002

$
118

$
26

$
144Impact of foreign currency exchange rate fluctuations





2


2Balance as of September 30, 2003

$
118

$
28

$
146


For
the fiscal year ended September 30, 2001, goodwill amortization, net of tax, amounted to $38 million. If the Company had adopted SFAS 142 at the beginning of
fiscal 2001 and discontinued goodwill amortization, the Company's net loss and loss per common share on a pro forma basis would have been as follows:

Year Ended
September 30,
2001Pro Forma Results
(dollars in millions, except per share amounts)Net loss, as reported

$
(352
)Goodwill amortization, net of tax


38Adjusted net loss


(314
)Accretion of Series B preferred stock


(27
)Adjusted loss available to common stockholders

$
(341
)Adjusted loss per common share:Basic and Diluted

$
(1.20
)


The
Company includes its acquired intangible assets with definitive lives in other assets on the Consolidated Balance Sheets. As of September 30, 2003 and 2002, such amortized
intangible assets included existing technology and amounted to $6 million and $18 million, net of accumulated amortization of $117 million and $105 million, respectively.

Acquired
intangible assets with definite lives are amortized over a period of three to six years. Amortization expense for such intangible assets was $12 million,
$35 million and $32 million for the

61

---

fiscal
years ended September 30, 2003, 2002 and 2001, respectively. Foreign currency exchange rate fluctuations accounted for a minimal decrease in intangibles assets, net as of
September 30, 2003, and a $2 million increase as of September 30, 2002. As of September 30, 2003, the Company estimates remaining amortization expense to be
$4 million in 2004 and $2 million in 2005.

In
addition, included in other assets in the Consolidated Balance Sheets as of September 30, 2003 and 2002 is an intangible asset of $63 million and $35 million,
respectively, representing unrecognized prior service costs associated with the recording of a minimum pension liability in fiscal 2003 and 2002. This intangible asset may be eliminated or adjusted as
necessary when the amount of minimum pension liability is reassessed, which is conducted at least annually. Based on the Company's fiscal 2003 annual assessment of its minimum pension liability, the
intangible asset increased by $28 million.

As
a result of the significant downturn in the communications technology industry, the Company noted a steep decline in the marketplace assumptions for virtual private networks in the
fourth quarter of fiscal 2002 as compared with the assumptions used when Avaya acquired this existing technology through its acquisition of VPNet Technologies, Inc. ("VPNet") in
February 2001. These circumstances caused the Company to review the recoverability of its acquired intellectual property and trademarks. The Company applied the provisions of SFAS
No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of" ("SFAS 121") to its intangible assets with definite
lives and determined that the carrying value of these assets was impaired. Accordingly, the Company recorded a $27 million intangibles impairment charge as an operating expense in fiscal 2002
to write-down the carrying value of these intangible assets to an amount representing their discounted future cash flows. At the same time, the Company
removed $49 million from its Consolidated Balance Sheet representing the gross carrying amount and accumulated amortization of the related impaired intangible assets. The $27 million
impairment charge, which was recorded as accumulated amortization on the Consolidated Balance Sheet, was attributed $24 million to Enterprise Communications Group ("ECG") and $3 million
to SMBS.

5. Business Combinations and Other Transactions

Acquisitions

The following table presents historical information about certain acquisitions made by the Company during fiscal 2001. These acquisitions were accounted for under
the purchase method of accounting, and the acquired technology valuation included existing technology, purchased in-process research and development ("IPR&D") and other intangibles. The
consolidated financial statements include the results of operations and the estimated fair values of the assets and liabilities assumed from the respective dates of acquisition. All charges related to
the write-off of purchased IPR&D were

62

---

recorded
in the quarter in which the transaction was completed. There were no material acquisitions accounted for under the purchase method in fiscal 2003 and 2002.

|           |  |                  |  |   |     | Allocation of Purchase Price(1) |   | Amortization Period
(in years)
|---------- |  | ---------------- |  | - | --- | ------------------------------- | - | ------------------------------
|
|
|Quintus(2) |  | April 11, 2001   |  | $ | 29  |                                 | $ | 11                            
|VPNet(3)   |  | February 6, 2001 |  | $ | 117 |                                 | $ | 60                            

---

Included
in the purchase price for each of the above acquisitions was purchased IPR&D. At the date of each acquisition, the IPR&D projects had not yet reached technological feasibility
and had no future alternative use. Accordingly, the value allocated to these projects was capitalized and immediately expensed at acquisition. The charge related to VPNet purchased IPR&D was not
tax-deductible. The remaining purchase price was allocated to tangible and intangible assets, goodwill, and existing technology, less liabilities assumed.

The
value allocated to purchased IPR&D for the acquisitions was determined using an income approach. This involved estimating the fair value of the IPR&D, using the present value of the
estimated after-tax cash flows expected to be generated by the purchased IPR&D, using risk-adjusted discount rates and revenue forecasts as appropriate. Where appropriate, the
Company deducted an amount reflecting the contribution of the core technology from the anticipated cash flows from an IPR&D project. The selection of the discount rate was based on consideration of
the Company's weighted average cost of capital, as well as other factors, including the useful life of each technology, profitability levels of each technology, the uncertainty of technological
advances that were known at the time, and the stage of completion of each technology. The Company believes that the estimated IPR&D amounts so determined represent the fair value and do not exceed the
amount a third party would have paid for the projects.

63

---

Revenue
forecasts were estimated based on relevant market size and growth factors, expected industry trends, individual product sales cycles and the estimated life of each product's
underlying technology. Estimated operating expenses, income taxes, and charges for the use of contributory assets were deducted from estimated revenue to determine estimated after-tax cash
flows for each project. Estimated operating expenses include cost of goods sold, selling, general and administrative expenses, and research and development expenses. The research and development
expenses include estimated costs to maintain the products once they have been introduced into the market and generate revenue and costs to complete the purchased IPR&D.

Management
is primarily responsible for estimating the fair value of the assets and liabilities acquired, and has conducted due diligence in determining the fair value. Management has
made estimates and assumptions that affect the reported amounts of assets, liabilities and expenses resulting from such acquisitions. Actual results could differ from these amounts.

Other Transactions

Aircraft Sale-LeasebackIn June 2001, the Company sold a corporate aircraft for
approximately $34 million and subsequently entered into an agreement to lease it back over a five-year period. In March 2002, the Company elected to terminate the aircraft
sale-lease-back agreement and, pursuant to the terms of the agreement, purchased the aircraft in April 2002 from the lessor for a purchase price equal to the unamortized
lease balance of approximately $33 million.

Outsourcing of Certain Manufacturing FacilitiesIn May 2001, the Company closed the first phase of a
five-year strategic manufacturing agreement to outsource most of the manufacturing operations related to its ECG and SMBS segments to Celestica Inc. ("Celestica"). The Company
received $200 million in proceeds for assets transferred to Celestica and deferred $100 million of these proceeds, which are being recognized on a straight-line basis over
the term of the agreement. As of September 30, 2003 and 2002, the unamortized portion of these proceeds amounted to $20 million in other current liabilities for both periods and
$30 million and $52 million in other liabilities, respectively. The remaining phases of the transaction, which included closing the Shreveport, Louisiana facility, were completed in the
first quarter of fiscal 2002.

See
Note 20Subsequent Events for disclosure regarding the sale of Connectivity Solutions and the acquisition of Expanets.

64

---



6. Supplementary Financial Information

Statements of Operations Information

|                                                                                         |                                     | Year Ended September 30, |    
|---------------------------------------------------------------------------------------- | ----------------------------------- | ------------------------ | ---
|
|
|DEPRECIATION AND AMORTIZATION:                                                           |                                     |                          |    
|INCLUDED IN COSTS:                                                                       |                                     |                          |    
|Amortization of software development costs                                               |                                     | $                        | 25 
|INCLUDED IN SELLING, GENERAL AND ADMINISTRATIVE EXPENSES:                                |                                     |                          |    
|Amortization of goodwill                                                                 |                                     |                          |   
|Amortization of intangible assets                                                        |                                     |                          | 12 
|INCLUDED IN COSTS AND OPERATING EXPENSES:                                                |                                     |                          |    
|Depreciation and amortization of property, plant and equipment and internal use software |                                     |                          | 164
|                                                                                         |                                     |                          |    
|                                                                                         | Total depreciation and amortization |                          | $  
|                                                                                         |                                     |                          |    
|OTHER INCOME (EXPENSE), NET                                                              |                                     |                          |    
|Loss on foreign currency transactions                                                    |                                     | $                        | (2 
|Gain on assets sold                                                                      |                                     |                          | 14 
|Interest income                                                                          |                                     |                          | 15 
|Impairment of investments                                                                |                                     |                          |   
|Loss on long-term debt extinguishment, net                                               |                                     |                          | (34
|Lucent securities litigation charge                                                      |                                     |                          | (25
|Miscellaneous, net                                                                       |                                     |                          | 1  
|                                                                                         |                                     |                          |    
|                                                                                         | Total other income (expense), net   |                          | $  
|                                                                                         |                                     |                          |    

Balance Sheet Information

|                                   |                                                 | As of September 30, |    
|---------------------------------- | ----------------------------------------------- | ------------------- | ---
|
|
|INVENTORY                          |                                                 |                     |    
|Finished goods                     |                                                 | $                   | 300
|Work in-process and raw materials  |                                                 |                     | 106
|                                   |                                                 |                     |    
|                                   | Total inventory                                 |                     | $  
|                                   |                                                 |                     |    
|PROPERTY, PLANT AND EQUIPMENT, NET |                                                 |                     |    
|Land and improvements              |                                                 | $                   | 39 
|Buildings and improvements         |                                                 |                     | 500
|Machinery and equipment            |                                                 |                     | 967
|Assets under construction          |                                                 |                     | 8  
|Internal use software              |                                                 |                     | 158
|                                   |                                                 |                     |    
|                                   | Total property, plant and equipment             |                     |    
|                                   | Less: Accumulated depreciation and amortization |                     |    
|                                   |                                                 |                     |    
|                                   | Property, plant and equipment, net              |                     | $  
|                                   |                                                 |                     |    

65

---

Supplemental Cash Flow Information

|                                                    |  | Year Ended September 30, |   
|--------------------------------------------------- |  | ------------------------ | --
|
|
|ACQUISITION OF BUSINESSES:                          |  |                          |   
|Fair value of assets acquired, net of cash acquired |  | $                        | 8 
|Less: Fair value of liabilities assumed             |  |                          | (2
|                                                    |  |                          |   
|Acquisition of businesses, net of cash acquired     |  | $                        | 6 
|                                                    |  |                          |   

In
the second quarter of fiscal 2001, the Company paid off $9 million of debt assumed from its acquisition of VPNet.

