Nuance Communications Annual Report 2008

Plain-text annual report

Table of ContentsUNITED STATES SECURITIES AND EXCHANGE COMMISSIONWashington, D.C. 20549Form 10-K(Mark One)  ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)OF THE SECURITIES EXCHANGE ACT OF 1934 For the fiscal year ended September 30, 2008ORoo TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from to Commission file number 0-27038NUANCE COMMUNICATIONS, INC.(Exact name of Registrant as Specified in its Charter)Delaware 94-3156479(State or Other Jurisdiction ofIncorporation or Organization) (I.R.S. EmployerIdentification No.) 1 Wayside RoadBurlington, Massachusetts 01803(Address of Principal Executive Offices) (Zip Code)Registrant’s telephone number, including area code:(781) 565-5000SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT:NoneSECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT:Common Stock, par value $0.001 per shareIndicate by check mark if the Registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes  No oIndicate by check mark if the Registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes o No Indicate by check mark whether the Registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities ExchangeAct of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has beensubject to such filing requirements for the past 90 days. Yes  No oIndicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not becontained, to the best of Registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of thisForm 10-K or any amendment to this Form 10-K. Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reportingcompany. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.(Check one):Large accelerated filer Accelerated filer oNon-accelerated filer oSmaller reporting company o(Do not check if a smaller reporting company)Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o No The aggregate market value of the outstanding common equity held by non-affiliates of the Registrant as of the last business day of theRegistrant’s most recently completed second fiscal quarter was approximately $2,883,498,885 based upon the last reported sales price on theNasdaq National Market for such date. For purposes of this disclosure, shares of Common Stock held by officers and directors of the Registrantand by persons who hold more than 5% of the outstanding Common Stock have been excluded because such persons may be deemed to beaffiliates. This determination of affiliate status is not necessarily conclusive.The number of shares of the Registrant’s Common Stock, outstanding as of October 31, 2008, was 240,514,913.DOCUMENTS INCORPORATED BY REFERENCEPortions of the Registrant’s definitive Proxy Statement to be delivered to stockholders in connection with the Registrant’s 2009 Annual Meetingof Stockholders are incorporated by reference into Part III of this Form 10-K. NUANCE COMMUNICATIONS, INC.TABLE OF CONTENTS PagePART I Item 1. Business 1 Item 1A. Risk Factors 5 Item 1B. Unresolved Staff Comments 15 Item 2. Properties 16 Item 3. Legal Proceedings 16 Item 4. Submission of Matters to a Vote of Security Holders 17 PART II Item 5. Market for the Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases ofEquity Securities 18 Item 6. Selected Consolidated Financial Data 19 Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations 19 Item 7A. Quantitative and Qualitative Disclosures about Market Risk 46 Item 8. Financial Statements and Supplementary Data 46 Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure 111 Item 9A. Controls and Procedures 111 Item 9B. Other Information 112 PART III Item 10. Directors, Executive Officers and Corporate Governance 112 Item 11. Executive Compensation 113 Item 12. Security Ownership of Certain Beneficial Owners and Management and Related StockholderMatters 113 Item 13. Certain Relationships and Related Transactions, and Director Independence 113 Item 14. Principal Accountant Fees and Services 113 PART IV Item 15. Exhibits and Financial Statement Schedules 113 EX-10.39 Letter, dated June 3, 2008, from the Registrant to Thomas Beaudoin regarding certain employment matters EX-21.1 Subsidiaries of the Registrant EX-23.1 Consent of BDO Seidman, LLP EX-31.1 Section 302 Certification of CEO EX-31.2 Section 302 Certification of CFO EX-32.1 Section 906 Certification of CEO & CFOTable of ContentsPART IThis Annual Report on Form 10-K contains forward-looking statements within the meaning of the Private Securities LitigationReform Act of 1995 that involve risks, uncertainties and assumptions that, if they never materialize or if they prove incorrect, couldcause our consolidated results to differ materially from those expressed or implied by such forward-looking statements. All statementsother than statements of historical fact are statements that could be deemed forward-looking, including statements pertaining to: ourrevenue, earnings, cash flows and liquidity; the potential of future product releases; our product development plans and investments inresearch and development; future acquisitions; international operations and localized versions of our products; our contractualcommitments; our fiscal 2009 revenue and expense expectations and legal proceedings and litigation matters. You can identify these andother forward-looking statements by the use of words such as “may,” “will,” “should,” “expects,” “plans,” “anticipates,” “believes,”“estimates,” “predicts,” “intends,” “potential,” “continue” or the negative of such terms, or other comparable terminology. Forward-looking statements also include the assumptions underlying or relating to any of the foregoing statements. Our actual results could differmaterially from those anticipated in these forward-looking statements as a result of various factors, including those set forth in Item 1A ofthis Annual Report under the heading “Risk Factors.” All forward-looking statements included in this document are based on informationavailable to us on the date hereof. We will not undertake and specifically decline any obligation to update any forward-looking statements.Item 1. BusinessOverviewNuance Communications, Inc. is a leading provider of speech, imaging and keypad solutions for businesses, organizations andconsumers around the world. Our technologies, applications and services make the user experience more compelling by transforming theway people interact with information and how they create, share and use documents. Our solutions are used every day by millions ofpeople and thousands of businesses for tasks and services such as requesting account information from a phone-based self-servicesolution, dictating records, searching the mobile web by voice, entering a destination into a navigation system, or working with PDFdocuments. Our solutions help make these interactions, tasks and experiences more productive, compelling and efficient.We deliver solutions that address five core markets: • Enterprise. Our enterprise solutions help automate a range of customer services and business processes in information andprocess-intensive industries such as telecommunications, financial services, utilities, travel and entertainment, and government. • Mobile. Our mobile solutions add voice control and texting capabilities to mobile devices and services, allowing people to moreeasily dial a mobile phone, enter destination information into an automotive navigation system, dictate a text message or haveemails and screen information read aloud. • Healthcare. Our healthcare solutions comprise a portfolio of speech-driven clinical documentation and communication solutionsthat help healthcare provider organizations to reduce operating costs, increase reimbursement, and enhance patient care andsafety. • Desktop Dictation. Our Dragon products help people and businesses increase productivity by using speech to createdocuments, streamline repetitive and complex tasks, input data, complete forms and automate manual transcription processes. • Imaging. Our PDF and document imaging solutions reduce the time and cost associated with creating, using and sharingdocuments.We leverage our global professional services organization and our extensive network of partners to design and deploy innovativesolutions for businesses and organizations around the globe. We market and distribute our products through a global network of resellers,including system integrators, independent software vendors, value-1Table of Contentsadded resellers, hardware vendors, telecommunications carriers and distributors, and also sell directly through a dedicated sales forceand through our e-commerce website.We have built a world-class portfolio of technologies, applications and solutions through both internal development and acquisitions.We expect to continue to pursue opportunities to broaden these assets and expand our customer base through acquisitions. Our recentlycompleted, significant transactions include: • On October 1, 2008, we acquired SNAPin Software, Inc., a provider of mobile device and server self-service technology. TheSNAPin acquisition enhances our ability to deliver innovative, highly scalable mobile customer care solutions that improve theway mobile operators and enterprises interact with consumers in real-time on mobile devices. • On September 26, 2008, we acquired Philips Speech Recognition Systems GMBH (PSRS), a business unit of Royal PhilipsElectronics, a leading provider of speech recognition solutions for the European healthcare market. This acquisition significantlyenhances our ability to deliver innovative, clinical documentation and communication solutions to healthcare organizationsthroughout Europe. • On May 20, 2008, we acquired eScription, Inc., a provider of computer-aided medical transcription solutions. The eScriptionacquisition allows us to deliver scalable, highly productive medical transcription solutions, as well as accelerate futureinnovation to transform the way healthcare providers document patient care.Confronted by dramatic increases in electronic information, consumers, business personnel and healthcare professionals must use avariety of resources to retrieve information, transcribe patient records, conduct transactions and perform other job-related functions. Webelieve that the power of our solutions can transform the way people use the Internet, telecommunications systems, electronic medicalrecords, wireless and mobile networks and related corporate infrastructure to conduct business.Solutions to our core markets include:Enterprise Solutions — To remain competitive, organizations must improve the quality of customer care while reducing costs andensuring a positive customer experience. Technological innovation, competitive pressures and rapid commoditization have made itincreasingly important for organizations to achieve enduring market differentiation and secure customer loyalty. In this environment,organizations need to satisfy the expectations of increasingly savvy and mobile consumers who demand high levels of customer service.We deliver a portfolio of customer service business intelligence and authentication solutions that are designed to help companiesbetter support, understand and communicate with their customers. Our solutions improve the customer experience, increase the use ofself-service and enable new revenue opportunities. We complement our solutions and products with a global professional servicesorganization that supports customers and partners with business and systems consulting project management, user-interface design,speech science, application development and business performance optimization. Our acquisition of Viecore expanded our professionalservices capabilities and complements our existing partnerships, allowing us to deliver end-to-end speech solutions and system integrationfor speech-enabled customer care.We license our solutions to a wide variety of enterprises in customer-service intensive sectors, including telecommunications,financial services, travel and entertainment, and government. Our speech solutions are designed to serve our global partners andcustomers and are available in up to 50 languages and dialects worldwide. We often work closely with industry partners, includingAvaya, Cisco, Genesys and Nortel, that integrate our solutions into their hardware and software platforms.Mobile Solutions — Today, an increasing number of people worldwide rely on mobile devices to stay connected, informed andproductive. We see an opportunity in helping consumers use the powerful capabilities of their phones, cars and personal navigationdevices by using voice commands and keypad solutions to control these devices and to access the array of content and services availableon the Internet through wireless mobile devices. We expect to serve more than one billion consumers in the next three years with solutionsthat allow them to simply and effectively retrieve and communicate information on these mobile devices.2Table of ContentsOur portfolio of mobile solutions and services includes an integrated suite of voice solutions for mobile devices, predictive texttechnologies, mobile messaging services and emerging services such as voicemail-to-text. Our solutions are used by mobile phone,automotive, personal navigation device and other consumer electronic manufacturers and their suppliers, including Ford, LG Electronics,Nokia, Samsung and TomTom. In addition, telecommunications carriers, web search companies and content providers are increasinglyusing our mobile search and communication solutions to offer value-added services to their subscribers and customers. Our acquisitionof SNAPin enhances our ability to deliver innovative, highly scalable mobile customer care solutions that improve the way mobileoperators and enterprises interact with consumers in real-time on mobile devices.Healthcare Solutions — The healthcare industry is under significant pressure to streamline operations and reduce costs andimprove patient care. In recent years, healthcare organizations such as hospitals, clinics, medical groups, physicians’ offices andinsurance providers have increasingly turned to speech solutions to automate manual processes such as the dictation and transcription ofpatient records.We provide comprehensive dictation and transcription solutions and services that automate the input and management of medicalinformation. Our hosted and on-premise solutions for larger organizations provide platforms to generate and distribute clinicaldocumentation through the use of advanced dictation and transcription features. Our acquisition of eScription allows us to deliverscalable, highly productive medical transcription solutions, as well as accelerate future innovation to transform the way healthcareproviders document patient care. We also offer speech recognition solutions for radiology, cardiology, pathology and related specialties,that help healthcare providers dictate, edit and sign reports without manual transcription.Hospitals, clinics and group practices as well as physicians use our healthcare solutions to manage the dictation and transcription ofpatient records. We utilize a focused, enterprise sales team and professional services organization to address the market andimplementation requirements of the healthcare industry. Our acquisition of Philips Speech Recognition Systems significantly enhancesour ability to deliver innovative, speech-driven clinical documentation and communication solutions to healthcare organization throughoutEurope.Dragon NaturallySpeaking — Our suite of general purpose desktop dictation applications increases productivity by using speechto create documents, streamline repetitive and complex tasks, input data, complete forms and automate manual transcription processes.Our Dragon NaturallySpeaking family of products delivers enhanced productivity for professionals and consumers who need to createdocuments and transcripts. These solutions allow users to automatically convert speech into text at up to 160 words-per-minute, withsupport for over 300,000 words and with high accuracy. This vocabulary can be expanded by users to include specialized words andphrases and can be adapted to recognize individual voice patterns. Our desktop dictation software is currently available in elevenlanguages. We utilize a combination of our global reseller network and direct sales to distribute our speech recognition and dictationproducts. Our Dragon Medical solution is a desktop application that provides front-end speech recognition used by physicians andclinicians to create and navigate medical records.Imaging — The proliferation of the Internet, email and other networks have greatly simplified the ability to share electronicdocuments, resulting in an ever-growing volume of documents to be used and stored. Our PDF and document