WASHINGTON (CBS.MW) -- Life isn't quite as tough anymore for 4-year-old Avaya Inc. Once part of Lucent Technologies, which was itself a spinoff of AT&T, Avaya has emerged as a patch of green growth in the otherwise barren landscape of the communications-equipment industry.

It's back in the black. Sales are rising. And its stock is showing more than a little appreciation. The reason? Sales of corporate phone systems based on Internet technology -- Avaya's new calling card -- are starting to take off. The technology promises to lower communications costs and, perhaps more important, transform how companies do business.

Riding fresh momentum, Avaya recently reported its first year of net income and revenue growth since staking out its independence from Lucent in the fall of 2000. In fiscal 2004, sales rose 7 percent to $4.1 billion.

Things look even better for 2005, when Avaya projects its sales will rise as much as 27 percent, aided in part by a strong push overseas.

"The fastest adoption rate has been in the U.S., but it's beginning to pick up at a much quicker pace now in Europe," Avaya's chief financial officer, Garry McGuire, told CBS.MarketWatch in an interview.

Investors have noticed. Shares of Avaya have surged 34 percent this year, closing on Friday at $17.73. And most Wall Street analysts expect further gains in 2005.

Earlier this week, for example, S.G. Cowen & Co. said the stock could outperform the "market by 20 percent to 30 percent over the next 12 months."

Phoenix rising
The future didn't always look so rosy. Just one year ago, annual sales bottomed out at an adjusted $3.79 billion, down from $8.3 billion in 1999. After the U.S. economy hit a recession in early 2001, business customers cut their own spending and shied away from still-unproven Internet-based phone systems.

Avaya's management righted the listing ship, but the cost was high. Employees endured a series of layoffs that slashed the work force from 31,000, when the company was spun off by Lucent, to below 15,000. Morale plunged -- and so did the company's stock

Shares, which had traded as high as $26 early in the company's life, bottomed out at just over a buck in August 2002. "We did go through some tough times, obviously, and it's never easy to go through downsizing," McGuire said. Amid what some analysts have called the telecom industry's "nuclear winter," Avaya still devoted sizable resources to perfecting its technology and testing it with customers.

Once the U.S. economy improved, the Internet-telephony market was finally ready for a breakout. "As they began to see their own businesses get better, companies started spending again," McGuire said. "And momentum has been building slowly over the last 12 to 15 months."

Bit-by-bit approach
That's exactly what happened at Toronto-based MCCI, a call-center operator that fields customer inquiries for corporate clients. MCCI decided to install Internet-based technology a few years ago because of improvements in the economy and in Internet phone systems.

While competitors offered basic systems that required additional pieces of equipment -- thereby raising costs and complexity -- Avaya took a more straightforward approach.

"Out of the box, [Avaya's] was the most complete solution," said Stephen Haynes, senior vice president of operations. "It gave us a competitive advantage right out of the gate."

Yet like many companies, MCCI did not want to install an entirely Internet-based phone system. It wanted to add on to its circuit-based equipment and make the switch gradually, a tack that would save money and maintain backup in case the IP portion of the system failed.

Indeed, Avaya's ability to offer a piece-mail approach is a big selling point as it battles Cisco Systems, the huge data networker, for market dominance in IP telephony.

"You can put your toe in the pond instead of diving in. Test the temperature," said Daryl Schoolar of In-Stat/MDR, author of a study on why businesses are adopting the technology.

One of the pivotal moments in Avaya's recovery took place in 2003. After experiencing trouble with its new Internet-based phone system, Merrill Lynch decided to replace some equipment supplied by Cisco with gear from Avaya. The brokerage wanted a hybrid network.

"My understanding is that strategy won the day at Merrill Lynch," said Jim Kelleher, a longtime industry analyst at Argus Research.

Because it has less expertise in traditional phone networks, Cisco favors a "rip and replace" strategy. Pull out the entire old network and put in a new IP one.

"Voice is the most complex application you're ever going to put into an IP network. We have a 100-year history of voice in the telephony space," McGuire said. "Cisco is doing a good job, but they've started from scratch in telephony."

'Productivity nuts'
Of course, some executives are more than happy to get rid of their old phones. Avaya can do that, too. Take Headsets.com. The company sells a variety of phone headsets and also offers customer support. By installing Avaya's technology, employees can keep in constant contact, no matter where they are. Armed with a laptop or handheld device, they can access anything on the company network

The benefits also extend to customers who want to place an order or ask for help. If the phone lines get backed up, callers are routed from one office or employee to another to quickly disperse the backlog. Customers don't have to wait long.

Headsets.com CEO Mike Faith, a self-described "productivity nut," said the new technology has boosted revenue generated by each employee to a frothy $800,000 -- higher than the vaunted Cisco can claim.

"It was definitely more expensive, but it was such a slam dunk it was worth doing," he said. "I am a big believer. We wouldn't want to go back."

In other cases, Internet-based phone technology actually negates the need for expensive offices altogether. JetBlue Airways, the popular discount carrier, is one company that uses "virtual call centers."

"They don't have one single building where all the agents sit," McGuire said. "It's all work-at-home people." Aside from lower real-estate costs, Internet-phone technology also enables JetBlue to save on labor costs by adding staff only during busy periods.

"With a virtual call center, you can bring on the number of agents for the amount of time you need to cover that peak and then have them go back off," McGuire noted. "You're not paying someone for an eight-hour day."

The top dog
Since the Merrill episode, Avaya has rocketed past former market leader Cisco to take the top spot in sales of Internet-based phone systems to business customers.

In the third quarter, Avaya held a slight lead, though Cisco doesn't lag by much. Synergy Research estimates each company controls about one-quarter of the market.

Avaya can't rest on its laurels, however. Other rivals, such as Alcatel, Siemens and Nortel Networks, are likely to compete harder given the market's huge growth prospects.

In 2003, for instance, only about 3 percent of U.S. businesses had Internet-phone technology in their communications systems, according to In-Stat/MDR. That number will jump to 12 percent in 2004, 19 percent in 2005, 26 percent in 2006 and 33 percent in 2007.

"We're in a migration period, but it's going to take awhile," Schoolar said. Beyond the U.S., Europe is especially ripe for growth. That's why Avaya is purchasing Tenovis, a large German-based vendor with nearly $1 billion in sales. The deal will boost Avaya's presence on the Continent.

On top of that, the company has nearly $1.6 billion in cash -- up from $200 million two years ago -- and very little debt. So Avaya can make more deals if other good opportunities arise.

Looking ahead, Wall Street forecasts Avaya to generate $5.18 billion in sales in 2005 and $5.75 billion in 2006. Potential pitfalls include the company's ability to integrate a series of recent acquisitions, its success in navigating the intricacies of overseas markets, and the possibility of another global slowdown. After all, the equipment industry is historically cyclical.

If forecasts pan out, however, Avaya might even top its all-time stock high -- $26. By comparison, former parent Lucent languishes at $3.75, while Agere Systems, another Lucent spinoff, trades at a mere $1.33.

Clearly, independence is proving superior to life within the formerly far-flung Lucent empire. "You become a second-class citizen, at times," McGuire noted. "We are no longer confused about who are customers are or where are market is."

Jeffry Bartash is a reporter for CBS.MarketWatch.com in Washington.