|                                              |  | Year Ended September 30,
|--------------------------------------------- |  | ------------------------
|
|
|OTHER PAYMENTS:                               |  |                         
|Interest payments, net of amounts capitalized |  | $                       
|                                              |  |                         
|Income tax payments                           |  | $                       
|                                              |  |                         

|                                                                         |                                    | Year Ended September 30,
|------------------------------------------------------------------------ | ---------------------------------- | ------------------------
|
|
|NON-CASH TRANSACTIONS:                                                   |                                    |                         
|Issuance of common stock in connection with the LYONs Exchange Offer     |                                    | $                       
|Warrants to purchase common stock issued in LYONs Exchange Offer         |                                    |                         
|Accretion of Series B preferred stock                                    |                                    |                         
|Book value of converted Series B preferred stock                         |                                    |                         
|Conversion charge related to Series B preferred stock                    |                                    |                         
|Issuance of common stock in connection with the Warburg transactions     |                                    |                         
|Deferred taxes on stock options                                          |                                    |                         
|Fair market value of stock options issued in connection with acquisition |                                    |                         
|Adjustments to Contribution by Lucent:                                   |                                    |                         
|                                                                         | Accounts receivable                |                         
|                                                                         | Property, plant and equipment, net |                         
|                                                                         | Net benefit assets                 |                         
|                                                                         |                                    |                         
|Total non-cash transactions                                              |                                    | $                       
|                                                                         |                                    |                         

7. Securitization of Accounts Receivable

In June 2001, the Company entered into a receivables purchase agreement and transferred a designated pool of qualified trade accounts receivable to a
special purpose entity ("SPE"), which in

66

---

turn
sold an undivided ownership interest in the pool of receivables to an unaffiliated financial institution for cash proceeds of $200 million. The receivables purchase agreement was
terminated in March 2002 as described below. The designated pool of qualified receivables held by the SPE was pledged as collateral to secure the obligations to the financial institution.
During the term of the receivables purchase agreement, the Company, through the SPE, had a retained interest in the designated pool of receivables, representing collateral for the sale, to the extent
the value of the receivables exceeded the outstanding amount of the financial institution's investment. The financial institution had no recourse to the Company's other assets for failure of customers
to pay when due and the assets of the SPE were not available to pay creditors of the Company.

The
Company was responsible for defined fees payable monthly to the financial institution for costs associated with the outstanding capital issued by the financial institution to fund
the purchase of receivables. The Company continued to service, administer and collect the receivables on behalf of the financial institution and received a fee for performance of these services.
Collections of receivables
were used by the SPE to repay the financial institution's investment in accordance with the receivables purchase agreement, and the financial institution in turn purchased, from time to time, new
interests in receivables up to an aggregate investment at any time of $200 million.

The
transfer of accounts receivable was accounted for as a sale and, accordingly, during the term of the securitization, the accounts receivable balances were removed from the
Consolidated Balance Sheet and the proceeds received from the sale were reflected as cash provided by financing activities in the Consolidated Statement of Cash Flows. The fair value of the Company's
retained interest, which approximated its carrying amount because of the short-term nature of the receivables, was recorded in other current assets. The Company reviewed the fair value
assigned to retained interests at each reporting date using similar valuation techniques as those used to initially measure the retained interest. The Company did not record an asset or liability
related to any servicing obligations because the servicing fee received was determined to be just adequate to compensate the Company for its servicing responsibilities. Although not material, costs
associated with the sales of the receivables were recorded in other income (expense), net in the Consolidated Statement of Operations in fiscal 2001. No significant gains or losses resulted from these
transactions.

In
March 2002, the Company elected to terminate the receivables purchase agreement, which was scheduled to expire in June 2002. As a result of the early termination,
purchases of interests in receivables by the financial institution ceased, and collections on receivables that constituted the designated pool of trade accounts receivable were used to repay the
financial institution's $200 million investment, which had been entirely liquidated as of September 30, 2002. No portion of the retained interest was used to liquidate the financial
institution's investment. Upon liquidation in full in April 2002, the Company had reclassified the remaining $109 million retained interest to receivables.

8. Business Restructuring Reserve

The business restructuring reserve reflects the remaining balance associated with the business restructuring charges recorded in fiscal 2000 through 2002. The
following table summarizes the status

67

---

of
the Company's business restructuring reserve and other related expenses during fiscal 2003, 2002 and 2001:

|                                                                       |  | Business Restructuring Reserve |      |   |   |     |   |   |    
|---------------------------------------------------------------------- |  | ------------------------------ | ---- | - | - | --- | - | - | ---
|
|
|
|
|FISCAL 2001:                                                           |  |                                |      |   |   |     |   |   |    
|Balance as of October 1, 2000                                          |  | $                              | 345  |   | $ | 127 |   | $ | 27 
|Charges                                                                |  |                                | 650  |   |   | 24  |   |   |   
|Reversals                                                              |  |                                | (17  | ) |   | (7  | ) |   | (11
|Decrease in prepaid benefit costs/increase in benefit obligations, net |  |                                | (577 | ) |   |    |   |   |   
|Cash payments                                                          |  |                                | (250 | ) |   | (66 | ) |   | (11
|Asset impairments                                                      |  |                                |     |   |   |    |   |   |   
|Reclassification                                                       |  |                                | (55  | ) |   |    |   |   |   
|                                                                       |  |                                |      |   |   |     |   |   |    
|Balance as of September 30, 2001                                       |  | $                              | 96   |   | $ | 78  |   | $ | 5  
|                                                                       |  |                                |      |   |   |     |   |   |    
|FISCAL 2002:                                                           |  |                                |      |   |   |     |   |   |    
|Charges                                                                |  |                                | 116  |   |   | 84  |   |   | 1  
|Reversals                                                              |  |                                | (13  | ) |   | (4  | ) |   | (3 
|Net increase in benefit obligations                                    |  |                                | (3   | ) |   |    |   |   |   
|Cash payments                                                          |  |                                | (128 | ) |   | (56 | ) |   | (3 
|Asset impairments                                                      |  |                                |     |   |   |    |   |   |   
|                                                                       |  |                                |      |   |   |     |   |   |    
|Balance as of September 30, 2002                                       |  | $                              | 68   |   | $ | 102 |   | $ |   
|                                                                       |  |                                |      |   |   |     |   |   |    
|FISCAL 2003:                                                           |  |                                |      |   |   |     |   |   |    
|Charges                                                                |  |                                |     |   |   |    |   |   |   
|Reversals                                                              |  |                                | (19  | ) |   | (2  | ) |   |   
|Cash payments                                                          |  |                                | (45  | ) |   | (38 | ) |   |   
|                                                                       |  |                                |      |   |   |     |   |   |    
|Balance as of September 30, 2003                                       |  | $                              | 4    |   | $ | 62  |   | $ |   
|                                                                       |  |                                |      |   |   |     |   |   |    

Fiscal 2003

During fiscal 2003, the Company recorded reversals to income of $21 million primarily attributable to fewer involuntary employee separations than
originally anticipated. Additionally, in fiscal 2003 the Company incurred $16 million in other related expenses associated with our fourth quarter of fiscal 2002 restructuring initiative. These
expenses were primarily attributable to information technology ("IT") costs incurred to relocate the development of certain IT applications to India.

Fiscal 2002

During fiscal 2002, the Company experienced a decrease in its revenue as a result of the continued decline in spending on IT by its customers, specifically for
enterprise communications products and services. Despite the unpredictability of the business environment, the Company remained focused on its strategy to return to profitability by focusing on
sustainable cost and expense reduction, among other things. To achieve that goal, the Company initiated restructuring actions in fiscal 2002 to enable it to reduce costs and expenses further in order
to lower the amount of revenue needed to reach the

68

---

Company's
profitability break-even point. As a result, the Company recorded a pretax charge of $229 million in fiscal 2002 for business restructuring and related expenses. The
components of the charge included $116 million of employee separation costs, $84 million of lease termination costs, $1 million of other exit costs, and $28 million of
other related expenses. This charge was partially offset by a $20 million reversal to income primarily attributable to fewer involuntary employee separations than originally anticipated.

The
charge for employee separation costs was composed of $113 million for severance and other related costs and $3 million primarily related to the cost of curtailment in
accordance with SFAS No. 88, "Employers' Accounting for Settlements and Curtailments of Defined Benefit Pension Plans and for Termination Benefits" ("SFAS 88"). Lease termination costs included
approximately $72 million of real estate, net of sublease income that management believed was probable, and $12 million of IT lease termination payments. The $28 million of other
related expenses include relocation and consolidation costs, computer system transition expenditures, and asset impairments associated with the Company's ongoing restructuring initiatives.

The
employee separation costs were incurred in connection with the elimination of approximately 4,240 management and union-represented employee positions worldwide. As of
September 30, 2003, this workforce reduction had been completed. Employee separation payments included in the business restructuring reserve were made either through a lump sum or a series of
payments extending over a period of up to two years from the date of departure, which was an option available to certain union-represented employees. Payments to employees who elected to receive
severance through a series of payments will extend through fiscal 2004.

The
$72 million charge for real estate lease termination obligations includes approximately one million square feet of excess sales and services support, research and development,
call center and administrative offices located primarily in the U.S., which had been entirely vacated as of September 30, 2003. The real estate charge also included an adjustment to increase
the accrued amount for previously reserved sites due to a deterioration in the commercial real estate market. As a result, the Company had extended its estimates as to when it will be able to begin
subleasing certain vacated sites and established an additional accrual for lease payments originally estimated to have been offset by sublease rental income. Payments on lease obligations, net of
estimated sublease income, will be extended
through 2011 because, in certain circumstances, the remaining lease payments were less than the termination fees.

Fiscal 2001

In fiscal 2001, the Company outsourced certain manufacturing facilities and accelerated its restructuring plan that was originally adopted in
September 2000 to improve profitability and business performance as a stand-alone company. As a result, the Company recorded a pretax charge of $872 million in fiscal 2001 for business
restructuring and related expenses. This charge was partially offset by a $35 million reversal to income primarily attributable to fewer involuntary employee separations than originally
anticipated and more favorable than expected real estate lease termination costs.

The
components of the fiscal 2001 charge included $650 million of employee separation costs, $24 million of lease termination costs, and $198 million of other
related expenses. The charge for employee separation costs was composed of $577 million primarily related to enhanced pension and

69

---

postretirement
benefits, which represented the cost of curtailment in accordance with SFAS 88, and $73 million for severance, special benefit payments and other employee separation costs. The
$198 million of other related expenses was composed of $178 million for incremental period expenses primarily to facilitate the separation from Lucent, including computer system
transition costs, and $20 million for an asset impairment charge related to buildings and equipment at the Shreveport manufacturing facility. Employee separation costs of $55 million
established in fiscal 2000 for union-represented employees at Shreveport were paid as enhanced severance benefits from existing pension and benefit assets and, accordingly, such amount was
reclassified in fiscal 2001 out of the business restructuring reserve and recorded as a reduction to prepaid benefit costs.