imaging solutions reducethe costs associated with paper documents through easy to use scanning, document management and electronic document routingsolutions. We offer versions of our products to hardware vendors, home offices, small businesses and enterprise customers.Our imaging solutions offer comprehensive PDF applications designed specifically for business users, optical character recognitiontechnology to deliver highly accurate document and PDF conversion and applications that combine PDF creation with network scanningto work quickly with scanned paper documents, PDF files and digital documents and software development toolkits for independentsoftware vendors. We utilize a combination of our global reseller network and direct sales to distribute our document conversion and PDFproducts. We license our software to companies such as Brother, Canon, Dell, HP and Xerox, which bundle our solutions withmultifunction devices, digital copiers, printers and scanners.3Table of ContentsResearch and Development/Intellectual PropertyIn recent years, we have developed and acquired extensive technology assets, intellectual property and industry expertise in speechand imaging that provide us with a competitive advantage in markets where we compete. Our technologies are based on complexalgorithms which require extensive amounts of linguistic and image data, acoustic models and recognition techniques. A significantinvestment in capital and time would be necessary to replicate our current capabilities.We continue to invest in technologies to maintain our market-leading position and to develop new applications. Our technologies arecovered by more than 650 issued patents and 680 patent applications. Our intellectual property, whether purchased or developedinternally, is critical to our success and competitive position and, ultimately, to our market value. Our products and services build on aportfolio of patents, copyrights, trademarks, services marks, trade secrets, confidentiality provisions and licensing arrangements toestablish and protect our intellectual property and proprietary rights.International OperationsWe have principal offices in a number of international locations including: Belgium, Canada, Germany, Hungary, India, Japan,Australia, and the United Kingdom. The responsibilities of our international operations include research and development, healthcaretranscription and editing, customer support, sales and marketing and administration. Additionally, we maintain smaller sales, servicesand support offices throughout the world to support our international customers and to expand international revenue opportunities.Geographic revenue classification is based on the geographic areas in which our customers are located. For fiscal 2008, 2007 and2006, 77%, 78% and 74% of revenue was generated in the United States and 23%, 22% and 26% of revenue was generated by ourinternational operations, respectively.CompetitionThe individual markets in which we compete are highly competitive and are subject to rapid technology changes. There are anumber of companies that develop or may develop products that compete in our target markets; however, currently there is no onecompany that competes with us in all of our product areas. While we expect competition to continue to increase both from existingcompetitors and new market entrants, we believe that we will compete effectively based on many factors, including: • Technological Superiority. Our speech and imaging technologies, applications and solutions are often recognized as the mostproficient products in their respective categories. Our speech technology has industry-leading recognition accuracy and provides anatural, speech-enabled interaction with systems, devices and applications. Our imaging technology is viewed as the mostaccurate in the industry. Technology publications, analyst research and independent benchmarks have indicated our productsrank at or above performance levels of alternative solutions. • Broad Distribution Channels. Our extensive global network of resellers, comprising system integrators, independent softwarevendors, value-added resellers, hardware vendors, telecommunications carriers and distributors; our dedicated direct sales force;and our e-commerce website (www.nuance.com) enable us to address the needs of specific markets, such as financial, legal,healthcare and government, and introduce new products quickly and effectively. • International Appeal. The international reach of our products is due to the broad language coverage of our offerings, includingour speech technology which provides recognition for up to 50 languages and dialects and natural sounding synthesized speechin 26 languages and supports a broad range of hardware platforms and operating systems. Our imaging technology supportsmore than 100 languages. • Specialized Professional Services. Our superior technology, when coupled with the high quality of our professional services,allows our customers and partners to place a high degree of confidence and trust in our ability to deliver results.4Table of ContentsIn our core markets, we compete with companies such as Adobe, IBM, Medquist, Microsoft, Google and Spheris. In addition, anumber of smaller companies in both speech and imaging produce technologies or products that are competitive with our solutions insome markets. In certain markets, some of our partners such as Avaya, Cisco, Genesys and Nortel develop and market products andservices that might be considered substitutes for our solutions. Current and potential competitors have established, or may establish,cooperative relationships among themselves or with third parties to increase the ability of their technologies to address the needs of ourprospective customers.Some of our competitors or potential competitors in our markets, such as Adobe, IBM, Microsoft and Google, have significantlygreater financial, technical and marketing resources than we do. These competitors may be able to respond more rapidly than we can tonew or emerging technologies or changes in customer requirements. They may also devote greater resources to the development, promotionand sale of their products than we do.EmployeesAs of September 30, 2008, we had approximately 6,100 full time employees in total, including approximately 650 in sales andmarketing, approximately 1,000 in professional services, approximately 800 in research and development, approximately 400 in generaland administrative and approximately 3,250 that provide healthcare transcription and editing services. Approximately fifty-five percent ofour employees are based outside of the United States, the majority of who provide healthcare transcription and editing services and arebased in India. Our employees are not represented by any labor union and are not organized under a collective bargaining agreement, andwe have never experienced a work stoppage. We believe that our relationships with our employees are generally good.Company InformationOur website is located at www.nuance.com. This Annual Report on Form 10-K, our Quarterly Reports on Form 10-Q, our CurrentReports on Form 8-K, and all amendments to these reports, as well as proxy statements and other information we file with or furnish tothe Securities and Exchange Commission, or the SEC, are accessible free of charge on our website. We make these documents availableas soon as reasonably practicable after we file them with, or furnish them to, the SEC. Except as otherwise stated in these documents, theinformation contained on our website or available by hyperlink from our website is not incorporated by reference into this report or anyother documents we file with or furnish to the SEC.Item 1A. Risk FactorsYou should carefully consider the risks described below when evaluating our company and when deciding whether to invest in ourcompany. The risks and uncertainties described below are not the only ones we face. Additional risks and uncertainties not presentlyknown to us or that we do not currently believe are important to an investor may also harm our business operations. If any of the events,contingencies, circumstances or conditions described in the following risks actually occurs, our business, financial condition or ourresults of operations could be seriously harmed. If that happens, the trading price of our common stock could decline and you may losepart or all of the value of any of our shares held by you.Risks Related to Our BusinessOur operating results may fluctuate significantly from period to period, and this may cause our stock price to decline.Our revenue and operating results have fluctuated in the past and are expected to continue to fluctuate in the future. Given thisfluctuation, we believe that quarter to quarter comparisons of revenue and operating results are not necessarily meaningful or an accurateindicator of our future performance. As a result, our results of operations5Table of Contentsmay not meet the expectations of securities analysts or investors in the future. If this occurs, the price of our stock would likely decline.Factors that contribute to fluctuations in operating results include the following: • slowing sales by our distribution and fulfillment partners to their customers, which may place pressure on these partners toreduce purchases of our products; • volume, timing and fulfillment of customer orders; • our efforts to generate additional revenue from our portfolio of intellectual property; • concentration of operations with one manufacturing partner and our inability to control expenses related to the manufacture,packaging and shipping of our boxed software products; • customers delaying their purchasing decisions in anticipation of new versions of our products; • customers delaying, canceling or limiting their purchases as a result of the threat or results of terrorism; • introduction of new products by us or our competitors; • seasonality in purchasing patterns of our customers; • reduction in the prices of our products in response to competition, market conditions or contractual obligations; • returns and allowance charges in excess of accrued amounts; • timing of significant marketing and sales promotions; • impairment charges against goodwill and intangible assets; • in-process research and development expense relating to acquisitions; • delayed realization of synergies resulting from our acquisitions; • write-offs of excess or obsolete inventory and accounts receivable that are not collectible; • increased expenditures incurred pursuing new product or market opportunities; • general economic trends as they affect retail and corporate sales; and • higher than anticipated costs related to fixed-price contracts with our customers.Due to the foregoing factors, among others, our revenue and operating results are difficult to forecast. Our expense levels are based insignificant part on our expectations of future revenue and we may not be able to reduce our expenses quickly to respond to a shortfall inprojected revenue. Therefore, our failure to meet revenue expectations would seriously harm our operating results, financial condition andcash flows.We have grown, and may continue to grow, through acquisitions, which could dilute our existing stockholders.As part of our business strategy, we have in the past acquired, and expect to continue to acquire, other businesses and technologies.In connection with past acquisitions, we issued a substantial number of shares of our common stock as transaction consideration andalso incurred significant debt to finance the cash consideration used for our acquisitions, including our acquisitions of Dictaphone,Focus, BeVocal, VoiceSignal, Tegic, Viecore, eScription and SNAPin. We may continue to issue equity securities for future acquisitions,which would dilute existing stockholders, perhaps significantly depending on the terms of such acquisitions. We may also incuradditional debt in connection with future acquisitions, which, if available at all, may place additional restrictions on our ability to operateour business.6Table of ContentsOur ability to realize the anticipated benefits of our acquisitions will depend on successfully integrating the acquiredbusinesses.Our prior acquisitions required, and our recently completed acquisitions continue to require, substantial integration and managementefforts and we expect our pending and future acquisitions to require similar efforts. Acquisitions of this nature involve a number of risks,including: • difficulty in transitioning and integrating the operations and personnel of the acquired businesses; • potential disruption of our ongoing business and distraction of management; • potential difficulty in successfully implementing, upgrading and deploying in a timely and effective manner new operationalinformation systems and upgrades of our finance, accounting and product distribution systems; • difficulty in incorporating acquired technology and rights into our products and technology; • potential difficulties in completing projects associated with in-process research and development; • unanticipated expenses and delays in completing acquired development projects and technology integration; • management of geographically remote business units both in the United States and internationally; • impairment of relationships with partners and customers; • assumption of unknown material liabilities of acquired companies; • customers delaying purchases of our products pending resolution of product integration between our existing and our newlyacquired products; • entering markets or types of businesses in which we have limited experience; and • potential loss of key employees of the acquired business.As a result of these and other risks, if we are unable to successfully integrate acquired businesses, we may not realize the anticipatedbenefits from our acquisitions. Any failure to achieve these benefits or failure to successfully integrate acquired businesses andtechnologies could seriously harm our business.Accounting treatment of our acquisitions could decrease our net income or expected revenue in the foreseeable future,which could have a material and adverse effect on the market value of our common stock.Under accounting principles generally accepted in the United States of America, we record the market value of our common stock orother form of consideration issued in connection with the acquisition and the amount of direct transaction costs as the cost of acquiringthe company or business. We have allocated that cost to the individual assets acquired and liabilities assumed, including variousidentifiable intangible assets such as acquired technology, acquired trade names and acquired customer relationships based on theirrespective fair values and also to in-process research and development. Intangible assets generally will be amortized over a five to ten yearperiod. Goodwill and certain intangible assets with indefinite lives, are not subject to amortization but are subject to an impairmentanalysis, at least annually, which may result in an impairment charge if the carrying value exceeds its implied fair value. As ofSeptember 30, 2008, we had identified intangible assets amounting to approximately $585.0 million and goodwill of approximately$1.7 billion. In addition, purchase accounting limits our ability to recognize certain revenue that otherwise would have been recognized bythe acquired company as an independent business. The combined company may delay revenue recognition or recognize less revenue thanwe and the acquired company would have recognized as independent companies.Our significant debt could adversely affect our financial health and prevent us from fulfilling our obligations under ourcredit facility and our convertible debentures.We have a significant amount of debt. As of September 30, 2008, we had a total of $907.0 million of gross debt outstanding,including $657.0 million in term loans due in March 2013 and $250.0 million in convertible debentures which investors may require usto redeem in August 2014. We also have a $75.0 million revolving credit line7Table of Contentsavailable to us through March 2012. As of September 30, 2008, there were $16.6 million of letters of credit issued under the revolvingcredit line and there were no other outstanding borrowings under the revolving credit line. On October 8, 2008, we drew $55.0 millionagainst our existing revolving credit line. Our debt level could have important consequences, for example it could: • require us to use a large portion of our cash flow to pay principal and interest on debt, including the convertible debentures andthe credit facility, which will reduce the availability of our cash flow to fund working capital, capital expenditures, acquisitions,research and