Positive

Avaya is a major provider of communications products and services (see Table 1). Since finalizing its acquisition of Nortel Enterprise Solutions (NES) in December 2009, the company has made progress restructuring its direct sales organization and growing its indirect sales organizations, diminishing overlap in job responsibilities, reducing head count and minimizing product portfolio overlap with NES offers. Avaya continues to enhance its communications solutions, and has initiated an emphasis on collaboration strategies that include a new range of Avaya Flare devices and user interfaces. However, its financial rating remains Caution.

Avaya is making progress integrating NES assets, and refining and improving product migration road maps for users of heritage Nortel products. Increasing market share outside of Avaya's sizable customer base remains essential.

During the first half of 2010, Gartner estimates Avaya's global telephony share to be 13.8% in terms of total line shipments (see Table 2). This means that Avaya is the global leader by a very small margin compared with Cisco, with its estimated 13% global market share. While the two providers are neck and neck now, the trending shows Cisco is closing the gap. Last year, Avaya had almost a 15% share (when combined with Nortel's results) and Cisco nearly a 12% share of the global telephony market.

The close of the NES acquisition has not resulted in the expectation that Avaya would immediately gain a substantial market share lead in the enterprise telephony market. Based on comments from Gartner clients, customers of heritage Nortel telephony platforms are equally divided when it comes to staying with Avaya or looking at competitive offers. However, Avaya continues to accomplish important milestones, including the launch of new collaboration devices and solutions, improving its global channel-centric model, achieving more cost reductions in products, enhancing Avaya Aura's Session Initiation Protocol (SIP)-based architecture, and offering attractively priced wholesale services to partners.

It's also important to note Avaya's worldwide contact center market share for 2009 agent shipments was 36.5%. Avaya maintains sizable contact center market shares in North America, Latin America, Asia/Pacific and EMEA, with 2009 shipments more than twice that of competitors Cisco and Genesys. Conversations with Avaya contact center customers indicate that while they have been approached by competitors with Avaya-Nortel displacement incentive programs, they are delaying decisions to switch because Avaya's vision and road maps for its next-generation offers are appealing.

A strategic priority for Avaya is helping customers improve efficiency, collaboration, customer service, productivity and competitiveness by integrating communications systems with business processes. To that end, Avaya has been focusing on:

• Re-architecting its portfolio around Avaya Aura, SIP-enabled session management, virtualization and application enablement centered on the Avaya Agile Communication Environment (ACE).

• Introducing Avaya Flare software, as well as a desktop device with a touchscreen that offers the Avaya Flare unified communications and collaboration (UCC) capability in a unique intuitive user interface. Avaya Flare software orients collaboration toward a people-centric view of communication.

• Partnering with its channel for installation and support services; offering wholesale rates to partners to encourage resale of Avaya services.

• Restructuring its direct sales organization and growing its indirect sales organizations, eliminating overlap in job responsibilities, and leveraging Avaya and Nortel heritage intellectual property and product portfolios.

• Transforming sales, distribution, pricing and support models to meet the needs of global organizations.

Avaya needs to improve market share growth for UCC within organizations outside its large installed base of customers, and leverage the acquisition of Nortel's data networking business.

Gartner uses a standard methodology for deriving its vendor financial rating, to provide a comparable view among vendors. This is based on four key criteria, taken from public financial statements. All the financial statements use a 12-month rolling period to the most recently announced quarterly results. The criteria are:

1. Last 12-month year-over-year revenue growth

2. Last 12-month net profit margin (net income as a percentage of revenue)

3. Cash from operations as a percentage of revenue

4. Balance sheet strength, denoted by the current ratio (current assets divided by current liabilities).

Based on these metrics, Gartner rates Avaya Caution on its financials. This rating reflects Avaya's better-than-average cash-generation capabilities (as measured by cash from operations as a percent of revenue), weak profit margins (as measured by its net margin for the last reported 12-month period), its solid balance sheet (as measured by the current ratio), and good revenue growth over the last 12 months (driven by the acquisition of Nortel's assets and a generally improving market for its products and services).

While this rating is unchanged from our last Vendor Rating, it is important to point out that Avaya's raw financial score has improved since the last time we rated the company, so there has been progress made on the financial front. Also, we believe analysis of other metrics paints a picture of improvement from an operations/integration perspective and one of stability from the standpoint of debt servicing. From an operational standpoint, we see evidence of improvement in Avaya's latest disclosed financials, where we observe growing sequential revenue and improvements in profitability (gross margin; earnings before interest, taxes, depreciation and amortization [EBITDA] margin; and net margin). From the standpoint of debt servicing, we note that cash remains over $500 million, and we can also see improvement with better ratios for EBITDA-to-interest expense (now 1.2, up from 0.9 one quarter ago) and lower net debt-to-EBITDA ratios (9.0 in the latest quarter versus 12.0 in the quarter ending in March 2010).