The
employee separation costs in fiscal 2001 were incurred in connection with the elimination of 6,810 employee positions of which 5,600 were through a combination of involuntary and
voluntary separations, including an early retirement program targeted at U.S. management employees, and a workforce reduction of 1,210 employees due to the outsourcing of certain of the Company's
manufacturing operations. Employee separation payments included in the business restructuring reserve were made either through a lump sum or a series of payments extending over a period of up to two
years from the date of departure, which was an option available to certain union-represented employees. This workforce reduction was completed as of September 30, 2002.

Real
estate lease termination costs were incurred primarily in the U.S., Europe and Asia, and were reduced for sublease income that management believed was probable. Payments on lease
obligations, which consisted of real estate and equipment leases, will extend through fiscal 2005. In fiscal 2001, accrued costs for lease obligations represented approximately 666,000 square feet of
excess sales and
services support offices, materials, stocking and logistics warehouses, and Connectivity Solutions facilities. As of September 30, 2002, the Company had entirely vacated this space.

9. Long-Term Debt

Long-term debt outstanding consists of the following:

|                                                        |                      | As of September 30, |    
|------------------------------------------------------- | -------------------- | ------------------- | ---
|
|
|LYONs convertible debt, net of discount                 |                      | $                   | 287
|111/8%Senior Secured Notes, net of discount and premium |                      |                     | 666
|                                                        |                      |                     |    
|                                                        | Total long-term debt |                     | $  
|                                                        |                      |                     |    

---

70

---

Debt Ratings

The Company's ability to obtain external financing and the related cost of borrowing is affected by the Company's debt ratings, which are periodically reviewed by
the major credit rating agencies. During the first quarter of fiscal 2003, the Company's long-term debt ratings were downgraded. Debt ratings and outlooks as of September 30, 2003
and 2002 are as follows:

As of September 30,2003

2002Debt Ratings

Outlook

Debt Ratings

OutlookMoody's:Long-term senior unsecured debt

B3

Negative

Ba3

NegativeSenior secured notes

B2

Stable

Ba2

NegativeCorporate credit

B3

Stable

No RatingStandard & Poor's:Long-term senior unsecured debt

B

Stable

B

NegativeSenior secured notes

B+

Stable

B+

NegativeCorporate credit

B+

Stable

BB-

Negative


LYONs Convertible Debt

In the first quarter of fiscal 2002, the Company sold through an underwritten public offering under a shelf registration statement an aggregate principal amount
at maturity of approximately $944 million of Liquid Yield Option Notes due 2021 ("LYONs"). The proceeds of approximately $448 million, net of a $484 million discount
and $12 million of underwriting fees, were used to refinance a portion of the Company's outstanding commercial paper. The underwriting fees of $12 million were recorded as deferred
financing costs and are being amortized to interest expense over a three-year period through October 31, 2004, which represents the first date holders may require the Company to
purchase all or a portion of their LYONs.

The
original issue discount of $484 million accretes daily at a rate of 3.625% per year calculated on a semiannual bond equivalent basis. The Company does not make periodic cash
payments of interest on the LYONs. Instead, the amortization of the discount is recorded as interest expense and represents the accretion of the LYONs issue price to their maturity value. The discount
will cease to accrete on the LYONs upon maturity, conversion, purchase by the Company at the option of the holder, or redemption by Avaya. The LYONs are unsecured obligations that rank equally in
right of payment with all existing and future unsecured and unsubordinated indebtedness of the Company.

Interest
expense related to the amortization of the discount on the LYONs amounted to $14 million and $16 million for fiscal 2003 and 2002, respectively. In addition,
interest expense related to the amortization of deferred financing costs on the LYONs amounted to $4 million in each of the fiscal years ended September 30, 2003 and 2002.

71

---

LYONs Exchange Offer

In December 2002, the Company, together with 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 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 11Convertible Participating Preferred Stock 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. In January 2003, following the completion of the Exchange Offer, the Warburg Entities exercised the 5,581,101 series A warrants
for aggregate cash consideration of $55,811 and converted the LYONs they acquired in the Exchange Offer into shares of the Company's common stock, 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 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 for the loss on
long-term debt extinguishment related to the Exchange Offer, which was included in other income (expense), net. This charge reflects a $26 million loss related to the retirement of
LYONs and $10 million of expenses related to (i) series C warrants issued to the Warburg Entities; (ii) common stock issued to the Warburg Entities;
(iii) transaction costs; and (iv) the unamortized deferred financing costs from the original issuance of LYONs that were retired.

Repurchases of LYONs

During fiscal 2003, the Company repurchased $310 million aggregate principal amount at maturity of LYONs, or $160 million in accreted value, in a
series of open market transactions. The Company used a total of approximately $156 million in cash to repurchase these LYONs. The Company recognized a pre-tax gain of approximately
$2 million, net of the write-off of deferred financing costs related to the LYONs repurchased.

72

---

Conversion of LYONs

As of September 30, 2003, the 549,022 of outstanding LYONs are convertible into 20,557,415 shares of the Company's common stock at any time on or before
the maturity date. The conversion rate of
37.4437 will not be adjusted for accrued original issue discount. Upon conversion, the holder will not receive any cash payment representing accrued original issue discount. Accrued original issue
discount will be considered paid by the shares of common stock received by the holder of the LYONs upon conversion.

The
Company will adjust the conversion rate for:



The
Company and the trustee under the indenture governing the LYONs may modify or amend the LYONs or the indenture with the consent of the holders of not less than a majority in
aggregate principal amount at maturity of the LYONs then outstanding. However, the consent of the holders of each outstanding LYON would be required to make certain changes to the terms of the
indenture and the LYONs, including any change that adversely affects the rights of a holder to convert a LYON.

The
Company may redeem all or a portion of the LYONs for cash at any time on or after October 31, 2004 at a price equal to the sum of the issue price and accrued original issue
discount on the LYONs as of the applicable redemption date. Conversely, holders 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. The Company may, at its option, elect to pay the purchase price in cash or shares of common stock, or any combination thereof. If the Company
were to purchase all of the 549,022 LYONs outstanding as of September 30, 2003 at the option of the holders, the aggregate
purchase price would be approximately $298 million on October 31, 2004, $320 million on October 31, 2006, and $383 million on October 31, 2011. If the Company
elected to pay the purchase price in shares of Avaya common stock, the number of shares would be equal to the purchase price divided by the average of the market prices of Avaya common stock for the
five trading day period ending on the third business day prior to the applicable purchase date.

The
indenture governing the LYONs includes certain covenants, including a limitation on the Company's ability to grant liens on significant domestic real estate properties or the stock
of its subsidiaries holding such properties.

73

---

Senior Secured Notes

In March 2002, the Company issued through an underwritten public offering $440 million aggregate principal amount of 111/8% Senior
Secured Notes due April 2009 ("Senior Secured Notes") and received net proceeds of approximately $425 million, net of a $5 million discount and $10 million of issuance
costs. Interest on the Senior Secured Notes is payable on April 1 and October 1 of each year beginning on October 1, 2002. The $5 million discount is being amortized to
interest expense over the seven-year term to maturity. The $10 million of issuance costs were recorded as deferred financing costs and are also being amortized to interest expense
over the term of the Senior Secured Notes. The proceeds from the issuance were used to repay amounts outstanding under the five-year Credit Facility and for general corporate purposes.

The
Company may redeem the Senior Secured Notes, in whole or from time to time in part, at the redemption prices expressed as a percentage of the principal amount plus accrued and unpaid
interest to the applicable redemption date, if redeemed during the twelve-month period beginning on April 1 of the following years: (i) 2006 at 105.563%; (ii) 2007 at 102.781%;
and (iii) 2008 at 100.0%.

The
Senior Secured Notes are secured by a second priority security interest in the collateral securing the Company's obligations under the five-year Credit Facility. In the
event that (i) the Company's corporate credit is rated at least BBB by Standard & Poor's and its long-term senior unsecured debt is rated at least Baa2 by Moody's, each
without a negative outlook or its equivalent, or (ii) subject to certain conditions, at least $400 million of unsecured indebtedness is outstanding or available under the Credit
Facilities or a bona fide successor credit facility, the security interest in the collateral securing the Senior Secured Notes will terminate. The indenture governing the Senior Secured Notes includes
negative covenants that limit the Company's ability to incur secured debt and enter into sale/leaseback transactions. In addition, the indenture also includes conditional covenants that limit the
Company's ability to incur debt, enter into affiliate transactions, or make restricted payments or investments and advances. These conditional covenants will apply to the
Company until such time that the Senior Secured Notes are rated at least BBB- by Standard & Poor's and Baa3 by Moody's, in each case without a negative outlook or its equivalent.

In
May 2003, the Company sold an additional $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 included 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 March 2002.

The
Company recorded interest expense related to the Senior Secured Notes of $58 million and $25 million for the fiscal years ended September 30, 2003 and 2002,
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 $2 million and
$1 million for the fiscal years ended September 30, 2003 and 2002, respectively.

74

---



Fair Value of Long-Term Debt

The estimated aggregate fair market value of the Senior Secured Notes increased from September 30, 2002 by $463 million to $742 million as of
September 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
$232 million. With regard to the LYONs, the estimated aggregate fair value as of September 30, 2003 increased from September 30, 2002 by $112 million to
$305 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 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 values as of September 30, 2003 and 2002:

As of September 30, 2003

As of September 30, 2002Number of
Notes
Outstanding

Accreted
Value

Fair
Value

Number of
Notes
Outstanding

Accreted
Value

Fair
Value(dollars in millions)LYONs

549,022

$
287

$
305

943,632

$
476

$
193Senior Secured Notes

640,000

$
650

$
742

440,000

$
435

$
279


Credit Facility

In April 2003, the Company and the lenders under the Company's five-year revolving credit agreement ("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 September 30, 2003 and 2002, 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.

For
the four quarter period ending September 30, 2003, the Company was required to maintain a minimum Adjusted EBITDA of $220 million and a ratio of Adjusted EBITDA to
interest expense of 2.70 to 1. The Company was in compliance with all required covenants as of September 30, 2003.

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



75

---



Upon
the sale of the Company's Connectivity Solutions segment (see Note 20-Subsequent Events), 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:



Upon
the sale of the Company's Connectivity Solutions segment, 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, prior to the
October 31, 2004 put date. 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 and 50% of the net cash proceeds from the sale of the Company's Connectivity Solutions segment and its corporate aircraft. The
$216 million issuance of Senior Secured Notes in May 2003 and the $349 million of net proceeds resulting from the equity offering in September 2003, described in
Note 11Convertible Participating Preferred Stock and Other Equity Transactions, increased the amount of cash the Company may use to repurchase LYONs to the $400 million
maximum amount allowable under the Credit Facility. As of September 30, 2003, the Company had used approximately $156 million in cash to repurchase LYONs and, as a result of the
amendments to the Credit Facility, the May 2003 public offering of Senior Secured Notes and the September 2003 equity offering, the Company has the ability under the amended Credit
Facility to use an additional $244 million in cash to repurchase LYONs.