development expenditures and other business activities; • restrict us from making strategic acquisitions or exploiting business opportunities; • place us at a competitive disadvantage compared to our competitors that have less debt; and • limit, along with the financial and other restrictive covenants in our debt, our ability to borrow additional funds, dispose ofassets or pay cash dividends.Our ability to meet our payment and other obligations under our debt instruments depends on our ability to generate significant cashflow in the future. This, to some extent, is subject to general economic, financial, competitive, legislative and regulatory factors as well asother factors that are beyond our control. We cannot assure you that our business will generate cash flow from operations, or thatadditional capital will be available to us, in an amount sufficient to enable us to meet our payment obligations under the convertibledebentures and our other debt and to fund other liquidity needs. If we are not able to generate sufficient cash flow to service our debtobligations, we may need to refinance or restructure our debt, including the convertible debentures, sell assets, reduce or delay capitalinvestments, or seek to raise additional capital. If we are unable to implement one or more of these alternatives, we may not be able to meetour payment obligations under the convertible debentures and our other debt.In addition, a substantial portion of our debt bears interest at variable rates. If market interest rates increase, our debt servicerequirements will increase, which would adversely affect our cash flows. While we have entered into an interest rate swap agreementlimiting our exposure for a portion of our debt, the agreement does not offer complete protection from this risk.Our debt agreements contain covenant restrictions that may limit our ability to operate our business.The agreement governing our senior credit facility contains, and any of our other future debt agreements may contain, covenantrestrictions that limit our ability to operate our business, including restrictions on our ability to: • incur additional debt or issue guarantees; • create liens; • make certain investments; • enter into transactions with our affiliates; • sell certain assets; • redeem capital stock or make other restricted payments; • declare or pay dividends or make other distributions to stockholders; and • merge or consolidate with any entity.Our ability to comply with these covenants is dependent on our future performance, which will be subject to many factors, some ofwhich are beyond our control, including prevailing economic conditions. As a result of these covenants, our ability to respond to changesin business and economic conditions and to obtain additional financing, if needed, may be significantly restricted, and we may beprevented from engaging in transactions that might otherwise be beneficial to us. In addition, our failure to comply with these covenantscould result in a default under our debt agreements, which could permit the holders to accelerate our obligation to repay the debt. If any ofour debt is accelerated, we may not have sufficient funds available to repay the accelerated debt.8Table of ContentsWe have a history of operating losses, and may incur losses in the future, which may require us to raise additional capital onunfavorable terms.We reported net losses of approximately $30.1 million, $14.0 million and $22.9 million for fiscal years 2008, 2007 and 2006,respectively. We had an accumulated deficit of approximately $235.1 million at September 30, 2008. If we are unable to achieve andmaintain profitability, the market price for our stock may decline, perhaps substantially. We cannot assure you that our revenue willgrow or that we will achieve or maintain profitability in the future. If we do not achieve profitability, we may be required to raiseadditional capital to maintain or grow our operations. The terms of any transaction to raise additional capital, if available at all, may behighly dilutive to existing investors or contain other unfavorable terms, such as a high interest rate and restrictive covenants.Speech technologies may not achieve widespread acceptance, which could limit our ability to grow our speech business.We have invested and expect to continue to invest heavily in the acquisition, development and marketing of speech technologies. Themarket for speech technologies is relatively new and rapidly evolving. Our ability to increase revenue in the future depends in largemeasure on acceptance of speech technologies in general and our products in particular. The continued development of the market for ourcurrent and future speech solutions will also depend on: • consumer and business demand for speech-enabled applications; • development by third-party vendors of applications using speech technologies; and • continuous improvement in speech technology.Sales of our speech products would be harmed if the market for speech technologies does not continue to develop or develops moreslowly than we expect, and, consequently, our business could be harmed and we may not recover the costs associated with ourinvestment in our speech technologies.The markets in which we operate are highly competitive and rapidly changing and we may be unable to compete successfully.There are a number of companies that develop or may develop products that compete in our targeted markets. The individualmarkets in which we compete are highly competitive, and are rapidly changing. Within speech, we compete with AT&T, IBM,Microsoft, Google, and other smaller providers. Within healthcare dictation and transcription, we compete with Spheris, Medquist andother smaller providers. Within imaging, we compete directly with ABBYY, Adobe, eCopy, I.R.I.S. and NewSoft. In speech, some of ourpartners such as Avaya, Cisco, Edify, Genesys and Nortel develop and market products that can be considered substitutes for oursolutions. In addition, a number of smaller companies in both speech and imaging produce technologies or products that are in somemarkets competitive with our solutions. Current and potential competitors have established, or may establish, cooperative relationshipsamong themselves or with third parties to increase the ability of their technologies to address the needs of our prospective customers.The competition in these markets could adversely affect our operating results by reducing the volume of the products we license orthe prices we can charge. Some of our current or potential competitors, such as Adobe, IBM, Microsoft and Google, have significantlygreater financial, technical and marketing resources than we do. These competitors may be able to respond more rapidly than we can tonew or emerging technologies or changes in customer requirements. They may also devote greater resources to the development, promotionand sale of their products than we do.Some of our customers, such as IBM, Microsoft and Google, have developed or acquired products or technologies that compete withour products and technologies. These customers may give higher priority to the sale of these competitive products or technologies. To theextent they do so, market acceptance and penetration of our products, and therefore our revenue, may be adversely affected. Our successwill depend substantially upon our ability to enhance our products and technologies and to develop and introduce, on a timely and cost-effective basis, new products and features that meet changing customer requirements and incorporate technological advancements.9Table of ContentsIf we are unable to develop new products and enhance functionalities or technologies to adapt to these changes, or if we are unable torealize synergies among our acquired products and technologies, our business will suffer.The failure to successfully maintain the adequacy of our system of internal control over financial reporting could have amaterial adverse impact on our ability to report our financial results in an accurate and timely manner.The SEC, as directed by Section 404 of the Sarbanes-Oxley Act of 2002, adopted rules requiring public companies to include areport of management on internal control over financial reporting in their annual reports on Form 10-K that contain an assessment bymanagement of the effectiveness of the Company’s internal control over financial reporting. In addition, our independent registered publicaccounting firm must attest to and report on the effectiveness of the internal control over financial reporting. Any failure in theeffectiveness of our system of internal control over financial reporting could have a material adverse impact on our ability to report ourfinancial statements in an accurate and timely manner, could subject us to regulatory actions, civil or criminal penalties, shareholderlitigation, or loss of customer confidence, which could result in an adverse reaction in the financial marketplace due to a loss of investorconfidence in the reliability of our financial statements, which ultimately could negatively impact our stock price.A significant portion of our revenue and a significant portion of our research and development are based outside the UnitedStates. Our results could be harmed by economic, political, regulatory and other risks associated with these internationalregions.Because we operate worldwide, our business is subject to risks associated with doing business internationally. We anticipate thatrevenue from international operations will increase in the future. Reported international revenue, classified by the major geographic areasin which our customers are located, represented approximately $199.2 million, $130.4 million and $100.2 million, representing 23%,22% and 26% of our total revenue, for fiscal 2008, 2007 and 2006, respectively. Most of our international revenue is generated by salesin Europe and Asia. In addition, some of our products are developed and manufactured outside the United States and we have a largenumber of employees in India that provide transcription services. A significant portion of the development and manufacturing of ourspeech products are completed in Belgium, and a significant portion of our imaging research and development is conducted in Hungary.We also have significant research and development resources in Aachen, Germany, Montreal, Canada and Vienna, Austria. Accordingly,our future results could be harmed by a variety of factors associated with international sales and operations, including: • changes in a specific country’s or region’s economic conditions; • geopolitical turmoil, including terrorism and war; • trade protection measures and import or export licensing requirements imposed by the United States or by other countries; • compliance with foreign and domestic laws and regulations; • negative consequences from changes in applicable tax laws; • difficulties in staffing and managing operations in multiple locations in many countries; • difficulties in collecting trade accounts receivable in other countries; and • less effective protection of intellectual property than in the United States.We are exposed to fluctuations in foreign currency exchange rates.Because we have international subsidiaries and distributors that operate and sell our products outside the United States, we areexposed to the risk of changes in foreign currency exchange rates or declining economic conditions in these countries. In certaincircumstances, we have entered into forward exchange contracts to hedge against foreign currency fluctuations. We use these contracts toreduce our risk associated with exchange rate movements, as the gains or losses on these contracts are intended to offset any exchange ratelosses or gains on the10Table of Contentshedged transaction. We do not engage in foreign currency speculation. Forward exchange contracts hedging firm commitments qualify forhedge accounting when they are designated as a hedge of the foreign currency exposure and they are effective in minimizing such exposure.With our increased international presence in a number of geographic locations and with international revenue and costs projected toincrease, we are exposed to changes in foreign currencies including the Euro, British Pound, Canadian Dollar, Japanese Yen, Israeli NewShekel, Indian Rupee and the Hungarian Forint. Changes in the value of the Euro or other foreign currencies relative to the value of theU.S. dollar could adversely affect future revenue and operating results.Impairment of our intangible assets could result in significant charges that would adversely impact our future operatingresults.We have significant intangible assets, including goodwill and intangibles with indefinite lives, which are susceptible to valuationadjustments as a result of changes in various factors or conditions. The most significant intangible assets are patents and core technology,completed technology, customer relationships and trademarks. Customer relationships are amortized on an accelerated basis based uponthe pattern in which the economic benefits of customer relationships are being utilized. Other identifiable intangible assets are amortized ona straight-line basis over their estimated useful lives. We assess the potential impairment of identifiable intangible assets on an annualbasis, as well as whenever events or changes in circumstances indicate that the carrying value may not be recoverable. Factors that couldtrigger an impairment of such assets, include the following: • significant underperformance relative to historical or projected future operating results; • significant changes in the manner of or use of the acquired assets or the strategy for our overall business; • significant negative industry or economic trends; • significant decline in our stock price for a sustained period; • changes in our organization or management reporting structure could result in additional reporting units, which may requirealternative methods of estimating fair values or greater disaggregation or aggregation in our analysis by reporting unit; and • a decline in our market capitalization below net book value.Future adverse changes in these or other unforeseeable factors could result in an impairment charge that would impact our results ofoperations and financial position in the reporting period identified. As of September 30, 2008, we had identified intangible assetsamounting to approximately $585.0 million and goodwill of approximately $1.7 billion.We depend on limited or sole source suppliers for critical components of our healthcare-related products. The inability toobtain sufficient components as required, and under favorable purchase terms, could harm our business.We are dependent on certain suppliers, including limited and sole source suppliers, to provide key components used in ourhealthcare-related products. We have experienced, and may continue to experience, delays in component deliveries, which in turn couldcause delays in product shipments and require the redesign of certain products. In addition, if we are unable to procure necessarycomponents under favorable purchase terms, including at favorable prices and with the order lead-times needed for the efficient andprofitable operation of our business, our results of operations could suffer.Our sales to government clients subject us to risks including early termination, audits, investigations, sanctions andpenalties.We derive revenue from contracts with the United States government, as well as various state and local governments, and theirrespective agencies. Our sales to government agencies have increased as a result of our acquisitions of Viecore and Dictaphone.Government contracts are generally subject to audits and investigations which could identify violations of these agreements. Governmentcontract violations could result in a range of consequences including, but not limited to, contract price adjustments, civil and criminalpenalties, contract11Table of Contentstermination, forfeiture of profit and/or suspension of payment, and suspension or debarment from future government contracts. We couldalso suffer serious harm to our reputation if we were found to have violated the terms of our government contracts.We recently conducted an analysis of our compliance with the terms and conditions of certain contracts with the U.S. GeneralServices Administration (“GSA”). Based upon our analysis, we voluntarily notified GSA of non-compliance with the terms of contractsentered into by Dictaphone Corporation, which we acquired in March 2006. The final resolution of this matter may adversely impact ourfinancial position.If we are unable to attract and retain key personnel, our business could be harmed.If any of our key employees were to leave, we could face substantial