Avaya has established brand awareness for its communications solutions. Its marketing effort has provided focused road maps targeted to customers and prospects, which are helping to adeptly merge two large installed bases and product lines. However, Avaya needs to do a better job of translating its technological capabilities and real-time communications experience into organizational value and user benefits. Avaya has made progress with Avaya Aura and Session Manager, which were introduced in May 2009, and by boosting awareness for unified communications (UC) offerings such as Avaya ACE and Presence Services, as well as messaging and conferencing solutions.

A significant turnover among executives started after Avaya became privately held, and has continued since the NES acquisition. Virtually all those executives have either been replaced or reassigned new responsibilities, which has improved the company's ability to be more responsive to changing market conditions by focusing on providing new solutions and establishing high customer satisfaction, while aligning NES assets with Avaya's business objectives.

Avaya Aura is the brand that encompasses Avaya's communications solutions from infrastructure to software, and incorporates five key capabilities: voice/IP telephony, contact center, unified communications, data networking and services.

Aura's SIP-based architecture, combined with Avaya Communication Manager (CM) software, supports Internet Protocol (IP), digital and analog endpoints for communication requirements that range from a few hundred to many thousands of users. Its centralized Linux-based core server is capable of distributing intelligence across remote sites while providing a consistent user interface and feature transparency.

Avaya has a strong presence in the large enterprise market segment and offers solutions for small or midsize businesses (SMBs). In November 2009, it launched its virtual server for the midsize enterprise. Avaya's small and medium enterprise solutions include role- and user-based packaging intended to make Avaya SMB products more cost-effective. However, the process of blending the NES Business Communications Manager (BCM) platform with Avaya IP Office has allowed increased competition from vendors that historically target the SMB market.

Avaya supports a range of fully featured, scalable contact center solutions for call and multimedia routing, an interactive voice response (IVR)/voice portal and an outbound dialing solution. It also offers enterprise application integration templates and ties to the company's UC, communications-enabled business process (CEBP) and SIP-based product strategies. In July 2010, Avaya announced its vision and product solution for end-to-end Experience Management based on the Avaya Aura Contact Center Suite, which was built on technology from both Nortel and Avaya platforms. Contact center solutions are an essential part of the Avaya business model, independent of the telephony infrastructure. The company continues developing successful strategies to maintain its sizable customer base and win new business.

Avaya Aura Session Manager enables delivery of applications on feature servers, and blending them into existing communications environments without modifying Avaya CM or other application services. This results in uniform application deployment and distribution across networks, regardless of location.

Avaya ACE is software that simplifies the integration of business applications with communications. Avaya ACE consists of packaged applications, as well as developer toolkits. Toolkits allow developers to create communication-enabled applications and custom telephony features by exposing communications services as Web services APIs. There are also prewritten software adapters for SIP, TR/87 and Java Telephony API (JTAPI) that allow Avaya ACE to integrate business applications with Avaya, Cisco, Microsoft, IBM and other vendors' communication systems, as well as for Avaya Application Enablement Services (AES), Avaya Meridian Link Services (MLS), and JTAPI, which allow integration of business applications with communication systems from Avaya CM, Avaya Communication Server (CS) 1000 and Cisco Unified Communications Manager, respectively.

Avaya Flare software and desktop touchscreen device offers a UCC capability in a unique intuitive user interface for voice and video calls, instant messaging (IM) and presence. A desktop video portfolio focuses on providing competitively priced low-bandwidth, high-definition solutions that are SIP-based and interoperate with H.323 systems. A managed video service is also offered globally.

The company's UC portfolio offers conferencing and unified messaging, as well as Avaya one-X clients that provide a consistent user interface, regardless of device, for UC, personal assistant, mobility and contact center solutions.

Following the NES acquisition, customers were initially skeptical about Avaya's commitment to growing the data business. Avaya has reduced this skepticism with new product launches, marketing campaigns and public commitment to data networking solutions, noting that the data products portfolio is positioned to play a critical role in its growth.