In
connection with the October 31, 2004 put obligation, 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. For purposes of this calculation,

76

---

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 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. To the extent the Company can satisfy this liquidity test, it may use cash to satisfy any put obligation with respect to the LYONs.

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.

See
Note 20Subsequent Events for disclosure regarding an amendment made to the Credit Facility in October 2003.

10. Derivatives and Other Financial Instruments

The Company conducts its business on a multi-national basis in a wide variety of foreign currencies and, as such, uses derivative financial instruments to reduce
earnings and cash flow volatility associated with foreign exchange rate changes. Specifically, the Company uses foreign currency forward contracts, and to a lesser extent, foreign currency options to
mitigate the effects of fluctuations of exchange rates associated with certain existing assets and liabilities that are denominated in non-functional currencies and, from time to time, to
reduce anticipated net foreign currency cash flows resulting from normal business operations. In addition, the Company uses interest rate swap agreements to manage its proportion of fixed and floating
rate debt and to reduce interest expense.

The
Company engages in foreign currency hedging activities to reduce the risk that changes in exchange rates will adversely affect the eventual net cash flows resulting from the sale of
products to foreign customers and purchases from foreign suppliers. The Company believes that it has achieved risk reduction and hedge effectiveness because the gains and losses on its derivative
instruments substantially offset the losses and gains on the assets, liabilities and transactions being hedged. Hedge effectiveness is periodically measured by comparing the change in fair value of
each hedged foreign currency exposure at the applicable market rate with the change in market value of the corresponding derivative instrument.

Recorded Transactions

The Company utilizes foreign currency forward contracts primarily to manage short-term exchange rate exposures on certain receivables, payables and
loans residing on foreign subsidiaries' books, which are denominated in currencies other than the subsidiary's functional currency. When these items are revalued into the subsidiary's functional
currency at the month-end exchange rates, the fluctuations in the exchange rates are recognized in earnings as other income or expense. Changes in the fair value of the Company's foreign
currency forward and option contracts used to offset these exposed items are also recognized in earnings as other income or expense in the period in which the exchange rates change. For the fiscal
years ended September 30, 2003 and 2002, the changes in the fair value of the

77

---

foreign
currency forward and option contracts were substantially offset by changes resulting from the revaluation of the hedged items.

Forecasted Transactions

From time to time, the Company uses foreign currency forward and option contracts to offset certain forecasted foreign currency transactions primarily related to
the purchase or sale of product expected to occur during the ensuing twelve months. The change in the fair value of foreign currency forward and option contracts is recognized as other income or
expense in the period in which the exchange rates change. For the fiscal year ended September 30, 2003, these gains and losses were not material to the Company's results of operations. The
Company did not use any foreign currency forward or option contracts for forecasted transactions in fiscal 2002. As permitted under SFAS 133, the Company has elected not to designate its
forward and option contracts as hedges thereby precluding the use of hedge accounting for these instruments.

The
notional amount of the Company's financial instruments represents the face amount of the contractual arrangements and the basis on which U.S. dollars are to be exchanged. They are
not a measure of market or credit exposure. The notional amount as of September 30, 2003 and 2002 of the Company's foreign currency forward contracts were $472 million and
$271 million, respectively. As of September 30, 2003, the Company did not hold any foreign currency option contracts. As of September 30, 2002, the notional amount of the
Company's foreign currency option contracts were $20 million. In fiscal 2003, these notional amounts principally represent the equivalent in U.S. dollars for contracts in euros of
$256 million, British pound sterling of $153 million, Australian dollars of $14 million, Mexican pesos of $12 million, Canadian dollars of $10 million and other
foreign currencies of $27 million. In fiscal 2002, these notional amounts principally represented the equivalent in U.S. dollars for contracts in British pounds sterling of $121 million,
euros of $116 million, Canadian dollars of $31 million and other foreign currencies of $23 million.

Fair Value

The carrying amounts of cash and cash equivalents, accounts receivable, accounts payable and accrued liabilities approximate fair value because of their
short-term maturity and variable rates of interest.

As
of September 30, 2003 and 2002, the estimated fair values of forward contracts and options were $11 million and $10 million, respectively, and were included in
other current assets. The estimated fair values of these forward contracts and options were based on market quotes obtained through independent pricing sources.

Interest Rate Swap Agreements

In April 2002, the Company entered into two interest rate swap agreements with a total notional amount of $200 million that were to mature in
April 2009 and were executed in order to: (i) convert a portion of the Senior Secured Notes fixed-rate debt into floating-rate debt; (ii) maintain a
capital structure containing appropriate amounts of fixed and floating-rate debt; and (iii) reduce net interest payments and expense in the near-term.

78

---

In
December 2002, the Company cancelled both interest rate swap agreements. 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. The Company recognized $3 million in fiscal 2003, 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 $16 million as of September 30, 2003.

Under
these agreements, the Company received a fixed interest rate of 111/8% and paid a floating interest rate based on the six-month LIBOR (in arrears) plus
an agreed-upon spread, which was equal to a weighted average interest rate of 6.8% as of September 30, 2002. The amounts paid and received were calculated based on the total
notional amount of $200 million. Since the relevant terms of the swap agreements matched the corresponding terms of the Senior Secured Notes, there was no hedge ineffectiveness. Accordingly, as
required by SFAS 133, gains and losses on the swap agreements fully offset the losses and gains on the hedged portion of the Senior Secured Notes, which were marked to market at each reporting
date. As of September 30, 2002, the Company recorded the fair market value of the swaps of $22 million as other assets along with a
corresponding increase to the hedged debt with equal and offsetting unrealized gains and losses included in other income (expense), net.

Interest
payments were recognized through interest expense and were to be made and received on the first day of each April and October, commencing on October 1, 2002 and ending on
the maturity date. On the last day of each semi-annual interest payment period, the interest payment for the previous six months was to be made based upon the six-month LIBOR
rate (in arrears) on that day, plus the applicable spread, as shown in the table below. Since the interest rate was not known until the end of each semi-annual interest period, estimates
were used during such period based upon published forward-looking LIBOR rates. Any differences between the estimated interest expense and the actual interest payment were recorded to interest expense
at the end of each semi-annual interest period. These interest rate swaps resulted in a reduction to actual interest expense in fiscal 2002 of $4 million.

The
following table outlines the terms of the swap agreements:

|Maturity Date |       | Notional Amount |     | Receive Fixed
Interest Rate |       | Pay Variable Interest Rate
|------------- | ----- | --------------- | --- | --------------------------- | ----- | --------------------------
|
|April 2009    |       | $               | 150 |                             | 111/8 | %                         
|April 2009    |       |                 | 50  |                             | 111/8 | %                         
|              |       |                 |     |                             |       |                           
|              | Total |                 | $   | 200                         |       |                           
|              |       |                 |     |                             |       |                           

Each
counterparty to the swap agreements was a lender under the five-year Credit Facility. The Company's obligations under these swap agreements were secured on the same
basis as its obligations under the five-year Credit Facility.

Non-Derivative and Off-Balance-Sheet Instruments

Requests for providing commitments to extend credit and financial guarantees are reviewed and approved by senior management. Management regularly reviews all
outstanding commitments, letters of credit and financial guarantees, and the results of these reviews are considered in assessing the

79

---

adequacy
of the Company's reserve for possible credit and guarantee losses. See Note 18-Commitments and Contingencies for the disclosure of these items.

11. Convertible Participating Preferred Stock and Other Equity Transactions

Warburg Transactions

Convertible Participating Preferred Stock

In October 2000, the Company sold to the Warburg Entities four million shares of the Company's Series B convertible participating preferred stock
and series A and series B warrants to purchase the Company's common stock for an aggregate purchase price of $400 million. The Series B preferred stock had an aggregate
initial liquidation value of $400 million and accreted at an annual rate of 6.5%, compounded quarterly. The $400 million of proceeds were initially allocated between the Series B
preferred stock and warrants based upon the relative fair market value of each security. The fair value allocated to the Series B preferred stock of $368 million was recorded in the
mezzanine section of the Consolidated Balance Sheet and the fair value allocated to the warrants of $32 million was included in additional paid-in capital.

In
March 2002, the Company completed a series of transactions pursuant to which the Warburg Entities acquired 53 million shares of Avaya common stock by
(i) converting all four million shares of the Series B preferred stock into 38,329,365 shares of the Company's common stock based on a conversion price of $11.31 per share, which was
reduced from the original conversion price of $26.71 per share, (ii) exercising 286,682 warrants at an exercise price of $34.73 per share resulting in gross proceeds of approximately
$10 million, and (iii) purchasing 14,383,953 shares of the Company's common stock for $6.26 per share, which was the reported closing price of Avaya's common stock on the New York Stock
Exchange on March 8, 2002, resulting in gross proceeds of approximately $90 million. In connection with these transactions, the Company incurred approximately $4 million of
transaction costs, which were recorded as a reduction to additional paid-in capital. Following these transactions, there were no shares of Series B preferred stock outstanding.

The
conversion of the Series B preferred stock and the exercise of the warrants resulted in a charge to accumulated deficit of approximately $125 million, which primarily
represented the impact of reducing the preferred stock conversion price from $26.71 per share to $11.31 per share. The Company also recorded as a reduction to accumulated deficit a total of
$12 million and $27 million of accretion for the period from October 1, 2001 through the date of conversion and for fiscal 2001, respectively.

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 and was 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, which is a component of other income (expense), net.

80

---

As
of September 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


Public Offerings of Common Stock

In September 2003, the Company sold 34.5 million shares of common stock for $10.20 per share in a public offering. The Company received proceeds of
approximately $349 million, which was net of approximately $3 million of underwriting discounts and commissions reflected as a reduction to additional paid-in capital.

In
March 2002, the Company sold 19.55 million shares of common stock for $5.90 per share in a public offering. The Company received proceeds of approximately
$112 million, which was net of approximately $3 million of underwriting fees reflected as a reduction to additional paid-in capital.

12. Loss Per Share of Common Stock

Basic earnings (loss) per common share is calculated by dividing net loss available to common stockholders by the weighted average number of common shares
outstanding during the year. Diluted earnings (loss) per common share is calculated by adjusting net 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.