difficulty in hiring qualified successors and could experience aloss in productivity while any successor obtains the necessary training and experience. Our employment relationships are generally at-willand we have had key employees leave in the past. We cannot assure you that one or more key employees will not leave in the future. Weintend to continue to hire additional highly qualified personnel, including software engineers and operational personnel, but may not beable to attract, assimilate or retain qualified personnel in the future. Any failure to attract, integrate, motivate and retain these employeescould harm our business.Our medical transcription services may be subject to legal claims for failure to comply with laws governing the confidentialityof medical records.Healthcare professionals who use our medical transcription services deliver to us health information about their patients includinginformation that constitutes a record under applicable law that we may store on our computer systems. Numerous federal and state lawsand regulations, the common law and contractual obligations govern collection, dissemination, use and confidentiality of patient-identifiable health information, including: • state and federal privacy and confidentiality laws; • our contracts with customers and partners; • state laws regulating healthcare professionals; • Medicaid laws; and • the Health Insurance Portability and Accountability Act of 1996 and related rules proposed by the Health Care FinancingAdministration.The Health Insurance Portability and Accountability Act of 1996 establishes elements including, but not limited to, federal privacyand security standards for the use and protection of protected health information. Any failure by us or by our personnel or partners tocomply with applicable requirements may result in a material liability to the Company. Although we have systems and policies in placefor safeguarding protected health information from unauthorized disclosure, these systems and policies may not preclude claims againstus for alleged violations of applicable requirements. There can be no assurance that we will not be subject to liability claims that couldhave a material adverse affect on our business, results of operations and financial condition.Adverse changes in general economic or political conditions in any of the major countries in which we do business couldadversely affect our operating results.As our business has grown, we have become increasingly subject to the risks arising from adverse changes in domestic and globaleconomic and political conditions. For example, the direction and relative strength of the U.S. and global economics have recently beenincreasingly uncertain due to softness in housing markets, extreme volatility in security prices, severely diminished liquidity and creditavailability rating downgrades of certain investments and declining valuations of others and continuing geopolitical uncertainties. Ifeconomic growth in the United States and other countries in which we do business is slowed, customers may delay or reduce technologypurchases and may be unable to obtain credit to finance purchase of our products. This could result in reduced sales of our products,longer sales cycles, slower adoption of new technologies and increased price competition. Any of these events would likely harm ourbusiness, results of operations and financial condition. Political instability in any12Table of Contentsof the major countries in which we do business would also likely harm our business, results of operations and financial condition.Security and privacy breaches in our systems may damage client relations and inhibit our growth.The uninterrupted operation of our hosted solutions and the confidentiality of third-party information that resides on our systems iscritical to our business. We have what we believe to be sufficient security around our systems to prevent unauthorized access. Anyfailures in our security and privacy measures could have a material adverse effect on our financial position and results of operations. Ifwe are unable to protect, or our clients perceive that we are unable to protect, the security and privacy of our electronic information, ourgrowth could be materially adversely affected. A security or privacy breach may: • cause our clients to lose confidence in our solutions; • harm our reputation; • expose us to liability; and • increase our expenses from potential remediation costs.While we believe we use proven applications designed for data security and integrity to process electronic transactions, there can beno assurance that our use of these applications will be sufficient to address changing market positions or the security and privacyconcerns of existing and potential clients.Risks Related to Our Intellectual Property and TechnologyUnauthorized use of our proprietary technology and intellectual property could adversely affect our business and results ofoperations.Our success and competitive position depend in large part on our ability to obtain and maintain intellectual property rights protectingour products and services. We rely on a combination of patents, copyrights, trademarks, service marks, trade secrets, confidentialityprovisions and licensing arrangements to establish and protect our intellectual property and proprietary rights. Unauthorized parties mayattempt to copy aspects of our products or to obtain, license, sell or otherwise use information that we regard as proprietary. Policingunauthorized use of our products is difficult and we may not be able to protect our technology from unauthorized use. Additionally, ourcompetitors may independently develop technologies that are substantially the same or superior to our technologies and that do not infringeour rights. In these cases, we would be unable to prevent our competitors from selling or licensing these similar or superior technologies. Inaddition, the laws of some foreign countries do not protect our proprietary rights to the same extent as the laws of the United States.Although the source code for our proprietary software is protected both as a trade secret and as a copyrighted work, litigation may benecessary to enforce our intellectual property rights, to protect our trade secrets, to determine the validity and scope of the proprietaryrights of others, or to defend against claims of infringement or invalidity. Litigation, regardless of the outcome, can be very expensive andcan divert management efforts.Third parties have claimed and may claim in the future that we are infringing their intellectual property, and we could beexposed to significant litigation or licensing expenses or be prevented from selling our products if such claims aresuccessful.From time to time, we are subject to claims that we or our customers may be infringing or contributing to the infringement of theintellectual property rights of others. We may be unaware of intellectual property rights of others that may cover some of our technologiesand products. If it appears necessary or desirable, we may seek licenses for these intellectual property rights. However, we may not beable to obtain licenses from some or all claimants, the terms of any offered licenses may not be acceptable to us, and we may not be ableto resolve disputes without litigation. Any litigation regarding intellectual property could be costly and time-consuming and could divertthe attention of our management and key personnel from our business operations. In the event of a claim of intellectual propertyinfringement, we may be required to enter into costly royalty or license agreements. Third13Table of Contentsparties claiming intellectual property infringement may be able to obtain injunctive or other equitable relief that could effectively block ourability to develop and sell our products.We may incur substantial costs enforcing or acquiring intellectual property rights and defending against third-party claimsas a result of litigation or other proceedings.In connection with the enforcement of our own intellectual property rights, the acquisition of third-party intellectual property rights,or disputes relating to the validity or alleged infringement of third-party intellectual property rights, including patent rights, we have been,are currently, and may in the future be, subject to claims, negotiations or complex, protracted litigation. Intellectual property disputes andlitigation are typically very costly and can be disruptive to our business operations by diverting the attention and energy of managementand key technical personnel. Although we have successfully defended or resolved past litigation and disputes, we may not prevail in anyongoing or future litigation and disputes. In addition, we may incur significant costs in acquiring the necessary third party intellectualproperty rights for use in our products. Third party intellectual property disputes could subject us to significant liabilities, require us toenter into royalty and licensing arrangements on unfavorable terms, prevent us from manufacturing or licensing certain of our products,cause severe disruptions to our operations or the markets in which we compete, or require us to satisfy indemnification commitments withour customers including contractual provisions under various license arrangements. Any of these could seriously harm our business.Our software products may have bugs, which could result in delayed or lost revenue, expensive correction, liability to ourcustomers and claims against us.Complex software products such as ours may contain errors, defects or bugs. Defects in the solutions or products that we developand sell to our customers could require expensive corrections and result in delayed or lost revenue, adverse customer reaction and negativepublicity about us or our products and services. Customers who are not satisfied with any of our products may also bring claims againstus for damages, which, even if unsuccessful, would likely be time-consuming to defend, and could result in costly litigation andpayment of damages. Such claims could harm our reputation, financial results and competitive position.Risks Related to our Corporate Structure, Organization and Common StockThe holdings of our two largest stockholders may enable them to influence matters requiring stockholder approval.On March 19, 2004,Warburg Pincus, a global private equity firm agreed to purchase all outstanding shares of our stock held byXerox Corporation for approximately $80.0 million. On May 9, 2005 and September 15, 2005, we sold shares of common stock, andwarrants to purchase common stock to Warburg Pincus for aggregate gross proceeds of approximately $75.1 million. Additionally, onMay 20, 2008, Warburg Pincus purchased 5,760,369 shares of our common stock and warrants to purchase 3,700,000 shares of ourcommon stock for an aggregate purchase price of $100.5 million. As of September 30, 2008, Warburg Pincus beneficially ownedapproximately 21% of our outstanding common stock, including warrants exercisable for up to 10,766,538 shares of our common stockand 3,562,238 shares of our outstanding Series B Preferred Stock, each of which is convertible into one share of our common stock. Asof September 30, 2008, Fidelity was our second largest stockholder, owning approximately 8% of our common stock. Because of theirlarge holdings of our capital stock relative to other stockholders, each of these two stockholders acting individually, or together, have astrong influence over matters requiring approval by our stockholders.The market price of our common stock has been and may continue to be subject to wide fluctuations, and this may make itdifficult for you to resell the common stock when you want or at prices you find attractive.Our stock price historically has been, and may continue to be, volatile. Various factors contribute to the volatility of the stock price,including, for example, quarterly variations in our financial results, new product introductions by us or our competitors and generaleconomic and market conditions. Sales of a substantial number14Table of Contentsof shares of our common stock by our two largest stockholders, or the perception that such sales could occur, could also contribute to thevolatility or our stock price. While we cannot predict the individual effect that these factors may have on the market price of our commonstock, these factors, either individually or in the aggregate, could result in significant volatility in our stock price during any given periodof time. Moreover, companies that have experienced volatility in the market price of their stock often are subject to securities class actionlitigation. If we were the subject of such litigation, it could result in substantial costs and divert management’s attention and resources.Compliance with changing regulation of corporate governance and public disclosure may result in additional expenses.Changing laws, regulations and standards relating to corporate governance and public disclosure, including the Sarbanes-Oxley Actof 2002, new regulations promulgated by the Securities and Exchange Commission and the rules of The Nasdaq Global Select Market,are resulting in increased general and administrative expenses for companies such as ours. These new or changed laws, regulations andstandards are subject to varying interpretations in many cases, and as a result, their application in practice may evolve over time as newguidance is provided by regulatory and governing bodies, which could result in higher costs necessitated by ongoing revisions todisclosure and governance practices. We are committed to maintaining high standards of corporate governance and public disclosure. As aresult, we intend to invest resources to comply with evolving laws, regulations and standards, and this investment may result inincreased general and administrative expenses and a diversion of management time and attention from revenue-generating activities tocompliance activities. If our efforts to comply with new or changed laws, regulations and standards differ from the activities intended byregulatory or governing bodies, our business may be harmed.Future sales of our common stock in the public market could adversely affect the trading price of our common stock andour ability to raise funds in new stock offerings.Future sales of substantial amounts of our common stock in the public market, or the perception that such sales could occur, couldadversely affect prevailing trading prices of our common stock and could impair our ability to raise capital through future offerings ofequity or equity-related securities. In connection with past acquisitions, we issued a substantial number of shares of our common stockas transaction consideration. We may continue to issue equity securities for future acquisitions, which would dilute existing stockholders,perhaps significantly depending on the terms of such acquisitions. For example, we issued, and registered for resale, approximately10.6 million shares of our common stock in connection with our recently completed acquisition of SNAPin. No prediction can be madeas to the effect, if any, that future sales of shares of common stock, or the availability of shares of common stock for future sale, willhave on the trading price of our common stock.We have implemented anti-takeover provisions, which could discourage or prevent a takeover, even if an acquisition would bebeneficial to our stockholders.Provisions of our certificate of incorporation, bylaws and Delaware law, as well as other organizational documents could make itmore difficult for a third party to acquire us, even if doing so would be beneficial to our stockholders. These provisions include: • authorized “blank check” preferred stock; • prohibiting cumulative voting in the election of directors; • limiting the ability of stockholders to call special meetings of stockholders; • requiring all stockholder actions to be taken at meetings of our stockholders; and • establishing advance notice requirements for nominations of directors and for stockholder proposals.Item 1B. Unresolved Staff CommentsNone.15Table of ContentsItem 2. PropertiesOur corporate headquarters and administrative, sales, marketing, research and development and support functions occupyapproximately 201,000 square feet of space that we lease in Burlington, Massachusetts. We also lease additional properties in the UnitedStates and a number of foreign countries. The following table summarizes our significant properties as of September 30, 2008:Location Sq. Ft. Lease Term Primary Use (approx.) Burlington, Massachusetts 201,000 June 2018 Corporate headquarters and administrative,sales, marketing, research and development andcustomer support functions.Redwood City, California (1) 141,000 July 2012 Twenty-two percent of this facility isunoccupied, the remainder has been sublet tothird party tenants.Melbourne, Florida 130,000 Owned Administrative, sales, marketing, customersupport and order fulfillment functions.Montreal, Quebec 74,000 December 2016 Sales, marketing, research and development,customer support and order fulfillmentfunctions.Sunnyvale, California 71,000 September 2013 Research and development, sales, marketingand customer support functions.Mahwah, New Jersey 38,000 June 2010 Professional services and sales functions.Menlo Park, California (1) 34,000 August 2009 This facility is unoccupied.New York, New York (2) 34,000 February 2016 Subleased to third-party tenants.Merelbeke, Belgium 25,000 March 2017 Administrative, sales, marketing, research anddevelopment and customer support functions.Budapest, Hungary 21,000 December 2009 Research and development.Aachen, Germany 20,000 March 2011 Research and development.