In January 2010, Avaya announced that it would focus the Data Solutions portfolio on five key areas: Ethernet switching, unified branch, wireless networking, access control and unified management. New portfolio products announced since the NES acquisition include the Avaya Ethernet Routing Switch 8800, Avaya Wireless LAN 8100 Series, Avaya Unified Communications Management (UCM), Configuration and Orchestration Manager (COM) and Avaya Advanced Gateway 2330. The challenge for Avaya is to find the balance between trying to deliver a very broad solution set and focusing on a more defined area where it can concentrate resources to gain market awareness and traction. Avaya should explore the possibility of a partnership in portfolio areas that are not critical to its long-term growth. Avaya and its customers would be better served by using the resources to shorten product delivery times. Avaya has a strong LAN switching portfolio, with a high level of resiliency and failover capabilities. Avaya has a large, and still loyal, following in LAN switching, and increasing efforts in this area would pay dividends. The most important tasks for Avaya are to increase awareness in the data market and appearance on shortlists, as well as pull through Avaya Aura sales from data customers.

Avaya Global Services contributes roughly half of the company's total revenue, has 7,000 employees, and offers a broad portfolio of services. The offer of wholesale pricing enables its channel to subcontract Avaya for services at market price. Services include:

• Maintenance services — Avaya has been investing to increase the availability of program managers and field engineers who can be deployed promptly to solve complex IP-based problems. Gartner clients have been reporting noticeable improvements since our last Vendor Rating, which can be attributed to the training of engineers, better diagnostic tools and improved internal escalation processes.

• Professional services — The focus includes strategic communications solutions, technical account services, and developing solutions specific to the healthcare, financial, retail/hospitality and public sectors. Professional services are available via direct and indirect Avaya channels. Depending on customer and partner need, the company has the flexibility to augment existing partner capabilities or directly deliver any of Avaya's professional services.

• Operations services — Avaya is beginning to revamp its approach to provide multivendor maintenance and managed services. Changes include a strategy to increase the percentage of Avaya technology that is the responsibility of the managed services provider; a tool to enable a standard network management platform; and a set of capabilities to enable partners and system integrators/service providers to optimize how they provision Avaya-based managed services. It is too early to know how receptive the market will be to these initiatives.

The Avaya Aura architecture integrates voice and video, presence services, system management and application integration, as well as session management capabilities and applications such as messaging and contact center. Avaya Aura Session Manager focuses on the delivery of UC applications to groups and individuals based on workforce profiles that can be independent of a user's device or location, and allows Avaya to address the needs of customers with heterogeneous networks that support a mix of vendors, including Avaya, Nortel, Cisco, Siemens, Alcatel-Lucent and Microsoft. With virtualization, Avaya ACE, NES integration and Avaya Flare, Avaya can support organizations with multivendor environments that are looking to consolidate, upgrade, migrate or refresh communications. In addition, Avaya is positioned very well to support emerging cloud-based offers with its infrastructure capabilities, UC solutions and contact center applications, although Avaya currently does not have its own cloud offering.

Avaya Aura offers Enterprise and Standard licenses. The Standard license contains basic elements and has limited portability between distributed sites. Enterprise licenses include UC functionality, one instance of Session Manager, System Manager, and maximum portability between sites. UC bundles include messaging, remote virtual private network phone licenses, presence, IM integration, UC client and mobile office extension capabilities. These applications are included in the Enterprise license, and available individually to Standard licensees for a one-time flat fee. Overall, Avaya has successfully modified market perceptions about its solutions being premium priced.

Avaya has completed the rollout of its global partner program, Avaya Connect, which has also smoothed the path for NES dealers that have decided to become Avaya business partners. The goals include global consistency, less conflict between Avaya and business partners, and more choices of dealers for customers.

Avaya markets directly and indirectly in North America, EMEA, the Asia/Pacific region, and Central and Latin America, with 75% of its revenue in 2Q10 coming from channel partners, up from 59% at the end of 2008. Its global channel operations have sometimes struggled with inefficiencies, including products with multiple stock-keeping units (SKUs), limited training and certifications in certain regions, and complex solutions that increased the length of the sales cycle. Initiatives during the last 12 months have resulted in more globally uniform pricing and policies, as well as updated training programs. Expansion of relationships with system integrators and strategic partners has been a priority for Avaya, as are financial programs that provide business partners the incentives to resell Avaya services.

Based on Gartner feedback from clients, Avaya is attaining good satisfaction scores regarding its maintenance and support services. Customers are seeing more pre- and post-sales cooperation between Avaya sales personnel and business partners as Avaya works to minimize confusion about who has ultimate account responsibility. To be regarded as a resource that can improve communications, collaboration and business processes, Avaya needs to keep strengthening its relationships with IT organizations and continue to communicate the role that SIP, presence and collaboration will play in its next-generation products.