81

---

Net
loss available to common stockholders for both the basic and diluted loss per common share calculations for the fiscal year ended September 30, 2002 includes the
$125 million conversion charge related to the Series B preferred stock.

|                                                                           |                             | Year Ended
September 30, |      
|-------------------------------------------------------------------------- | --------------------------- | ------------------------ | -----
|
|
|Net loss available to common stockholders                                  |                             | $                        | (88  
|                                                                           |                             |                          |      
|Shares used in computing loss per common share:                            |                             |                          |      
|Basic and Diluted                                                          |                             |                          | 378  
|                                                                           |                             |                          |      
|Loss per common share:                                                     |                             |                          |      
|Basic and Diluted                                                          |                             | $                        | (0.23
|                                                                           |                             |                          |      
|Securities excluded from the computation of diluted loss per common share: |                             |                          |      
|Options(1)                                                                 |                             |                          | 43   
|Restricted stock units(1)                                                  |                             |                          | 4    
|Series B preferred stock(2)                                                |                             |                          |     
|Warrants(1)                                                                |                             |                          | 10   
|Common shares issuable upon conversion of LYONs:                           |                             |                          |      
|                                                                           | Settled in common shares(3) |                          |      
|                                                                           | Settled in cash(4)          |                          |      
|                                                                           |                             |                          |      
|Total                                                                      |                             |                          | 213  
|                                                                           |                             |                          |      

---

82

---



13. Income Taxes

A reconciliation of the Company's income tax provision (benefit) at the federal statutory rate to the income tax provision (benefit) at the effective tax rate is
as follows:

|                                                                                  |  | Year Ended September 30, |    
|--------------------------------------------------------------------------------- |  | ------------------------ | ---
|
|
|Income tax provision (benefit) computed at the federal statutory rate             |  | $                        | 2  
|State and local income taxes, net of federal income tax effect                    |  |                          | 2  
|Tax differentials on foreign earnings                                             |  |                          | 17 
|Purchased in-process research and development and other acquisition related costs |  |                          |   
|Non-deductible restructuring costs                                                |  |                          | 17 
|LYONs redemption                                                                  |  |                          | 6  
|Audit settlements                                                                 |  |                          | (45
|Sale of investments                                                               |  |                          | (5 
|Non-deductible meals and entertainment and employee benefit costs                 |  |                          | 2  
|Other differencesnet                                                             |  |                          | (1 
|Valuation allowance                                                               |  |                          | 98 
|                                                                                  |  |                          |    
|Provision (benefit) for income taxes                                              |  | $                        | 93 
|                                                                                  |  |                          |    

The
following table presents the U.S. and foreign components of income (loss) before income taxes and the provision (benefit) for income taxes:

|                                      |  | Year Ended September 30, |   
|------------------------------------- |  | ------------------------ | --
|
|
|INCOME (LOSS) BEFORE INCOME TAXES:    |  |                          |   
|U.S.                                  |  | $                        | 2 
|Foreign                               |  |                          | 3 
|                                      |  |                          |   
|Income (loss) before income taxes     |  | $                        | 5 
|                                      |  |                          |   
|PROVISION (BENEFIT) FOR INCOME TAXES: |  |                          |   
|CURRENT                               |  |                          |   
|Federal                               |  | $                        |  
|State and local                       |  |                          | 3 
|Foreign                               |  |                          | 22
|                                      |  |                          |   
|Subtotal                              |  | $                        | 25
|                                      |  |                          |   
|DEFERRED                              |  |                          |   
|Federal                               |  | $                        | 49
|State and local                       |  |                          | 22
|Foreign                               |  |                          | (3
|                                      |  |                          |   
|Subtotal                              |  | $                        | 68
|                                      |  |                          |   
|Provision (benefit) for income taxes  |  | $                        | 93
|                                      |  |                          |   

83

---

The
components of deferred tax assets and liabilities as of September 30, 2003 and 2002 are as follows:

As of September 30,2003

2002(dollars in millions)DEFERRED INCOME TAX ASSETSBenefit obligations

$
506

$
523Accrued liabilities


346


387Net operating loss/credit carryforwards


436


241Other


59


82Gross deferred tax assets

$
1,347

$
1,233DEFERRED INCOME TAX LIABILITIESProperty, plant and equipment

$
(41
)
$
(5
)Other


(53
)

(84
)Gross deferred tax liabilities

$
(94
)
$
(89
)Valuation allowance

$
(814
)
$
(612
)NET DEFFERED TAX ASSET

$
439

$
532


As
of September 30, 2003, the Company had tax credit carryforwards of $37 million and federal, state and local and foreign net operating loss carryforwards
(after-tax) of $399 million. The various tax credit carryforwards of $11 million, $16 million and $10 million expire within 5 years, between 5 and ten
years, and in excess of ten years, respectively. Federal and state net operating loss
carryforwards expire through the year 2023, the majority of which expire in excess of ten years. The majority of foreign net operating loss carryforwards have no expiration.

During
fiscal 2003, the Company recorded an increase of $202 million to its net deferred tax asset valuation allowance. 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, a $93 million reduction in accumulated
other comprehensive loss associated with the minimum pension liability recorded in accordance with SFAS No. 87, "Employers' Accounting for Pensions," ("SFAS 87"), and a $3 million
adjustment related to the exercise of stock options which served to decrease taxable income for the year. In addition, the valuation allowance balance increased by $32 million as a result of
the reversal of certain deferred tax liabilities related to pre-spin federal income tax audits. The increase in the valuation allowance was partially offset by a $9 million benefit
included in the tax provision as a result of having positive book taxable income for the year including certain other tax adjustments.

During
fiscal 2002, the Company recorded an increase of $563 million to its net deferred tax asset valuation allowance. The increase in the valuation allowance was comprised of a
$364 million charge included in the provision for income taxes and a $202 million reduction in accumulated other comprehensive loss associated with the minimum pension liability recorded
in accordance with SFAS 87. The increase in the valuation allowance was partially offset with $3 million of net operating losses that expired during fiscal 2002.

84

---

The
valuation allowances recorded in fiscal 2003 and 2002 were calculated in accordance with the provisions of SFAS No. 109, "Accounting for Income Taxes," which places primary
importance on the Company's cumulative operating results.

In
assessing the realizability of deferred tax assets, the Company considers whether it is more likely than not that some portion or all of the deferred tax assets will not be realized.
The Company considered the scheduled reversal of deferred tax liabilities, projected future taxable income, and certain distinct tax planning strategies in making this assessment. The amount of net
deferred tax determined to be realizable was measured by calculating the tax effect of the tax planning strategies, which include potential sale of assets and liabilities. Based on this assessment, as
of September 30, 2003, the Company determined that it is more likely than not that $439 million of such assets will be realized, therefore resulting in a valuation allowance of
$814 million. Based on the fiscal 2002 assessment, the Company had determined that it was more likely than not that $532 million of such assets were to be realized, therefore resulting
in a valuation allowance of $612 million. If changes occur in the assumptions underlying the Company's tax planning strategies or in the scheduling of the reversal of the Company's deferred tax
liabilities, the valuation allowance may need to be adjusted in the future.

The
Company has not provided for U.S. deferred income taxes or foreign withholding taxes on $681 million and $632 million of undistributed earnings of its
non-U.S. subsidiaries as of September 30, 2003 and 2002, respectively, since the Company intends to reinvest these earnings indefinitely.

14. Benefit Obligations

Pension and Postretirement Benefits

The Company maintains defined benefit pension plans covering the majority of its employees and retirees, and postretirement benefit plans for retirees that
include healthcare benefits and life insurance coverage. In fiscal 2003, the Company adopted amendments to its pension and postretirement plans. Effective December 31, 2003, the Company froze
the benefit accruals and additional participation in the plans for its management employees. The Company also enhanced its 401(k) savings plan for its management employees, effective January 1,
2004. The changes in the pension and postretirement plans were accounted for as curtailments in accordance with SFAS 88. Effective June 1, 2003, the Company entered into new collective
bargaining agreements with the Communications Workers of America and the International Brotherhood of Electrical Workers, which included pension increases and postretirement healthcare limitation
increases over the term of the 3 year agreements. Additionally, the Company provided current retirees of the management pension plan with a one-time opportunity to take a full or
partial lump sum distribution from the plan with a payout date of December 1, 2003.

For
the fiscal year ended September 30, 2003, the Company recorded a net pension credit of $8 million, which included a $31 million curtailment gain from freezing
management pension benefit accruals, and a $7 million charge for special termination benefits offered to represented employees as a result of the new collective bargaining agreements. The
Company also recorded a net postretirement benefit expense of $18 million, which included a $15 million gain related to the curtailment. During fiscal 2003, the projected benefit
obligation decreased by $55 million as a result of the amendments to the Company's pension plan for the curtailment of benefit accruals, the new collective bargaining agreements, and the lump
sum distribution for its retirees. The projected postretirement benefit

85

---

obligation
increased by $98 million as a result of the amendment to the Company's postretirement plan for the collective bargaining agreements.

In
fiscal 2003, the Company made contributions totaling $155 million to its pension plans, which included $42 million under the minimum funding requirements of ERISA
and a $105 million voluntary
contribution to fund the pension obligation for management employees. This voluntary contribution eliminated the required contribution that was to be made in fiscal 2004.

On
September 30, 2003, the Company's annual measurement date, the accumulated benefit obligation related to the Company's pension plans exceeded the fair value of the pension plan
assets (such excess is referred to as an unfunded accumulated benefit obligation). This difference reflects an increase in the accumulated benefit obligation that resulted from a decrease from 6.5% to
6.0% in the interest rate used to discount the projected benefit obligation to its present settlement amount. The unfunded accumulated benefit obligation exceeded the Company's accrued pension
liability by $813 million, an increase of $265 million from September 30, 2002. As a result, in accordance with SFAS 87, the Company recorded an adjustment to increase the
additional minimum pension liability from $548 million at September 30, 2002 to $813 million at September 30, 2003. This resulted in a $237 million increase to
accumulated other comprehensive loss, from $513 million at September 30, 2002 to $750 million at September 30, 2003, and a $28 million increase to intangible assets,
from $35 million at September 30, 2002 to $63 million at September 30, 2003.

In
conjunction with the recognition of the additional minimum pension liability, the Company also recorded in fiscal 2003 a deferred tax asset of $93 million for which a full
valuation allowance was established. This increased the deferred tax asset related to the minimum pension liability from $202 million at September 30, 2002, to $295 million at
September 30, 2003. Accordingly, both the deferred tax asset and related valuation allowance were recorded through accumulated other comprehensive loss.

In
fiscal 2002, the Company recorded pension and postretirement expense of $6 million and $23 million, respectively, including charges for curtailment and special
termination benefits of $1 million each related to its pension plan, in connection with the Company's business restructuring efforts. During fiscal 2002, the Company amended its pension plan
for represented employees by increasing the pension benefit for certain employees, which resulted in an increase of $11 million to the projected benefit obligation.

In
fiscal 2001, the Company recorded pension and postretirement expense of $457 million and $138 million, respectively, including charges for curtailment and special
termination benefits of $474 million and $112 million, respectively, in connection with the Company's business restructuring efforts. The Company's pension plans experienced significant
decreases in the number of active employees due to these restructuring initiatives related to a manufacturing outsourcing transaction and an early retirement program. As a result, interim measurements
were performed and curtailment accounting was implemented. The Company recognized a charge from curtailment and special termination benefits related to its pension plan of $26 million and
$448 million, respectively. The Company has several non-pension postretirement benefit plans. Consistent with the curtailment accounting recorded for pensions during fiscal 2001,
the Company recorded curtailment and special termination benefit charges of $91 million and $21 million, respectively. The special termination benefits provided employees with improved
pension benefits and earlier eligibility for postretirement benefits.