(1)The leases for these properties were assumed as part of our acquisition in September 2005 of Nuance Communications, Inc, whichwe refer to as Former Nuance.(2)The lease for this property was assumed as part of our acquisition of SpeechWorks.In addition to the properties referenced above, we also lease a number of small sales and marketing offices in the United States andinternationally. As of September 30, 2008, we were productively utilizing substantially all of the space in our facilities, except for spaceidentified above as unoccupied, or that has been subleased to third parties.Item 3. Legal ProceedingsLike many companies in the software industry, we have from time to time been notified of claims that we may be infringing certainintellectual property rights of others. These claims have been referred to counsel, and they are in various stages of evaluation andnegotiation. If it appears necessary or desirable, we may seek licenses for these intellectual property rights. There is no assurance thatlicenses will be offered by all claimants, that the terms of any offered licenses will be acceptable to us or that in all cases the dispute willbe resolved without litigation, which may be time consuming and expensive, and may result in injunctive relief or the payment ofdamages by us.In August 2001, the first of a number of complaints was filed in the United States District Court for the Southern District of NewYork, on behalf of a purported class of persons who purchased Former Nuance stock16Table of Contentsbetween April 12, 2000 and December 6, 2000. Those complaints have been consolidated into one action. The complaint generally allegesthat various investment bank underwriters engaged in improper and undisclosed activities related to the allocation of shares in FormerNuance’s initial public offering of securities. The complaint makes claims for violation of several provisions of the federal securities lawsagainst those underwriters, and also against Former Nuance and some of Former Nuance’s directors and officers. Similar lawsuits,concerning more than 250 other companies’ initial public offerings, were filed in 2001. In February 2003, the Court denied a motion todismiss with respect to the claims against Former Nuance. In the third quarter of 2003, a proposed settlement in principle was reachedamong the plaintiffs, issuer defendants (including Former Nuance) and the issuers’ insurance carriers. The settlement called for thedismissal and release of claims against the issuer defendants, including Former Nuance, in exchange for a contingent payment to be paid,if necessary, by the issuer defendants’ insurance carriers and an assignment of certain claims. The settlement was not expected to haveany material impact upon the Company, as payments, if any, were expected to be made by insurance carriers, rather than by theCompany. On December 5, 2006, the Court of Appeals for the Second Circuit reversed the Court’s order certifying a class in several “testcases” that had been selected by the underwriter defendants and the plaintiffs in the coordinated proceeding. The plaintiffs petitioned theSecond Circuit for rehearing of the Second Circuit’s decision, however, on April 6, 2007, the Second Circuit denied the petition forrehearing. At a status conference on April 23, 2007, the district court suggested that the issuers’ settlement could not be approved in itspresent form, given the Second Circuit’s ruling. On June 25, 2007, the district court issued an order terminating the settlement agreement.The plaintiffs in the case have since filed amended master allegations and amended complaints and have moved for class certification,while the defendants have moved to dismiss the complaints and have filed oppositions to the motion for class certification. We intend todefend the litigation vigorously and believe we have meritorious defenses to the claims against Former Nuance.We believe that the final outcome of the current litigation matter described above will not have a significant adverse effect on ourfinancial position or results of operations. However, even if our defense is successful, the litigation could require significant managementtime and will be costly. Should we not prevail in this litigation matter, our operating results, financial position and cash flows could beadversely impacted.Item 4. Submission of Matters to a Vote of Security HoldersNo matters were submitted to a vote of security holders in the fourth quarter of the fiscal year covered by this Annual Report onForm 10-K.17Table of ContentsPART IIItem 5. Market for the Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity SecuritiesMarket InformationOur common stock is traded on the NASDAQ Global Select Market under the symbol “NUAN.” The following table sets forth, forour fiscal quarters indicated, the high and low sales prices of our common stock, in each case as reported on the NASDAQ Global SelectMarket. Low High Fiscal 2007: First quarter $7.64 $12.02 Second quarter 11.00 16.63 Third quarter 14.94 18.85 Fourth quarter 14.81 20.24 Fiscal 2008: First quarter $17.48 $22.56 Second quarter 12.45 18.80 Third quarter 15.25 21.47 Fourth quarter 12.04 17.98 HoldersAs of October 31, 2008, there were 1,004 stockholders of record of our common stock.Dividend PolicyWe have never declared or paid any cash dividends on our common stock. We currently expect to retain future earnings, if any, tofinance the growth and development of our business and do not anticipate paying any cash dividends in the foreseeable future. The termsof our credit facility place restrictions on our ability to pay dividends except for stock dividends.Issuer Purchases of Equity SecuritiesWe have not announced any currently effective authorization to repurchase shares of our common stock.18Table of ContentsItem 6. Selected Consolidated Financial DataOn October 23, 2004, our Board of Directors approved a change in the Company’s fiscal year end from December 31 toSeptember 30, effective beginning September 30, 2004. All references in this Annual Report on Form 10-K to fiscal 2004 refer to the ninemonth period ended September 30, 2004. References to fiscal 2005, 2006, 2007 and 2008, refer to the twelve month periods endedSeptember 30.The following selected consolidated financial data is not necessarily indicative of the results of future operations and should be readin conjunction with “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and our consolidatedfinancial statements and related notes included elsewhere in this Annual Report on Form 10-K. Nine Months Ended Fiscal Year Ended September 30, September 30, 2008 2007 2006 2005 2004 (In millions, except per share data) Operations: Total revenue $868.5 $602.0 $388.5 $232.4 $130.9 Gross margin 552.8 404.1 267.5 163.2 89.1 Income (loss) from operations 32.6 39.0 8.4 2.0 (8.0)Provision for income taxes 14.6 22.5 15.1 6.8 1.3 Loss before cumulative effect of accounting change (30.1) (14.0) (22.2) (5.4) (9.4)Net loss $(30.1) $(14.0) $(22.9) $(5.4) $(9.4)Basic and Diluted Earnings Per Share Data: Loss before cumulative effect of accounting change $(0.14) $(0.08) $(0.13) $(0.05) $(0.09)Net loss $(0.14) $(0.08) $(0.14) $(0.05) $(0.09)Weighted average common shares outstanding: Basic and diluted 209.8 176.4 163.9 109.5 103.8 Financial Position: Cash, cash equivalents and short and long-termmarketable securities $261.6 $187.0 $112.3 $95.8 $47.7 Total assets 2,846.2 2,172.8 1,235.1 757.2 392.7 Long-term debt, net of current portion 894.2 899.9 350.0 — 27.7 Total stockholders’ equity 1,424.9 878.3 576.6 514.7 301.7 Selected Data and Ratios: Working capital $133.5 $164.9 $51.3 $12.1 $27.9 Depreciation of property and equipment 16.4 12.1 8.4 5.0 2.9 Amortization of intangible assets 82.6 37.7 30.1 13.1 10.4 Gross margin percentage 63.7% 67.1% 68.8% 70.2% 68.1%Item 7. Management’s Discussion and Analysis of Financial Condition and Results of OperationsThe following Management’s Discussion and Analysis is intended to help the reader understand the results of operations andfinancial condition of our business. Management’s Discussion and Analysis is provided as a supplement to, and should be read inconjunction with, our consolidated financial statements and the accompanying notes to the consolidated financial statements.19Table of ContentsForward-Looking StatementsThis Annual Report on Form 10-K contains forward-looking statements within the meaning of the Private Securities LitigationReform Act of 1995 that involve risks, uncertainties and assumptions that, if they never materialize or if they prove incorrect, couldcause our consolidated results to differ materially from those expressed or implied by such forward-looking statements. These forward-looking statements include predictions regarding: • our future revenue, cost of revenue, research and development expenses, selling, general and administrative expenses,amortization of intangible assets and gross margin; • our strategy relating to speech and imaging technologies; • the potential of future product releases; • our product development plans and investments in research and development; • future acquisitions, and anticipated benefits from pending and prior acquisitions; • international operations and localized versions of our products; and • legal proceedings and litigation matters.You can identify these and other forward-looking statements by the use of words such as “may,” “will,” “should,” “expects,”“plans,” “anticipates,” “believes,” “estimates,” “predicts,” “intends,” “potential,” “continue” or the negative of such terms, or othercomparable terminology. Forward-looking statements also include the assumptions underlying or relating to any of the foregoingstatements. Our actual results could differ materially from those anticipated in these forward-looking statements for many reasons,including the risks described in Item 1A — “Risk Factors” and elsewhere in this Annual Report on Form 10-K.You should not place undue reliance on these forward-looking statements, which speak only as of the date of this Annual Report onForm 10-K. We undertake no obligation to publicly release any revisions to the forward-looking statements or reflect events orcircumstances after the date of this document.OverviewNuance is a leading provider of speech, imaging and keypad solutions for businesses, organizations and consumers around theworld. Our technologies, applications and services make the user experience more compelling by transforming the way people interactwith information and how they create, share and use documents. Our solutions are used every day by millions of people and thousandsof businesses for tasks and services such as requesting account information from a phone-based self-service solution, dictating records,searching the mobile web by voice, entering a destination into a navigation system, or working with PDF documents. Our solutions helpmake these interactions, tasks and experiences more productive, compelling and efficient.We have four groups which address our core markets including: Enterprise (formerly referred to as Network), Mobile (formerlyreferred to as Embedded), Healthcare and Dictation, and Imaging.We leverage our global professional services organization and our extensive network of partners to design and deploy innovativesolutions for businesses and organizations around the globe. We market and distribute our products through a global network of resellers,including system integrators, independent software vendors, value-added resellers, hardware vendors, telecommunications carriers anddistributors, and also sell directly through a dedicated sales force and through our e-commerce website.We have built a world-class portfolio of speech solutions both through internal development and acquisitions. We continue to pursueopportunities to broaden our speech solutions and expect to continue to make acquisitions of other companies, businesses andtechnologies to complement our internal investments. We have a team that focuses on evaluating market needs and potential acquisitions tofulfill them. In addition, we have a disciplined20Table of Contentsmethodology for integrating acquired companies and businesses after the transaction is complete. Acquisitions completed or announcedsince fiscal 2006 include the following significant transactions: • On March 31, 2006, we acquired Dictaphone Corporation, a leading healthcare information technology company, to broaden ourrange of digital dictation, transcription, and report management system solutions. • On March 26, 2007, we acquired Bluestar Resources Limited, the parent of Focus Enterprises Limited and Focus Infosys IndiaPrivate Limited, a leading provider of healthcare transcription services, to complement our Dictaphone iChart web-basedtranscription solutions and expand our ability to deliver web-based speech recognition solutions and provide scalable Internetdelivery of automated transcription. • On April 24, 2007, we acquired BeVocal, Inc., a provider of hosted self-service customer case solutions to expand our productportfolio in the areas of mobile customer lifecycle management, mobile premium services and other mobile consumer products. • On August 24, 2007, we acquired Voice Signal Technologies, Inc., a global provider of speech technology for mobile devices toenhance our solutions and expertise addressing the accelerating demand for speech-enabled mobile devices and services that allowpeople to use spoken commands to simply and effectively navigate and retrieve information and to control and operate mobilephones. • On August 24, 2007, we acquired Tegic Communications, Inc., a wholly owned subsidiary of AOL LLC and a developer ofembedded software for mobile devices. The Tegic acquisition expands our presence in the mobile device industry and acceleratesthe delivery of a new mobile user interface that combines voice, text and touch to improve the user experience for consumers andmobile professionals. • On September 28, 2007, we acquired Commissure Inc., a provider of speech-enabled radiology workflow optimization and dataanalysis solutions to enhance the capabilities of our Dictaphone Healthcare solutions for the medical imaging industry, extend ourdomain expertise in the radiology market. • On November 26, 2007, we acquired Viecore, Inc., a consulting and systems integration firm. The Viecore acquisition expandsour professional services capabilities and complements our existing partnerships, allowing us to deliver end-to-end speechsolutions and system integration for speech-enabled customer care in key vertical markets including financial services,telecommunications, healthcare, utilities and government. • On May 20, 2008, we acquired eScription, Inc., a provider of hosted or premises-based computer-aided medical transcriptionsolutions. The eScription acquisition allows us to deliver scalable, highly productive medical transcription solutions, as well asaccelerate future innovation to transform the way healthcare providers document patient care. • On September 26, 2008, we acquired Philips Speech Recognition Systems GMBH (PSRS), a business unit of Royal PhilipsElectronics and leader in speech recognition solutions, especially in the European healthcare market. This acquisitionsignificantly enhances our ability to deliver innovative, speech-driven clinical documentation and communication solutions tohealthcare organization throughout Europe. • On October 1, 2008, we acquired SNAPin Software, Inc., a provider of mobile device and server self-service technology. TheSNAPin acquisition enhances our ability to deliver innovative, highly scalable mobile customer care solutions that improve theway mobile operators and enterprises interact with consumers in real-time on mobile devices.These acquisitions have had a material impact on our results of