Quite frankly, I was perplexed about digital communications solutions provider Avaya's (NYSE:AVYA) disastrous warning released after Thursday's close:
Based on the information currently available for the third quarter ended June 30, 2022, the company expects revenue to be between $575 million and $580 million, compared to guidance of $685 million to $700 million, and Adjusted EBITDA to be between $50 million and $55 million, compared to guidance of $140 million to $150 million.1 The company is also finalizing testing of its goodwill and intangible assets that is expected to result in significant non-cash impairment charges as of June 30, 2022.
Avaya also announced it has initiated cost-cutting measures that are expected to primarily impact the company’s overall selling, general and administrative expenses, as well as discretionary spending. These actions are expected to generate between $225 million and $250 million in annual cost reductions beginning in the first quarter of fiscal 2023.
The company also replaced CEO and President Jim Chirico with former Vonage CEO Alan Masarek.
Remember that the company already provided Q2 guidance well below expectations on May 10 with almost six weeks of the quarter already behind it.
On the Q2 conference call, management attributed the weak guidance to a faster-than-expected shift to the company's OneCloud subscription offering and to a lesser extent to disruptions from Russia's assault on Ukraine as well as currency headwinds.
This time, Avaya has not provided any explanation for the massive miss which, in combination with the CEO removal and very aggressive cost cutting efforts, points to severe structural issues in the company's business.
Moreover, just two weeks ago, Avaya closed on an aggregate $600 million in new senior secured debt financings in order to address the upcoming maturity of $350 million in convertible notes next year.
Subsequently, the company used a portion of the proceeds to repurchase approximately $129 million principal amount of the convertible notes and terminated related hedge and warrant transactions.
Quite frankly, I don't think Avaya would have been able to secure these new capital commitments if the company had appropriately disclosed the dismal state of its business to creditors.
Even worse, with Q3 Adjusted EBITDA coming in almost $100 million below management's guidance, I would expect cash at the end of Q2 to be down by almost $150 million sequentially to approximately $175 million.
While Avaya just raised a meaningful amount of new capital and put some very aggressive cost cutting measures in place, at least in my view it is becoming increasingly clear that the company's quickly deteriorating business won't be able to support Avaya's $3+ billion debt load going forward, particularly not given the fact that the business is currently burning significant amounts of cash.
With the additional $600 million in debt raised earlier this month, the company will be paying well above $200 million in cash interest this year.
At the current quarterly revenue run rate, the company's debt service obligations (solely interest at this point) represent approximately 10% of sales which appears to be unsustainably high.
Given persistent macroeconomic headwinds, there won't be an easy cure for Avaya's structural issues and given the magnitude of the company's announced cost reduction efforts, I firmly expect revenues to decrease even further going forward.
After Thursday's news, a second bankruptcy filing has become increasingly likely.
Turning around Avaya within its current capital structure looks like a Herculean task for the company's new CEO.
While Avaya has sufficient liquidity to service its massive debt load for at least the next couple of quarters, the company's quickly deteriorating business won't be able to support $3+ billion in debt over the long term.
At least in my opinion, Avaya should hire restructuring advisors and stop servicing its unsustainable debt load as soon as possible to save valuable cash for a new start.
Considering the sheer amount of debt ranking ahead of equityholders, there's basically no chance for a meaningful recovery in case of bankruptcy.
With Avaya's business deteriorating at an alarming pace and chapter 11 an increasingly likely option, equityholders would be well-served to move to the sidelines here.
Avaya (NYSE:AVYA) shares have plunged around -20% post-market close after reporting preliminary Q3 revenues between $575M-$580M, way below its guidance of $685M-$700M and consensus revenue estimates of $688.39M.
Preliminary adjusted EBITDA is also set to be in the range of $50M-$55M, missing its previously stated guidance of $140M-$150M by a large margin. The firm is finalizing testing of its goodwill and intangible assets, leading to significant non-cash impairment charges.
Avaya has started cost-cutting measures to reduce overall selling, general and administrative expenses and discretionary spending by around $225M-$250M annually, starting from Q1 FY23.
The digital communications company warned that its prior financial guidance "should no longer be relied upon". Management will provide more information when the final Q3 results are announced on August 9, before market open.
Seeking Alpha's quant system rates the stock as sell.
Avaya has also named Alan Masarek as its new President and CEO, effective August 1. Masarek will take over from Jim Chirico, who will leave the company after 15 years of service.
Chirico will remain with Avaya until August 16 as part of the leadership transition. Masarek comes from Vonage, where he was CEO and led the company in its transformation from a VoIP-based residential phone provider to an enterprise cloud communications company.
Masarek has over 30 years of industry experience, including tenure as Director, Chrome & Apps at Google and co-founder and CEO of Quickoffice.