86

---

The
following table shows the activity in the Company's defined benefit and postretirement plans:

|                                                                  |  |   |       |   |   | Postretirement Benefits |  
|----------------------------------------------------------------- |  | - | ----- | - | - | ----------------------- | -
|
|
|
|
|
|CHANGE IN BENEFIT OBLIGATION                                      |  |   |       |   |   |                         |  
|Benefit obligation as of October 1                                |  | $ | 2,739 |   | $ | 2,518                   |  
|Service cost                                                      |  |   | 53    |   |   | 54                      |  
|Interest cost                                                     |  |   | 173   |   |   | 171                     |  
|Amendments                                                        |  |   | (55   | ) |   | 11                      |  
|Actuarial loss                                                    |  |   | 316   |   |   | 177                     |  
|Special termination benefits                                      |  |   | 7     |   |   | 1                       |  
|Benefits paid                                                     |  |   | (193  | ) |   | (193                    | )
|                                                                  |  |   |       |   |   |                         |  
|Benefit obligation as of September 30                             |  | $ | 3,040 |   | $ | 2,739                   |  
|                                                                  |  |   |       |   |   |                         |  
|CHANGE IN PLAN ASSETS                                             |  |   |       |   |   |                         |  
|Fair value of plan assets as of October 1                         |  | $ | 1,941 |   | $ | 2,371                   |  
|Actual return (loss) on plan assets                               |  |   | 311   |   |   | (241                    | )
|Employer contributions                                            |  |   | 155   |   |   | 4                       |  
|Benefits paid                                                     |  |   | (193  | ) |   | (193                    | )
|                                                                  |  |   |       |   |   |                         |  
|Fair value of plan assets as of September 30                      |  | $ | 2,214 |   | $ | 1,941                   |  
|                                                                  |  |   |       |   |   |                         |  
|UNFUNDED STATUS OF THE PLAN                                       |  | $ | (826  | ) | $ | (798                    | )
|Unrecognized prior service cost                                   |  |   | 39    |   |   | 1                       |  
|Unrecognized transition asset                                     |  |   |      |   |   | (1                      | )
|Unrecognized net loss                                             |  |   | 778   |   |   | 626                     |  
|                                                                  |  |   |       |   |   |                         |  
|Accrued benefit cost                                              |  | $ | (9    | ) | $ | (172                    | )
|                                                                  |  |   |       |   |   |                         |  
|AMOUNT RECOGNIZED IN THE CONSOLIDATED BALANCE SHEETS CONSISTS OF: |  |   |       |   |   |                         |  
|Accrued benefit cost                                              |  | $ | (822  | ) | $ | (720                    | )
|Intangible asset                                                  |  |   | 63    |   |   | 35                      |  
|Accumulated other comprehensive loss                              |  |   | 750   |   |   | 513                     |  
|                                                                  |  |   |       |   |   |                         |  
|Net amount recognized                                             |  | $ | (9    | ) | $ | (172                    | )
|                                                                  |  |   |       |   |   |                         |  

|                                                                 |  | As of September 30, |  
|---------------------------------------------------------------- |  | ------------------- | -
|
|PENSION AND POSTRETIREMENT BENEFITS WEIGHTED AVERAGE ASSUMPTIONS |  |                     |  
|Discount rate                                                    |  | 6.0                 | %
|Expected return on plan assets                                   |  | 9.0                 | %
|Rate of compensation increase                                    |  | 4.0                 | %

87

---

For
postretirement healthcare, a 10.3% annual rate of increase in the per capita cost of covered healthcare benefits was assumed for fiscal 2003. The rate was assumed to decline
gradually to 5.0% by the year 2009, and remain at that level thereafter.

|                                                 |  | Pension Benefits |      | Postretirement Benefits |  
|------------------------------------------------ |  | ---------------- | ---- | ----------------------- | -
|
|
|
|COMPONENTS OF NET PERIODIC BENEFIT (CREDIT) COST |  |                  |      |                         |  
|Service cost                                     |  | $                | 53   |                         | $
|Interest cost                                    |  |                  | 173  |                         |  
|Expected return on plan assets                   |  |                  | (214 | )                       |  
|Amortization of unrecognized prior service cost  |  |                  | 5    |                         |  
|Recognized net actuarial loss (gain)             |  |                  |     |                         |  
|Amortization of transition asset                 |  |                  | (1   | )                       |  
|Curtailment (gain) loss                          |  |                  | (31  | )                       |  
|Special termination benefits                     |  |                  | 7    |                         |  
|                                                 |  |                  |      |                         |  
|Net periodic benefit (credit) cost               |  | $                | (8   | )                       | $
|                                                 |  |                  |      |                         |  

As
of September 30, 2003 and 2002, the Company's pension and postretirement plan assets did not hold any direct investment in the Company's common stock.

Postretirement
health care trend rates have a slight effect on the amounts reported for the postretirement health care plan. A one-percentage-point increase in the Company's
healthcare cost trend rates would have increased the postretirement benefit obligation by $1 million. Conversely, a one-percentage-point decrease would have decreased the
postretirement benefit obligation by $1 million. A one-percentage-point change in the Company's healthcare cost trend rates would have had a minimal effect on the total of the
service and interest cost components of net periodic benefit costs.

Savings Plans

The majority of the Company's employees are eligible to participate in savings plans sponsored by the Company. The plans allow employees to contribute a portion
of their compensation on a pre-tax and after-tax basis in accordance with specified guidelines. Avaya matches a percentage of employee contributions up to certain limits. The
Company's expense related to these savings plans was $31 million, $24 million and $58 million in fiscal 2003, 2002 and 2001, respectively.

Effective
January 1, 2004, the Company enhanced its savings plans for management employees that increased the value of the Company's contribution towards the plans.

15. Stock Compensation Plans

The Company has stock compensation plans, which provide for the issuance to eligible employees of nonqualified stock options and restricted stock units
representing Avaya common stock. In addition,

88

---

the
Company has a stock purchase plan under which eligible employees have the ability to purchase shares of Avaya common stock at 85% of market value.

Stock Options

Stock options are generally granted with an exercise price equal to or above the market value of a share of common stock on the date of grant, have a term of
10 years or less and vest within four years from the date of grant. As of September 30, 2003, there were approximately 42 million stock options authorized for grant to purchase
Avaya common stock under the Company's stock compensation plans.

In
connection with certain of the Company's acquisitions, outstanding stock options held by employees of acquired companies became exercisable for Avaya's common stock, according to
their terms, effective at the acquisition date. For acquisitions accounted for as purchases, the fair value of these options was included as part of the purchase price.

The
following table summarizes information concerning options outstanding including the related transactions for the fiscal years ended September 30, 2003, 2002 and 2001:

|                                             |  | Shares
(000's) |   | Weighted Average
Exercise Price
|-------------------------------------------- |  | -------------- | - | -------------------------------
|OPTIONS OUTSTANDING AS OF SEPTEMBER 30, 2000 |  | 44,971         |   | $                              
|Granted/Assumed                              |  | 31,626         |   |                                
|Exercised                                    |  | (1,384         | ) |                                
|Forfeited/Expired/Exchanged(1)               |  | (26,890        | ) |                                
|                                             |  |                |   |                                
|OPTIONS OUTSTANDING AS OF SEPTEMBER 30, 2001 |  | 48,323         |   |                                
|Granted                                      |  | 10,391         |   |                                
|Exercised                                    |  | (153           | ) |                                
|Forfeited and Expired(2)                     |  | (13,733        | ) |                                
|                                             |  |                |   |                                
|OPTIONS OUTSTANDING AS OF SEPTEMBER 30, 2002 |  | 44,828         |   |                                
|Granted                                      |  | 14,076         |   |                                
|Exercised                                    |  | (1,087         | ) |                                
|Forfeited and Expired                        |  | (6,115         | ) |                                
|                                             |  |                |   |                                
|OPTIONS OUTSTANDING AS OF SEPTEMBER 30, 2003 |  | 51,702         |   | $                              
|                                             |  |                |   |                                

---

The
weighted average fair value of the Company's stock options granted during the fiscal years ended September 30, 2003, 2002 and 2001, calculated using the Black-Scholes
option-pricing model, was $1.80, $3.14, and $5.86 per share, respectively.

89

---

The
following table summarizes the status of the Company's stock options as of September 30, 2003:

|                   |  | Stock Options Outstanding |  | Stock Options Exercisable
|------------------ |  | ------------------------- |  | -------------------------
|
|$  0.01 to $  3.25 |  | 12,611                    |  | 6.13                     
|$  3.26 to $  7.39 |  | 7,664                     |  | 5.66                     
|$  7.40 to $11.75  |  | 3,003                     |  | 6.75                     
|$11.76 to $21.09   |  | 21,096                    |  | 6.87                     
|$21.10 to $51.21   |  | 7,328                     |  | 5.23                     
|                   |  |                           |  |                          
|Total              |  | 51,702                    |  |                          
|                   |  |                           |  |                          

At
September 30, 2002, there were 18.1 million exercisable outstanding stock options with a weighted average exercise price of $19.94. At September 30, 2001, there
were 13.4 million exercisable outstanding stock options with a weighted average exercise price of $26.03.

Non-Employee Directors Plan

The Company also has a Stock Compensation Plan for Non-Employee Directors under which stock options have been granted. Stock options were granted to
Non-Employee Directors in order to attract and retain qualified individuals to serve as members of the Board of Directors. The options granted were priced at the fair market value on the
date of grant. These options generally became exercisable six months from the date of grant and expire after ten years. No options have been granted under this plan since December 2002.

As
of September 30, 2003, there were approximately 915 thousand stock options outstanding under this plan with a weighted average exercise price of $10.08 issued to
Non-Employee Directors.

Employee Stock Purchase Plan

Under the terms of the Company's employee stock purchase plan, eligible employees may have up to 10% of eligible compensation deducted from their pay to purchase
Avaya common stock. The Avaya Inc. Employee Stock Purchase Plan ("2000 ESPP") was terminated on March 1, 2003 and replaced with the Avaya Inc. 2003 Employee Stock Purchase Plan
("2003 ESPP") which has terms virtually identical to the 2000 ESPP. The 2003 ESPP was approved by the Company's stockholders in February 2003, became effective January 1, 2003, and
expires on March 1, 2006. All purchases of the Company's common stock made after December 31, 2002 were made under the 2003 ESPP.

Under
the 2003 and 2000 ESPPs, the per share purchase price is 85% of the average high and low per share trading price of Avaya's common stock on the New York Stock Exchange ("NYSE") on
the last trading day of each month. During the fiscal years ended September 30, 2003, 2002 and 2001, 3.9 million, 3.8 million and 3.0 million shares were purchased under
the 2003 and 2000 ESPPs at a weighted average price of $2.48, $4.85 and $10.95, respectively.