operations. Our results of operations for fiscal 2008 included partialyear results from our acquisitions of Vocada, Viecore, eScription and PSRS. Our results of operations for fiscal 2007 included theoperations of Dictaphone for a full year and partial year results from our acquisitions of Focus, BeVocal, VoiceSignal, Tegic andCommissure. Our results of operations during fiscal 2006 included the operations of Dictaphone for six months.21Table of ContentsStrategyIn fiscal 2009, we will continue to focus on growth by providing market-leading, value-added solutions for our customers andpartners through a broad set of technologies, service offerings and channel capabilities. We will also continue to focus on expensediscipline and acquisition synergies to improve gross margins and operating margins. We intend to pursue growth through the followingkey elements of our strategy: • Extend Technology Leadership. Our solutions are recognized as among the best in their respective categories. We intend toleverage our global research and development organization and broad portfolio of technologies, applications and intellectualproperty to foster technological innovation and maintain customer preference for our solutions. We also intend to invest in ourengineering resources and seek new technological advancements that further expand the addressable markets for our solutions. • Broaden Expertise in Vertical Markets. Businesses are increasingly turning to Nuance for comprehensive solutions rather thanfor a single technology product. We intend to broaden our expertise and capabilities to deliver targeted solutions for a range ofindustries including mobile device manufacturers, healthcare, telecommunications, financial services and governmentadministration. We also intend to expand our global sales and professional services capabilities to help our customers andpartners design, integrate and deploy innovative solutions. • Increase Subscription and Transaction Based Recurring Revenue. We intend to increase our subscription and transactionbased offerings in our core markets. The expansion of our subscription or transaction based solutions will enable us to deliverapplications that our customers use on a repeat basis, and pay for on a per use basis, providing us with the opportunity to enjoythe benefits of recurring revenue streams. • Expand Global Presence. We intend to further expand our international resources to better serve our global customers andpartners and to leverage opportunities in emerging markets such as China, India, Latin America and Asia. We continue to addregional executives and sales employees in different geographic regions to better address demand for speech based solutions andservices. • Pursue Strategic Acquisitions. We have selectively pursued strategic acquisitions to expand our technology, solutions andresources to complement our organic growth. We have proven experience in integrating businesses and technologies and indelivering enhanced value to our customers, partners, employees and shareholders. We intend to continue to pursue acquisitionsthat enhance our solutions, serve specific vertical markets and strengthen our technology portfolio.22Table of ContentsRESULTS OF OPERATIONSThe following table presents, as a percentage of total revenue, certain selected financial data for the years ended September 30, 2008,2007 and 2006. 2008 2007 2006 Revenue: Product and licensing 47.7% 51.8% 60.7%Professional services, subscription and hosting 35.2 27.5 20.9 Maintenance and support 17.1 20.7 18.4 Total revenue 100.0 100.0 100.0 Costs and expenses: Cost of product and licensing 5.3 7.2 7.7 Cost of professional services, subscription and hosting 24.6 19.0 16.2 Cost of maintenance and support 3.6 4.5 4.0 Cost of revenue from amortization of intangible assets 2.8 2.2 3.3 Gross margin 63.7 67.1 68.8 Research and development 13.3 13.3 15.3 Sales and marketing 26.6 30.7 33.1 General and administrative 12.2 12.5 14.2 Amortization of intangible assets 6.7 4.1 4.4 In-process research and development 0.3 — — Restructuring and other charges (credits), net 0.8 — (0.3)Total operating expenses 59.9 60.6 66.7 Income from operations 3.8 6.5 2.1 Other income (expense), net (5.6) (5.1) (3.9)Income (loss) before income taxes (1.8) 1.4 (1.8)Provision for income taxes 1.7 3.7 3.9 Loss before cumulative effect of accounting change (3.5) (2.3) (5.7)Cumulative effect of accounting change — — 0.2 Net loss (3.5)% (2.3)% (5.9)%Total RevenueThe following table shows total revenue by geographic location, based on the location of our customers, in dollars and percentagechange (dollars in millions): % % Change Change Fiscal Fiscal Fiscal 2008 vs 2007 vs 2008 2007 2006 2007 2006 United States $669.3 $471.6 $288.3 41.9% 63.6%International 199.2 130.4 100.2 52.8 30.1 Total revenue $868.5 $602.0 $388.5 44.3% 55.0%23Table of ContentsThe following table presents revenue information for our core markets, in dollars and percentage change (dollars in millions): % % Change Change Fiscal Fiscal Fiscal 2008 vs 2007 vs 2008 2007 2006 2007 2006 Enterprise $283.3 $193.0 $142.8 46.8% 35.2%Mobile 155.5 53.8 36.6 189.0% 47.0%Healthcare and Dictation 349.8 281.3 136.7 24.4% 105.8%Imaging 79.9 73.9 72.4 8.1% 2.1%Total Revenue $868.5 $602.0 $388.5 44.3% 55.0%Fiscal 2008 Compared to Fiscal 2007The increase in total revenue in fiscal 2008 compared to fiscal 2007 was driven by a combination of organic growth andcontributions from acquisitions. Enterprise revenue increased $90.3 million, including contributions from our acquisitions of BeVocaland Viecore; healthcare and dictation revenue increased $68.5 million, including contributions from our acquisitions of Focus,Commissure, Vocada and eScription; mobile revenue increased $101.7 million, including contributions from our acquisitions ofVoiceSignal and Tegic, and imaging revenue increased $6.0 million.Based on the location of the customers, the geographic split in fiscal 2008 was 77% of total revenue in the United States and 23%internationally compared to 78% of total revenue in the United States and 22% internationally in fiscal 2007. The slight decrease inproportion of revenue generated in the United States was primarily due to acquisitions that have a higher proportion of their revenuederived from customers outside of the United States.Fiscal 2007 Compared to Fiscal 2006The increase in total revenue in fiscal 2007 compared to fiscal 2006 was driven by a combination of organic growth andcontributions from acquisitions. Enterprise revenue increased $50.2 million, including contributions from our acquisition of BeVocal;healthcare and dictation revenue increased $144.6 million, including contributions from our acquisitions of Dictaphone and Focus;mobile revenue increased $17.2 million, including contributions from our acquisitions of VoiceSignal and Tegic, and imaging revenueincreased $1.5 million.Based on the location of the customers, the geographic split in fiscal 2007 was 78% of total revenue in the United States and 22%internationally compared to 74% of total revenue in the United States and 26% internationally in fiscal 2006. The increase in proportionof revenue generated in the United States was primarily due to our acquisitions which have a higher proportion of their revenue derivedfrom customers in the United States.Product and Licensing RevenueProduct and licensing revenue primarily consists of sales and licenses of our technology. The following table shows product andlicensing revenue, in absolute dollars and as a percentage of total revenue (dollars in millions): % % Change Change Fiscal Fiscal Fiscal 2008 vs 2007 vs 2008 2007 2006 2007 2006 Product and licensing revenue $414.4 $311.8 $235.8 32.9% 32.2%As a percentage of total revenue 47.7% 51.8% 60.7% Fiscal 2008 Compared to Fiscal 2007The increase in product and licensing revenue in fiscal 2008 compared to fiscal 2007 consisted of a $98.6 million increase inmobile revenue, including contributions from our acquisitions of VoiceSignal and Tegic,24Table of Contentsand a $5.6 million increase in imaging revenue. Healthcare and dictation revenue increased by $6.3M, including contributions from theacquisition of Commissure, and the release of Dragon NaturallySpeaking Version 10 in the fourth fiscal quarter of 2008, but somewhatoffset by a decline in healthcare product revenue as customers migrate to our iChart hosted services solution. Enterprise revenue also sawa decline as customers migrate to our on-demand services solutions. As a percentage of total revenue, product and licensing revenuedecreased 4.1 percentage points primarily due to changes in revenue mix attributable to the accelerated growth in professional services,subscription and hosting revenue relative to product and licensing revenue.Fiscal 2007 Compared to Fiscal 2006Product and licensing revenue in fiscal 2007 increased $76.0 million compared to fiscal 2006 due to our 2007 acquisitions and toorganic revenue growth. Enterprise revenue increased $10.2 million; healthcare and dictation revenue increased $48.8 million, includingcontributions from our acquisition of Dictaphone; mobile revenue increased $16.0 million, including contributions from our acquisitionsof Tegic and VoiceSignal, and imaging revenue increased $1.0 million. Due to a change in revenue mix, primarily relating to theaccelerated growth of professional services, subscription and hosting revenue, product and licensing revenue decreased by 8.9 percentagepoints of total revenue compared to fiscal 2006.Professional Services, Subscription and Hosting RevenueProfessional services revenue primarily consists of consulting, implementation and training services for speech customers.Subscription and hosting revenue primarily relates to delivering hosted and transcription and dictation services over a specified term, aswell as self-service, on-demand offerings to carriers and enterprises. The following table shows professional services, subscription andhosting revenue, in absolute dollars and as a percentage of total revenue (dollars in millions): % % Change Change Fiscal Fiscal Fiscal 2008 vs 2007 vs 2008 2007 2006 2007 2006 Professional services, subscription and hosting revenue $305.5 $165.5 $81.3 84.6% 103.5%As a percentage of total revenue 35.2% 27.5% 20.9% Fiscal 2008 Compared to Fiscal 2007The increase in professional services, subscription and hosting revenue in fiscal 2008 compared to fiscal 2007 consisted primarilyof an $87.9 million increase in enterprise revenue including contributions from our acquisitions of BeVocal and Viecore and a$51.8 million increase in healthcare and dictation revenue including contributions from our acquisitions of Focus, Vocada andeScription, and to the growth of our iChart transcription solution. The growth in these organic and acquired revenue streams outpaced therelative growth of our other revenue types, resulting in a 7.7 percentage point increase in professional services, subscription and hostingrevenue, as a percentage of total revenue.Fiscal 2007 Compared to Fiscal 2006Professional services, subscription and hosting revenue increased by $84.2 million in fiscal 2007 compared to fiscal 2006 due torevenue from our 2007 acquisitions as well as from our organic revenue growth. The growth is due primarily to $32.0 million inenterprise revenue driven by increased demand for our core enterprise consulting and transactional directory assistance services, and a34% growth in our Dictaphone iChart solution. Additionally, our healthcare professional services, largely based on our acquisition ofDictaphone in March 2006, provided revenue growth of 45% in the second half of fiscal 2007 relative to the second half of fiscal 2006.As a percentage of total revenue, professional services, subscription and hosting revenue increased 6.6 percentage points due toaccelerated organic and acquisition-related growth.25Table of ContentsMaintenance and Support RevenueMaintenance and support revenue primarily consists of technical support and maintenance services. The following table showsmaintenance and support revenue, in absolute dollars and as a percentage of total revenue (dollars in millions): % % Change Change Fiscal Fiscal Fiscal 2007 vs 2007 vs 2008 2007 2006 2006 2006 Maintenance and support revenue $148.6 $124.6 $71.4 19.3% 74.5%As a percentage of total revenue 17.1% 20.7% 18.4% Fiscal 2008 Compared to Fiscal 2007The increase in maintenance and support revenue in fiscal 2008 compared to fiscal 2007 consisted primarily of a $10.4 millionincrease from the expansion of the current installed base in our healthcare and dictation solutions, an additional $10.4 million increaseassociated with enterprise revenue driven by a combination of organic growth and growth from our acquisition of Viecore. Maintenanceand support revenue related to mobile products also increased by $2.8 million as compared to fiscal 2007. As a percentage of totalrevenue, maintenance and support revenue decreased by 3.6 percentage points primarily due to changes in revenue mix attributable to theaccelerated growth in professional services, subscription and hosting revenue relative to maintenance and support revenue.Fiscal 2007 Compared to Fiscal 2006The $53.2 million increase in maintenance and support revenue in fiscal 2007 compared to fiscal 2006 consisted primarily of anincrease in organic revenue, as well as acquisition related maintenance and support revenue from our 2007 acquisitions which have asignificant customer base of maintenance and support contracts. Enterprise revenue increased $8.0 million; healthcare and dictationrevenue increased $45.3 million, including contributions from our acquisition of Dictaphone. As a percentage of total revenue,maintenance and support revenue grew 2.3 percentage points in fiscal 2007 due primarily due to our 2007 acquisitions.COSTS AND EXPENSESCost of Product and Licensing RevenueCost of product and licensing revenue primarily consists of material and fulfillment costs, manufacturing and operations costs andthird-party royalty expenses. The following table shows cost of product and licensing revenue, in absolute dollars and as a percentage ofproduct and licensing revenue (dollars in millions): % % Change Change Fiscal Fiscal Fiscal 2008 vs 2007 vs 2008 2007 2006 2007 2006 Cost of product and licensing revenue $45.7 $43.2 $29.7 5.8% 45.5%As a percentage of product and licensing revenue 11.0% 13.8% 12.6% Fiscal 2008 Compared to Fiscal 2007Cost of product and licensing revenue was relatively constant in fiscal 2008 compared to fiscal 2007 as lower hardware and softwarecosts related to our healthcare products were offset by increased royalty expense associated with our PDF product. Cost of product andlicensing revenue decreased as a percentage of product revenue primarily due to increased product and licensing revenue related to recentacquisitions that do not carry significant product cost, and, to a lesser extent, to a change in the revenue mix towards products withhigher margins.26Table of ContentsFiscal 2007 Compared to Fiscal 2006Cost of product and licensing revenue increased $13.5 million for fiscal 2007 compared to fiscal 2006 due in large part to our 2007acquisitions and increased royalties and fulfillment of certain productivity products. As a percentage of product revenue, costs increaseddue to the higher third-party hardware and royalties associated with products acquired through our 2007 acquisitions.Cost of Professional Services, Subscription and Hosting RevenueCost of professional services, subscription and hosting revenue primarily consists of compensation for consulting personnel,outside consultants and overhead, as well as the hardware and communications fees that support our subscription and hosted solutions.The following table shows cost of revenue, in dollars and as a percentage of professional services, subscription and hosting revenue(dollars in millions): % % Change Change Fiscal Fiscal Fiscal 2008 vs 2007 vs 2008 2007 2006 2007 2006 Cost of professional services, subscription and hosting revenue $214.0 $114.2 $62.8 87.4% 81.8%As a percentage of professional services, subscription and hostingrevenue 70.0% 69.0% 77.2% Fiscal 2008 Compared to Fiscal 2007The increase in cost of professional services, subscription and hosting revenue in fiscal 2008 compared to fiscal 2007 is due tocontributions from our acquisitions as well as organic growth of our core business. The cost of professional services, subscription andhosting revenue, increased modestly in fiscal 2008, as a percentage of the related revenue, as we increased spending to support our currentand future growth, particularly in our hosted applications. These applications require infrastructure spending in advance of the revenue,and include solutions acquired in fiscal 2007 and 2008 