90

---

Restricted Stock Units

The Company's stock compensation plans permit the granting of restricted stock units to eligible employees at fair market value at the date of grant and typically
become fully vested over a three-year period. Restricted stock units are payable in shares of the Company's common stock upon vesting. The Company records compensation expense for the
amortization of restricted stock units issued to employees, utilizing the intrinsic-value method, which would result in the same amount of compensation expense that would be recognized as if the
Company had applied the fair value recognition provisions of SFAS 123. Compensation expense recorded under APB 25 related to restricted stock units was $31 million, $24 million,
and $17 million for the fiscal years ended September 30, 2003, 2002, and 2001, respectively, of which $1 million and $7 million was recorded as business restructuring
charges in fiscal 2002 and 2001, respectively.

The
following table presents the total number of shares of common stock represented by restricted stock units granted to Company employees, including those granted in connection with the
Exchange described below:

Year Ended September 30,2003

2002

2001Restricted stock units granted (000's)


6,247


526


4,394Weighted average market value of shares granted during the period

$
3.29

$
7.11

$
13.06


As
of September 30, 2003, there were approximately 8 million restricted stock units not vested that are outstanding.

In
connection with the amounts recorded as a business restructuring charge for the vesting of restricted stock units, the Company issued 93,000 and 326,000 common shares to employees who
departed the business in fiscal 2002 and 2001, respectively.

In
June 2001, the Company commenced an offer to eligible employees to exchange (the "Exchange") certain employee stock options for restricted stock units representing common
shares. The Exchange was based on a predetermined exchange value divided by $12.85 per common share, which was the average of the high and low trading prices of Avaya common stock on the NYSE on
July 26, 2001. As a result of the Exchange, approximately 19.5 million options were cancelled and approximately 3.4 million restricted stock units were granted on July 31,
2001. The restricted stock units resulting from the Exchange will vest in three succeeding annual anniversary dates beginning on August 1, 2002, subject to acceleration of vesting upon certain
events.

The
Company recorded approximately $43 million as non-cash deferred compensation for the intrinsic value of the restricted stock units on the effective date of the
Exchange. This amount was calculated by multiplying the number of restricted stock units by $12.62, which was the average of the high and low trading price of the Company's common stock on the NYSE on
July 31, 2001, the date of grant of the restricted stock units. The non-cash deferred compensation associated with the restricted stock units will be recognized as compensation
expense recorded under APB 25, on a straight-line basis over the three-year vesting period.

91

---



16. Operating Segments

The Company reports its operations in four segments which include ECG, SMBS, Services and Connectivity Solutions. During the third quarter of fiscal 2003, the
Company changed the name of the Converged Systems and Applications segment to ECG. The ECG segment is focused on the sale of communications products and applications to large enterprises and includes
IP telephony, traditional voice communications systems, unified communications applications, multi-media contact center offerings, and appliances, such as telephone sets. ECG's operating results also
include our professional services organization that provides services required to customize the Company's communications applications solutions for individual customer needs. The SMBS segment
develops, markets and sells communications products and applications, including IP telephony systems, traditional voice systems, unified communication and contact center applications, for small and
medium-sized businesses. Traditional voice communication systems designed for small and medium-sized businesses are also known as Key and hybrid telephony systems. 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, which the Company agreed to sell in
October 2003, 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:

|                                 |                                 |   |       |     |   |     |    |   |       | Corporate |   |     |    
|-------------------------------- | ------------------------------- | - | ----- | --- | - | --- | -- | - | ----- | --------- | - | --- | ---
|
|
|
|
|2003                             |                                 |   |       |     |   |     |    |   |       |           |   |     |    
|Revenue                          |                                 | $ | 1,738 |     | $ | 225 |    | $ | 1,833 |           | $ | 542 |    
|Operating income (loss)          |                                 |   | (62   | )   |   | (3  | )  |   | 157   |           |   | 3   |    
|Capital expenditures(1)          |                                 |   | 5     |     |   |    |    |   | 4     |           |   | 3   |    
|Depreciation and amortization(1) |                                 |   | 93    |     |   | 6   |    |   | 59    |           |   | 38  |    
|Assets:                          |                                 |   |       |     |   |     |    |   |       |           |   |     |    
|                                 | Receivables, less allowances(2) |   |       |    |   |     |   |   |       |          |   |     | 66 
|                                 | Inventory                       |   |       | 120 |   |     | 26 |   |       | 118       |   |     | 142
|                                 | Goodwill                        |   |       | 118 |   |     | 28 |   |       |          |   |     |   
|                                 | Corporate assets(3)             |   |       |    |   |     |   |   |       |          |   |     |   
|                                 |                                 |   |       |     |   |     |    |   |       |           |   |     |    
|                                 | Total assets                    |   | $     | 238 |   | $   | 54 |   | $     | 118       |   | $   | 208
|                                 |                                 |   |       |     |   |     |    |   |       |           |   |     |    
|                                 |                                 |   |       |     |   |     |    |   |       |           |   |     |    

92

---

|2002                             |                                 |   |       |     |   |     |    |   |       |     |   |       |     |   |      |   |   |      |       |   |       |      
|-------------------------------- | ------------------------------- | - | ----- | --- | - | --- | -- | - | ----- | --- | - | ----- | --- | - | ---- | - | - | ---- | ----- | - | ----- | -----
|Revenue                          |                                 | $ | 2,080 |     | $ | 236 |    | $ | 2,068 |     | $ | 572   |     | $ |     |   | $ |     |       | $ | 4,956 |      
|Operating income (loss)(4)       |                                 |   | (205  | )   |   | (24 | )  |   | 271   |     |   | (72   | )   |   | (209 | ) |   | (109 | )     |   | (348  | )    
|Capital expenditures(1)          |                                 |   | 6     |     |   |    |    |   | 5     |     |   | 7     |     |   |     |   |   | 93   |       |   | 111   |      
|Depreciation and amortization(1) |                                 |   | 112   |     |   | 11  |    |   | 65    |     |   | 35    |     |   |     |   |   | 6    |       |   | 229   |      
|Assets:                          |                                 |   |       |     |   |     |    |   |       |     |   |       |     |   |      |   |   |      |       |   |       |      
|                                 | Receivables, less allowances(2) |   |       |    |   |     |   |   |       |    |   |       | 42  |   |      |  |   |      | 834   |   |       | 876  
|                                 | Inventory                       |   |       | 201 |   |     | 28 |   |       | 109 |   |       | 129 |   |      |  |   |      |      |   |       | 467  
|                                 | Goodwill                        |   |       | 118 |   |     | 26 |   |       |    |   |       |    |   |      |  |   |      |      |   |       | 144  
|                                 | Corporate assets(3)             |   |       |    |   |     |   |   |       |    |   |       |    |   |      |  |   |      | 2,410 |   |       | 2,410
|                                 |                                 |   |       |     |   |     |    |   |       |     |   |       |     |   |     
|                                 | Total assets                    |   | $     | 319 |   | $   | 54 |   | $     | 109 |   | $     | 171 |   | $    |  |   | $    | 3,244 |   | $     | 3,897
|                                 |                                 |   |       |     |   |     |    |   |       |     |   |       |     |   |     
|2001                             |                                 |   |       |     |   |     |    |   |       |     |   |       |     |   |      |   |   |      |       |   |       |      
|Revenue                          |                                 | $ | 2,871 |     | $ | 313 |    | $ | 2,286 |     | $ | 1,323 |     | $ |     |   | $ |     |       | $ | 6,793 |      
|Operating income (loss)(5)       |                                 |   | 10    |     |   | (13 | )  |   | 168   |     |   | 257   |     |   | (885 | ) |   | (101 | )     |   | (564  | )    
|Capital expenditures(1)          |                                 |   | 26    |     |   | 2   |    |   | 15    |     |   | 26    |     |   |     |   |   | 272  |       |   | 341   |      
|Depreciation and amortization(1) |                                 |   | 142   |     |   | 26  |    |   | 58    |     |   | 42    |     |   |     |   |   | 5    |       |   | 273   |      
|Assets:                          |                                 |   |       |     |   |     |    |   |       |     |   |       |     |   |      |   |   |      |       |   |       |      
|                                 | Receivables, less allowances(2) |   |       |    |   |     |   |   |       |    |   |       | 173 |   |      |  |   |      | 990   |   |       | 1,163
|                                 | Inventory(6)                    |   |       |    |   |     |   |   |       |    |   |       |    |   |      |  |   |      | 649   |   |       | 649  
|                                 | Goodwill                        |   |       | 108 |   |     | 67 |   |       |    |   |       |    |   |      |  |   |      |      |   |       | 175  
|                                 | Corporate assets(3)             |   |       |    |   |     |   |   |       |    |   |       |    |   |      |  |   |      | 2,661 |   |       | 2,661
|                                 |                                 |   |       |     |   |     |    |   |       |     |   |       |     |   |     
|                                 | Total assets                    |   | $     | 108 |   | $   | 67 |   | $     |    |   | $     | 173 |   | $    |  |   | $    | 4,300 |   | $     | 4,648
|                                 |                                 |   |       |     |   |     |    |   |       |     |   |       |     |   |     

---

93

---

Geographic Information

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

External Revenue(1)

Long-Lived Assets(2)Year Ended
September 30,

As of
September 30,2003

2002

2001

2003

2002(dollars in millions)U.S.

$
3,204

$
3,647

$
5,158

$
689

$
794International


1,134


1,309


1,635


94


102Total

$
4,338

$
4,956

$
6,793

$
783

$
896


---

Concentrations

Following the sale by Lucent 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 the Company 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 the Company 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 agreed in December 2002, because of the importance of
its relationship with Expanets and the customer base served by Expanets, 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:



94

---



In
the fourth quarter of fiscal 2003, the Company sold the $27 million term loan due from Expanets to a third party financial institution for $26 million.

For
the fiscal year ended September 30, 2001, sales to Expanets, which are included in the ECG, SMBS and Services segments, were approximately 10% of the Company's revenue.

See
Note 20Subsequent Events for disclosure regarding the acquisition of Expanets.

17. Related Party Transactions

As of September 30, 2003, the Warburg Entities hold approximately 60 million shares of Avaya common stock, which represents approximately 14.4% of
the Company's outstanding common stock, and warrants to purchase approximately 14 million additional shares of Avaya common stock. In October 2003, the Warburg Entities disposed of
25 million shares of the Company's 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 the Company's board of directors.

18. 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 the Company 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

95

---

these
cases under the Contribution and Distribution Agreement, as described in "Transactions with Lucent" below 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 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 of 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

96

---

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. 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. The Company recently reached agreement with
Lucent to pay $24 million in shares of the Company's common stock in full satisfaction of its obligations under the settlement. The terms of the settlement will be subject to a fairness hearing
scheduled for December 2003.