such as BeVocal, Commissure, Vocada and eScription, and also include ouriChart solution.Fiscal 2007 Compared to Fiscal 2006The increase in cost of professional services, subscription and hosting revenue in fiscal 2007 compared to fiscal 2006 is due togrowth in our organic business and from our acquisitions. As a percentage of professional services, subscription and hosting revenue, therelated costs decreased by 8.2 percentage points due primarily to our ability to increase the utilization of existing for our professionalservices resources, and from a change in relative mix towards incremental hosted revenue which provides a generally higher margin thando our professional services revenue.Cost of Maintenance and Support RevenueCost of maintenance and support revenue primarily consists of compensation for product support personnel and overhead. Thefollowing table shows cost of maintenance and support revenue, in dollars and as a percentage of maintenance and support revenue(dollars in millions): % % Change Change Fiscal Fiscal Fiscal 2008 vs 2007 vs 2008 2007 2006 2007 2006 Cost of maintenance and support revenue $31.5 $27.5 $15.6 14.5% 76.3%As a percentage of maintenance and support revenue 21.2% 22.0% 21.9% 27Table of ContentsFiscal 2008 Compared to Fiscal 2007The increase in cost of maintenance and support revenue in fiscal 2008 compared to fiscal 2007 was attributable to both the growthin maintenance and support revenue from our acquisitions consummated in fiscal 2008 and 2007, and organic growth of our maintenanceand support revenue. The cost of maintenance and support revenue as a percentage of the related revenue decreased by 0.8 percentagepoints.Fiscal 2007 Compared to Fiscal 2006The increase in cost of maintenance and support revenue in fiscal 2007 compared to fiscal 2006 was attributable to both the growthin maintenance and support revenue from our acquisitions consummated in fiscal 2007 and 2006, and to the growth in our organicmaintenance and support revenue. The cost of maintenance and support revenue as a percentage of revenue stayed relatively flat at 22%,as maintenance and support revenue and associated costs grew approximately 76% from fiscal 2006.Cost of Revenue from Amortization of Intangible AssetsCost of revenue from amortization of intangible assets consists of the amortization of acquired patents and core and completedtechnology using the straight-line basis over their estimated useful lives. The cost of revenue from amortization of intangible assets alsoincludes impairment charges when we determine that such charges are necessary. We evaluate these assets for impairment and forappropriateness of their remaining life on an ongoing basis. The following table shows cost of revenue from amortization of intangibleassets, in dollars and as a percentage of total revenue (in millions): % % Change Change Fiscal Fiscal Fiscal 2008 vs 2007 vs 2008 2007 2006 2007 2006 Cost of revenue from amortization of intangible assets $24.4 $13.1 $12.9 86.3% 1.6%As a percentage of total revenue 2.8% 2.2% 3.3% Fiscal 2008 Compared to Fiscal 2007The increase in cost of revenue from amortization of intangible assets in fiscal 2008 compared to fiscal 2007 was primarilyattributable to the amortization of intangible assets acquired in connection with our acquisitions closed in fiscal 2008 and 2007, as well asnew technology licensed in fiscal 2008. The amortization expense in fiscal 2008 also included $2.7 million, which represents a portion ofa settlement and license agreement that we entered into with a vendor in fiscal 2008.Based on the amortizable intangible assets as of September 30, 2008, and assuming no impairment or reduction in expected lives, weexpect cost of revenue from amortization of intangible assets for fiscal 2009 to be $26.3 million.Fiscal 2007 Compared to Fiscal 2006Cost of revenue from amortization of intangible assets increased $0.2 million in fiscal 2007 compared to fiscal 2006. The increasewas primarily attributable to $3.1 million in amortization of intangible assets related to our 2007 acquisitions offset by a fiscal 2006 non-recurring charge of $2.6 million to write down technology licensed from a third party to its net realizable value. As a percentage ofrevenue, cost of revenue from amortization of intangible assets declined, largely because of a non-recurring charge in fiscal 2006, as wellas the effect of amortization expense over a larger revenue base.28Table of ContentsResearch and Development ExpenseResearch and development expense primarily consists of salaries and benefits and overhead relating to our engineering staff. Thefollowing table shows research and development expense, in dollars and as a percentage of total revenue (dollars in millions): % % Change Change Fiscal Fiscal Fiscal 2008 vs 2007 vs 2008 2007 2006 2007 2006 Research and development expense $115.0 $80.0 $59.4 43.8% 34.7%As a percentage of total revenue 13.2% 13.3% 15.3% Fiscal 2008 Compared to Fiscal 2007The increase in research and development expense in fiscal 2008 compared to fiscal 2007 primarily consisted of an increase of$21.7 million in compensation expense due to increased headcount associated with our fiscal 2008 acquisitions and a full year ofoperations for our 2007 acquisitions, and a $3.6 million increase in contract labor and professional services to support ongoing researchand development projects. To date, we have not capitalized any internal development costs as the cost incurred after technologicalfeasibility but before release of products has not been significant. $7.2 million of the increase is attributable to increased share-basedpayments, and the remaining increase is related to other expenses related to travel, infrastructure costs, including depreciation ofincremental fixed assets.Fiscal 2007 Compared to Fiscal 2006Research and development expense increased $20.6 million in fiscal 2007 compared to fiscal 2006 due to an increase of$8.6 million in compensation expense due to increased headcount largely associated with our 2007 acquisitions, an additional$6.9 million for contract labor and professional services to support ongoing research and development projects and an additional$2.6 million of increased shared-based payment expense. The remaining increase relates to additional employee-related travel,entertainment and infrastructure expenses. While increasing in dollars, research and development expense decreased as a proportion oftotal revenue reflecting achievement of synergies following acquisitions and on-going efforts to increase productivity.Sales and Marketing ExpenseSales and marketing expense includes salaries and benefits, commissions, advertising, direct mail, public relations, tradeshowcosts and other costs of marketing programs, travel expenses associated with our sales organization and overhead. The following tableshows sales and marketing expense, in dollars and as a percentage of total revenue (dollars in millions): % % Change Change Fiscal Fiscal Fiscal 2008 vs 2007 vs 2008 2007 2006 2007 2006 Sales and marketing expense $231.2 $184.9 $128.4 25.0% 44.0%As a percentage of total revenue 26.6% 30.7% 33.1% Fiscal 2008 Compared to Fiscal 2007The increase in sales and marketing expenses in fiscal 2008 compared to fiscal 2007 was primarily due to $35.4 million increase incompensation and other variable costs, such as commissions and travel expenses related to increased headcount from our fiscal 2008acquisitions and a full year of operations for our fiscal 2007 acquisitions, and a $4.5 million increase related to marketing programs andchannel program expenses. Additionally, $4.1 million of the increase was related to increased share-based payments. Sales and marketingexpense as a percentage of total29Table of Contentsrevenue decreased by 4.1 percentage points, as a result of increased efficiency of our sales teams, cost efficiencies of our marketingexpenditures and a reduction of the share-based compensation relative to the increase in revenue.Fiscal 2007 Compared to Fiscal 2006Sales and marketing expense increased $56.5 million in fiscal 2007 compared to fiscal 2006 due to an increase of $35.0 million insalaries and other variable costs, such as commissions and travel expenses relating to increased headcount from our 2007 acquisitionsand to support the organic business, an increase of $13.0 million relating to share-based compensation, and an increase of $4.2 millionrelating to marketing programs and channel program expenses. The remaining increase in expenses relates to professional services,recruiting and other expenses associated with the support of the sales and marketing organization. While the expenses increased inabsolute dollars, sales and marketing expenses decreased as a percentage of total revenue due to synergies achieved from acquisitions andincreased productivity of sales organization.General and Administrative ExpenseGeneral and administrative expense primarily consists of personnel costs, including overhead, for administration, finance, humanresources, information systems, facilities and general management, fees for external professional advisors including accountants andattorneys, insurance, and provisions for doubtful accounts. The following table shows general and administrative expense, in dollars andas a percentage of total revenue (dollars in millions): % % Change Change Fiscal Fiscal Fiscal 2008 vs 2007 vs 2008 2007 2006 2007 2006 General and administrative expense $105.9 $75.6 $55.3 40.1% 36.7%As a percentage of total revenue 12.2% 12.6% 14.2% Fiscal 2008 Compared to Fiscal 2007The increase in general and administrative expense for fiscal 2008 compared to fiscal 2007 was primarily due to increasedcompensation of $16.0 million associated with our 2008 acquisitions. An additional $8.7 million increase in expenses related totemporary employees and professional services in order to support the incremental requirements that exist due to our growth fromacquisitions, and $4.7 million of the increase was related to increased share-based payments.Fiscal 2007 Compared to Fiscal 2006General and administrative expense increased $20.3 million in fiscal 2007 compared to fiscal 2006 due to increased compensationassociated with our 2007 acquisitions, an increase of $8.4 million relating to share-based compensation, and a $4.0 million increase inexpenses relating to temporary employees and professional services to support our growing organization. While the expense increased inabsolute dollars, general and administrative expense as a percentage of revenue decreased as we achieved higher sales volumes whileimproving control of our cost structure.Amortization of Intangible AssetsAmortization of intangible assets into operating expense includes amortization of acquired customer and contractual relationships,non-competition agreements and acquired trade names and trademarks. Customer relationships are amortized on an accelerated basisbased upon the pattern in which their economic benefits are being utilized. Other identifiable intangible assets are amortized on a straight-line basis over their estimated useful lives. The amortization of intangible assets also includes impairment charges when we determine thatsuch charges are necessary. We evaluate these assets for impairment and for appropriateness of their remaining life on an30Table of Contentsongoing basis. The following table shows amortization of intangible assets, in dollars and as a percentage of total revenue (dollars inmillions): % % Change Change Fiscal Fiscal Fiscal 2008 vs 2007 vs 2008 2007 2006 2007 2006 Amortization of intangible assets $58.2 $24.6 $17.2 136.6% 43.0%As a percentage of total revenue 6.7% 4.1% 4.4% Fiscal 2008 Compared to Fiscal 2007The increase in amortization of intangible assets in fiscal 2008 compared to fiscal 2007 was primarily attributable to theamortization of identifiable intangible assets acquired in connection with our acquisitions closed in fiscal 2008 and 2007. Also includedin the amortization expense in fiscal 2008 is $3.6 million relating to impairment charges recorded from our review of our ability to realizefuture cash flows relating to certain of the intangible assets; we did not record any impairment charges in fiscal 2007.Based on the amortizable intangible assets as of September 30, 2008, and assuming no impairment or reduction in expected lives, weexpect amortization of intangible assets for fiscal 2009 to be $73.0 million.Fiscal 2007 Compared to Fiscal 2006Amortization of intangible assets increased $7.4 million in fiscal 2007 compared to fiscal 2006. The increase was primarilyattributable to $10.6 million in amortization of intangible assets related to our 2007 and 2006 acquisitions.In-Process Research and DevelopmentIn fiscal 2008, we recorded in-process research and development of $2.6 million in connection with our acquisition of PSRS. Wedid not have any in-process research and development charges for any other acquisitions completed in fiscal 2008, 2007 or 2006. Thevalue assigned to in-process research and development was determined using an income approach by estimating the costs to develop theacquired technologies into commercially viable products, estimating the resulting net cash flows from the projects and discounting the netcash flows to their present values. At the date of acquisition, the development of these projects had not yet reached technologicalfeasibility, and the research and development in progress had no alternative future uses. The rates utilized to discount the net cash flowsto their present value were based on a number of factors, including our estimated costs of capital. Due to the nature of the forecasts andthe risks associated with the projected growth and profitability of these projects, discount rates of 25% to 35% were consideredappropriate. We anticipate costs to complete the development of these projects will be approximately $4.4 million, and will be completedbetween April 2009 and December 2009.Restructuring and Other Charges (Credits), NetIn fiscal 2008, we recorded restructuring and other charges of $7.2 million, of which $7.0 million was recorded to new restructuringactivities in fiscal 2008, and $0.2 million relates to pre-existing facilities that are included in accrued business combination costs whichare discussed in Note 13 in the accompanying notes to our consolidated financial statements. With respect to the $7.0 million of fiscal2008 restructuring activities, $4.2 million related to the elimination of approximately 155 personnel across multiple functions,$1.4 million related to a non-recurring, adverse ruling arising from a vendor’s claims of underpayment of historical royalties fortechnology discontinued in 2005 and $1.4 million related to the consolidation or elimination of excess facilities.During the second quarter of fiscal 2006, we recorded a $1.3 million reduction to existing restructuring reserves as a result of theexecution of a favorable sublease agreement relating to one of the facilities included in our 2005 restructuring plan. The amount waspartially offset by other net adjustments of $0.1 million associated with prior years’ restructuring programs.31Table of ContentsThe following table sets forth the activity relating to the restructuring accruals in fiscal 2008, 2007 and 2006 (in millions): Personnel Facilities Related Costs Other Total Balance at September 30, 2005 $1.8 $4.0 $— $5.8 Restructuring and other charges (credits), net — (1.2) — (1.2)Cash payments (1.4) (2.3) — (3.7)Balance at September 30, 2006 0.4 0.5 — 0.9 Restructuring and other charges (credits), net (0.1) — — (0.1)Cash payments — (0.5) — (0.5)Balance at September 30, 2007 0.3 — — 0.3 Restructuring and other charges (credits), net 4.2 1.4 1.4 7.0 Cash payments (4.2) (0.6) — (4.8)Balance at September 30, 2008 $0.3 $0.8 $1.4 $2.5 Other Income (Expense), NetThe following table shows other income (expense), net in dollars and as a percentage of total revenue (dollars in millions): % % Change Change Fiscal Fiscal Fiscal 2008 vs 2007 vs 2008 2007 2006 2007 2006 Interest income $8.0 $6.0 $3.3 33.3% 81.8%Interest expense (55.2) (36.5) (17.6) 51.2 107.4 Other income (expense), net (1.0) — (1.1) — (100.0)Total other income (expense), net $(48.2) $(30.5) $(15.4) As a percentage of total revenue (5.6)% (5.1)% (4.0)% Fiscal 2008 Compared to Fiscal 2007The increase in interest income in fiscal 2008 compared to fiscal 2007 was primarily due to higher cash balances, partially offset bylower interest rates during fiscal 2008 compared to fiscal 2007. The increase in interest expense was mainly due to the increase in our termloan borrowings and the $250.0 million convertible debentures that we issued in August 2007. Included in interest expense was$5.2 million in fiscal 2008 and $4.2 million in fiscal 2007 of non-cash