Commissions Arbitration Demand

In July 2002, Communications Development Corporation ("CDC"), 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. In April 2003, CDC initiated the arbitration before the American Arbitration Association. 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, CDC may likely increase its commission demand. The parties are in the process of selecting arbitrators.

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 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.

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 the Company and, as a result, the Company would be responsible for 10% of any such liability in excess of $50 million. The Company recently agreed with Lucent to pay
$6 million in satisfaction of its liability in this matter, although Lucent has notified the Company that it may be responsible for some additional costs that may be incurred in connection with
the conclusion of the claims administration. Based on the Company's discussions with Lucent, it does not expect those additional costs to be material.

Patent Infringement Claim

AudioFAX IP, LLC has filed an action against the Company in the U.S. District Court for the Northern District of Georgia, alleging that the Company has infringed
five of its patents relating to facsimile products in violation of federal patent laws. This matter is in the early stages of litigation and

97

---

the
Company cannot determine whether the outcome of this action will have a material adverse effect on its financial position, results of operations or cash flows.

Environmental, Health and Safety 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 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 are reasonably likely to generate environmental costs that will be individually material nor will environmental
costs for all sites in the aggregate be 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. Although the Company does not separately track recurring costs of managing hazardous substances and pollutants in ongoing operations, it 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 fiscal years ended September 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 matters for the fiscal years ended September 30, 2003 and 2002 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.

Product Warranties

The Company recognizes a liability for the estimated costs that may be incurred to remedy certain deficiencies of quality or performance of the Company's
products. These product warranties extend

98

---

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 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 fiscal year ended September 30, 2003:

(dollars in millions)Balance at September 30, 2002

$
40Warranties accrued during the fiscal year ended September 30, 2003


58Less actual warranty expenses incurred during the fiscal year


(60
)Balance at September 30, 2003

$
38


Guarantees of Indebtedness and Other Off-Balance Sheet Arrangements

Irrevocable Letters of Credit and Other Arrangements

The Company has entered into several uncommitted credit facilities totaling $53 million and other arrangements similar to irrevocable letters of credit
that vary in term totaling $10 million, of which an aggregate of $29 million in irrevocable letters of credit and other arrangements were outstanding as of September 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.

Surety Bonds

The Company acquires various types of surety bonds, such as license, permit, bid and performance bonds, which are irrevocable undertakings by the Company to make
payment in the event the Company fails to perform its obligations. These bonds vary in duration although most are issued and outstanding from one to three years. As of September 30, 2003, the
maximum potential payment under these surety bonds is approximately $7 million. Historically, no surety bonds have been drawn upon and there is no future expectation that these surety bonds
will be drawn upon.

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 September 30, 2003, the maximum potential payment under these commitments was approximately $82 million, of which the Company recorded a liability in the amount of
$8 million. The Company classified this liability as $3 million in other current liabilities and $5 million in other liabilities.

99

---

Product Financing Arrangements

The Company 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 the company's 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 the Company to the reseller. The repurchase amount is equal to the price originally paid to the Company 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 September 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 September 30, 2003 and has adequately provided for this guarantee in its financial
statements at September 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 $8 million as of September 30, 2003. The Company 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 September 30, 2003 and has adequately provided for this guarantee in its financial statements at September 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 9-Long-Tem Debt, 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.

100

---

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 ("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 recently reached agreement with Lucent to pay $24 million in
shares of the Company's common stock in full satisfaction of its obligations under the settlement. The terms of the settlement will be subject to a fairness hearing scheduled for December 2003.
The Company 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.

The
Company has resolved all of the Contribution and Distribution issues with Lucent related to the settlement of certain employee obligations and the transfer of certain assets.
Following the Distribution, the Company had identified approximately $15 million recorded in its Consolidated Balance Sheets that was primarily related to certain accounts receivable balances
due from Lucent and certain fixed assets, which the Company agreed would remain with Lucent. Since these assets, among other resolved issues, relate to the original capital contribution by Lucent, the
Company reduced additional paid-in capital in fiscal 2001 for the net effect of these adjustments.

Leases

The Company leases land, buildings and equipment under agreements that expire in various years through 2021. Rental expense under operating leases, excluding any
lease termination costs incurred related to the Company's restructuring initiatives, was $167 million, $192 million, and $194 million for the years ended September 30,
2003, 2002, and 2001, respectively. The table below shows the future minimum lease payments due under non-cancelable operating leases, of which $40 million of such lease payments
have been accrued as a business restructuring reserve, as of September 30, 2003.

Year Ended September 30,2004

2005

2006

2007

2008

Later
Years

Total(dollars in millions)$
135

$
87

$
65

$
55

$
48

$
218

$
608


101

---

19. Quarterly Information (Unaudited)

|                                                                        |      | Fiscal Year Quarters |      
|----------------------------------------------------------------------- | ---- | -------------------- | -----
|
|
|Year Ended September 30, 2003                                           |      |                      |      
|Revenue                                                                 |      | $                    | 1,067
|Gross margin                                                            |      |                      | 423  
|Business restructuring charges (reversals) and related expenses, net(1) |      |                      | 4    
|Provision for deferred income tax asset valuation allowance(2)          |      |                      | 83   
|Net income (loss)                                                       |      |                      | (121 
|Earnings (Loss) per shareBasic                                         |      | $                    | (0.33
|Earnings (Loss) per shareDiluted                                       |      | $                    | (0.33
|Stock price(3):                                                         |      |                      |      
|                                                                        | High |                      | $    
|                                                                        | Low  |                      | $    
|Year Ended September 30, 2002                                           |      |                      |      
|Revenue                                                                 |      | $                    | 1,306
|Gross margin                                                            |      |                      | 517  
|Business restructuring charges and related expenses, net(1)             |      |                      | 6    
|Goodwill and intangibles impairment charge                              |      |                      |     
|Provision for deferred income tax asset valuation allowance(2)          |      |                      |     
|Net loss                                                                |      |                      | (20  
|Loss per shareBasic and Diluted(4)                                     |      | $                    | (0.09
|Stock price(3):                                                         |      |                      |      
|                                                                        | High |                      | $    
|                                                                        | Low  |                      | $    

---

102

---

20. Subsequent Events

Sale of Connectivity Solutions

In October 2003, the Company agreed to sell certain assets and liabilities of the Connectivity Solutions segment to CommScope, Inc. ("CommScope").
Under the terms of the agreement, the Company will receive a purchase price of $263 million, subject to adjustment, consisting of approximately $210 million of cash, a note in the amount
of $18 million that is convertible into CommScope common stock one year after the closing, and CommScope common stock having a market value, at the time of the agreement, of $35 million.
In addition, CommScope assumed approximately $75 million of primarily employee-related liabilities of Connectivity Solutions. The waiting period applicable to the sale under the
Hart-Scott Rodino Antitrust Improvements Act, as amended, has expired. We expect the sale to close no later than the second quarter of fiscal 2004. Because the products offered by
Connectivity Solutions do not fit strategically with the rest of the Company's product portfolio, the Company believes the sale will enable it to strengthen its focus on its core products offerings.

Listed
below are the major classes of assets and liabilities as of September 30, 2003 that are included as part of the disposal group:

|($ in millions)                   
|----------------------------------
|
|Receivables                       
|Inventory                         
|Property, plant and equipment, net
|                                  
|Other assets                      
|                                  
|Total assets                      
|                                  

The
final carrying values of the assets and liabilities to be transferred to Commscope will be determined upon the closing date, with the exception of the benefit obligations noted
below.

Based
upon an actuarial calculation using data as of September 30, 2003, the Company estimates that it will recognize a pension and postretirement curtailment loss of
approximately $26 million upon the closing of the transaction and a settlement loss of approximately $37 million upon the transfer of pension and postretirement benefit assets and
liabilities to Commscope. The estimated curtailment and settlement losses are subject to change based upon intervening events that may occur up to the closing date and the date on which the pension
and postretirement benefit assets and liabilities are transferred, respectively. These losses will be recorded as a loss from discontinued operations. Additionally, these losses will increase the
benefit obligation being transferred to Commscope by approximately $52 million and will remove an intangible asset of approximately $11 million that relates to unrecognized prior service
costs associated with the benefit obligation which is included in other assets in the table above.

On
October 30, 2003, in exchange for the International Brotherhood of Electrical Worker's agreement to withdraw numerous pending and threatened grievances and arbitration demands
against the Company in connection with the Connectivity Solutions business, the Company agreed to provide a one-time payment of five thousand dollars to certain employees and offer an
enhanced retirement incentive for those employees who are pension eligible as of December 2, 2003. The settlement agreement is contingent upon the closing of the sale of Connectivity Solutions
to CommScope. Total payments, excluding the retirement incentive offer, are not expected to exceed $7 million. The

103

---

Company
expects to take a one-time charge in the first quarter of fiscal 2004 of approximately $4 million related to the acceptance by 124 employees of the retirement incentive
offer.

Acquisition of Expanets

In November 2003, the Company acquired substantially all of the assets and assumed certain liabilities of Expanets, a subsidiary of NorthWestern. Expanets
is a nationwide provider of networked communications and data products and services to small and mid-sized businesses and prior to the acquisition was one of the Company's largest dealer.
Under the terms of the asset purchase agreement, the Company paid NorthWestern approximately $55 million in cash. In addition, the Company paid approximately $39 million to creditors of
Expanets to satisfy certain debt obligations of Expanets and deposited approximately $13.5 million into an escrow account to satisfy certain liabilities of Expanets. The purchase price is
subject to adjustment within 90 days after the closing. The Company will include Expanets in its consolidated results of operations and financial position beginning in November 2003.
Certain information such as condensed balance sheet data of Expanets and the amount of any goodwill or intangibles assets identified is required to be disclosed for material acquisitions. However, due
to the proximity of the closing date of the acquisition and the filing of the Company's financial statements, it was not practicable to determine such amounts.

Credit Facility Amendment

In October 2003, the Company and the lenders under the Company's Credit Facility amended the Credit Facility to increase the amount allowed for external
investments from $50 million, by an additional $100 million, if the increased amount is to be used for the purchase of the stock or substantially all of the assets of Expanets prior to
December 31, 2003.

Grants of Stock Options and Restricted Stock Units

During the period from October 1, 2003 through December 1, 2003, the Company granted to eligible employees approximately 8 million stock
options at a weighted average exercise price of $13.24 and approximately 401 thousand restricted stock units at a weighted average market value of $13.28.

Interest Rate Swap Agreements

During the period from October 1, 2003 through December 11, 2003, the Company entered into three interest rate swap agreements each having a
notional amount of $50 million and a maturity date of April 2009. These interest rate swap agreements have the same terms as the interest rate swap agreements entered into in
April 2002, as discussed in Note 10Derivatives and Other Financial Instruments, with the exception of the agreed upon spread of 6.55%, 6.8575% and 6.94%, respectively, that
is added to the six month LIBOR (in arrears) used to calculate the variable interest rate that the Company will pay.

104

---

QuickLinks