interest expense mainly related to imputed interest in associationwith certain lease obligations included in our accrued business combination costs and accrued restructuring charges, the amortization ofdebt issuance costs and unamortized discount associated with our debt. Other income (expense), net principally consisted of foreignexchange gains (losses) as a result of the changes in foreign exchange rates on certain of our foreign subsidiaries who have transactionsdenominated in currencies other than their functional currencies, as well as the remeasurement of certain of our intercompany balances.Fiscal 2007 Compared to Fiscal 2006Interest income increased $2.7 million in fiscal 2007 compared to fiscal 2006 primarily due to higher cash and investment balancesduring fiscal 2007 as well as higher interest rates. Interest expense increased $18.9 million during fiscal 2007 compared to fiscal 2006primarily due to (i) interest related to the credit facility we entered into on March 31, 2006 having been outstanding for a full 12 months;(ii) the April 2007 and August 2007 amendments to that facility that added $90.0 million and $225.0 million of debt, respectively; and(iii) the $250.0 million convertible debentures that we issued in August 2007. Additionally, we recorded $4.6 million of non-cash interest32Table of Contentsexpense mainly related to imputed interest in association with certain lease obligations included in our accrued business combination costsand accrued restructuring charges, the amortization of debt issuance costs associated with the credit facility we entered into on March 31,2006 as well as to the accretion of the interest related to the note payable from our Phonetic acquisition in February 2005. Other income(expense) principally consisted of foreign exchange gains (losses) as a result of the changes in foreign exchange rates on certain of ourforeign subsidiaries who have transactions denominated in currencies other than their functional currencies, as well as the remeasurementof certain of our intercompany balances.Provision for Income TaxesThe following table shows the provision for income taxes, in dollars and the effective income tax rate (in thousands, exceptpercentages): % % Change Change Fiscal Fiscal Fiscal 2008 vs 2007 vs 2008 2007 2006 2007 2006 Income tax provision $14.6 $22.5 $15.1 (35.1)% 49.0%Effective income tax rate (93.8)% 265.1% (214.2)% Fiscal 2008 Compared to Fiscal 2007 and Fiscal 2006The variance from the federal statutory rate in all periods was due primarily to the increase in our valuation allowance with respect tocertain deferred tax assets. During fiscal 2008, the increase in the valuation allowance was largely offset by a fourth quarter benefit of theenactment of a Massachusetts state tax law. The change in law effects certain deferred tax liabilities associated with intangible assets andresults in these liabilities being taxed at a lower effective tax rate. As a result, a tax benefit in the amount of $20.4 million was recorded.This benefit includes an $8.0 million tax benefit related to the eScription acquisition which is currently treated as a stock purchase. Wecan elect, if we pay approximately $21.5 million in additional purchase price, to treat this acquisition as an asset purchase. In the eventwe elect to treat this as an asset purchase, we will be required to reverse the $8.0 million benefit as a tax provision during the quarter inwhich the asset election is made. The election is required to be made no later than February 15, 2009.In addition to the above effect of the state tax law, it is anticipated that regulations will be issued which will impact our ability to usecertain state net operating losses. Because the regulations have not been issued, we are unable to calculate the effect of these regulations.The regulations are expected to be issued during the first calendar quarter of 2009. The tax provision expense to be recorded by us whenregulations are issued could be up to approximately $2.0 million.Our utilization of deferred tax assets that were acquired in a business combination (primarily net operating loss carryforwards) willrequire the reversal of the deferred tax asset in accordance with the manner in which the deferred tax asset was originally recorded and willvary based upon the business combination whose deferred tax assets are being utilized. Our establishment of new deferred tax assets as aresult of operating activities requires the establishment of valuation allowances based upon the SFAS 109 “more likely than not”realization criteria. The establishment of a valuation allowance relating to operating activities is recorded as an increase to tax expense.Our tax provision also includes state and foreign tax expense, which is determined on either a legal entity or separate tax jurisdictionbasis.33Table of ContentsLIQUIDITY AND CAPITAL RESOURCESCash and cash equivalents totaled $261.5 million as of September 30, 2008, an increase of $77.2 million compared to$184.3 million as of September 30, 2007. As of September 30, 2008, total retained deficit was $235.1 million. We do not expect ourretained deficit to impact our future ability to operate the business given our current cash position and strong cash flow generation. Ourincrease in cash and cash equivalents reflected $196.2 million provided by operating activities, partially offset by the net impact of cashprovided by financing activities and cash used in investing activities.Cash provided by operating activitiesCash provided by operating activities for fiscal 2008 was $196.2 million, an increase of $89.8 million, or 84%, from$106.4 million provided by operating activities in fiscal 2007. The increase was primarily composed of additional cash generated fromchanges in working capital accounts. As compared to last year, we generated an additional $76.3 million from accounts receivable,$3.6 million from inventory, prepaid and other assets and $9.3 million from deferred revenue. These increases from working capitalaccounts were partially offset by an incremental usage of $46.2 million for accounts payable and accrued expenses. In addition to theincrease from the working capital accounts, cash provided by operating activities also improved by $46.7 million due to additional cashgenerated from our net loss after adding back non-cash items such as depreciation and amortization and share-based payments, partiallyoffset by a $13.6 million difference in our deferred tax position.Cash provided by operating activities for fiscal 2007 was $106.4 million, an increase of $44.4 million, or 72%, from $62.0 millionprovided by operating activities in fiscal 2006. The increase was composed of changes relating to the net loss after adding back non-cashitems such as depreciation and amortization and share-based compensation. In fiscal 2007 this amount was $105.1 million compared to$54.9 million in fiscal 2006, an increase of $50.2 million, or 91%. The change in working capital accounts contributed $1.3 million infiscal 2007 as compared to $7.1 million in fiscal 2008, a net decrease of $5.8 million in fiscal 2008 from fiscal 2007.Cash used in investing activitiesCash used in investing activities for fiscal 2008 was $446.1 million, a decrease of $131.6 million, or 23%, as compared to net cashused in investing activities of $577.7 million for fiscal 2007. The decrease in cash used in investing activities was primarily attributableto cash paid relating to our acquisitions, with cash payments of $564.3 million in fiscal 2007, as compared to $392.5 million in fiscal2008. This was partially offset by an incremental $29.0 million that we paid for third party licenses and patent defense costs in fiscal2008 as compared to fiscal 2007.Cash used in investing activities for fiscal 2007 was $577.7 million, an increase of $207.5 million, or 56% compared to$370.2 million for fiscal 2006. The increase in cash used in investing activities was primarily driven by a $171.5 million increase incash paid for acquisitions in fiscal 2007 compared to fiscal 2006. Our purchases of property and equipment and fees paid to defend ourintellectual property each increased in fiscal 2007 relative to fiscal 2006, collectively using $20.2 million in fiscal 2007 compared to$12.6 million in fiscal 2006, using an additional $7.5 million in cash. In fiscal 2007 we generated $28.6 million less cash frommaturities of marketable securities and removal of encumbrances against certain restricted cash balances, as we generated $6.7 millionand $35.3 million during fiscal 2007 and 2006, respectively. The decrease in cash provided from marketable securities and restrictedcash was the result of most of our investments and restricted cash having been converted to cash and cash equivalents during fiscal2006.Cash provided by financing activitiesCash provided by financing activities for fiscal 2008 was $327.1 million, as compared to net cash provided by financing activitiesof $541.5 million for fiscal 2007, a decrease of $214.4 million, or 40%. The majority of the cash provided by financing activities infiscal 2008 was composed of $330.6 million in net proceeds from equity issuances, and in fiscal 2007 was $551.4 million fromborrowings relating to our Expanded 2006 Credit Facility and 2.75% Convertible Senior Debentures. The net decrease between the fiscal2008 equity issuances and the fiscal 2007 debt issuances is $220.8 million. We received $28.4 million in fiscal 2007 from ouremployees’ exercise of34Table of Contentscertain share-based awards, compared to $11.1 million in fiscal 2008. In fiscal 2007 we paid $18.7 million relating to a deferredacquisition payment for an acquisition consummated in fiscal 2005, we did not have any deferred payments of this nature in fiscal 2008.Cash provided by financing activities for fiscal 2007 was $541.5 million, an increase of $192.8 million, or 55% compared to$348.7 million in fiscal 2006. The increase in cash provided by financing activities is primarily related to $205.4 million of incrementalnet borrowings from our Expanded 2006 Credit Facility and 2.75% Convertible Senior Debentures. This increase in cash generated waspartially offset by $4.5 million additional payments of notes and payables and capital leases, $4.2 million in additional deferredacquisition payments, $3.2 million for repurchase of shares originally issued to the former shareholders of Mobile Voice Control, Inc.,incremental $1.1 million purchases of additional treasury stock and $2.3 million less cash generated for proceeds from issuance ofcommon stock under employee share-based compensation plans.Credit Facilities and Debt2.75% Convertible Senior DebenturesOn August 13, 2007, Nuance issued $250 million of 2.75% convertible senior debentures due in 2027 (“the 2027 Debentures”) in aprivate placement to Citigroup Global Markets Inc. and Goldman, Sachs & Co. (the “Initial Purchasers”). Total proceeds, net of debtdiscount of $7.5 million and deferred debt issuance costs of $1.1 million, were $241.4 million. The 2027 Debentures bear an interest rateof 2.75% per annum, payable semi-annually in arrears beginning on February 15, 2008, and mature on August 15, 2027 subject to theright of the holders of the 2027 Debentures to require us to redeem the 2007 Debentures on August 15, 2014, 2017 and 2022. The relateddebt discount and debt issuance costs are being amortized to interest expense using the effective interest rate method through August 2014.As of September 30, 2008 and 2007, the ending unamortized discount was $6.3 million and $7.4 million, respectively, and the endingunamortized deferred debt issuance costs were $0.8 million and $1.1 million, respectively. The 2027 Debentures are general seniorunsecured obligations, ranking equally in right of payment to all of our existing and future unsecured, unsubordinated indebtedness andsenior in right of payment to any indebtedness that is contractually subordinated to the 2027 Debentures. The 2027 Debentures areeffectively subordinated to our secured indebtedness to the extent of the value of the collateral securing such indebtedness and arestructurally subordinated to indebtedness and other liabilities of our subsidiaries. If converted, the principal amount of the 2027Debentures is payable in cash and any amounts payable in excess of the principal of $250 million, will (based on an initial conversionrate, which represents an initial conversion price of $19.47 per share, subject to adjustment as defined) be paid in cash or shares of ourcommon stock, at our election, only in the following circumstances and to the following extent: (i) on any date during any fiscal quarterbeginning after September 30, 2007 (and only during such fiscal quarter) if the closing sale price of our common stock was more than120% of the then current conversion price for at least 20 trading days in the period of the 30 consecutive trading days ending on the lasttrading day of the previous fiscal quarter; (ii) during the five consecutive business-day period following any five consecutive trading-dayperiod in which the trading price for $1,000 principal amount of the Debentures for each day during such five trading-day period wasless than 98% of the closing sale price of our common stock multiplied by the then current conversion rate; (iii) upon the occurrence ofspecified corporate transactions, as described in the indenture for the 2027 Debentures; and (iv) at the option of the holder at any time onor after February 15, 2027. Additionally, we may redeem the 2027 Debentures, in whole or in part, on or after August 20, 2014 at parplus accrued and unpaid interest; each holder shall have the right, at such holder’s option, to require us to repurchase all or any portionof the 2027 Debentures held by such holder on August 15, 2014, August 15, 2017 and August 15, 2022. Upon conversion, we will paycash and shares of our common stock (or, at our election, cash in lieu of some or all of such common stock), if any. If we undergo afundamental change (as described in the indenture for the 2027 Debentures) prior to maturity, holders will have the option to require us torepurchase all or any portion of their debentures for cash at a price equal to 100% of the principal amount of the debentures to bepurchased plus any accrued and unpaid interest, including any additional interest to, but excluding, the repurchase date. As ofSeptember 30, 2008, no conversion triggers were met. If the conversion triggers were met, we could be required to repay all or some of theprincipal amount in cash prior to the maturity date.35Table of ContentsExpanded 2006 Credit FacilityWe have entered into a credit facility which consists of a $75 million revolving credit line including letters of credit, a $355 millionterm loan entered into on March 31, 2006, a $90 million term loan entered into on April 5, 2007 and a $225 million term loan enteredinto on August 24, 2007 (the “Expanded 2006 Credit Facility”). The term loans are due March 2013 and the revolving credit line is dueMarch 2012. As of September 30, 2008, $657.0 million remained outstanding under the term loans and there were $16.6 million ofletters of credit issued under the revolving credit line. There were no other outstanding borrowings under the revolving credit line as ofSeptember 30, 2008. On October 8, 2008, we drew $55.0 million against our revolving credit line.The Expanded 2006 Credit Facility contains covenants, including, among other things, covenants that restrict the ability of us andour subsidiaries to incur certain additional indebtedness, create or permit liens on assets, enter into sale-leaseback transactions, makeloans or investments, sell assets, make certain acquisitions, pay dividends, or repurchase stock. The agreement also contains events ofdefault, including failure to make payments of principal or interest, failure to observe covenants, breaches of representations andwarranties, defaults under certain other material indebtedness, failure to satisfy material judgments, a change of control and certaininsolvency events. As of September 30, 2008, we were in compliance with the covenants under the Expanded 2006 Credit Facility.Borrowings under the Expanded 2006 Credit Facility bear interest at a rate equal to the applicable margin plus, at our option, either(a) the base rate (which is the higher of the corporate base rate of UBS AG, Stamford Branch, or the federal funds rate plus 0.50% perannum) or (b) LIBOR (equal to (i) the British Bankers’ Association Interest Settlement Rates for deposits in U.S. dollars divided by(ii) one minus the statutory reserves applicable to such borrowing). The applicable margin for term loan borrowings under the Expanded2006 Credit Facility ranges from 0.75% to 1.50% per annum with respect to base rate borrowings and from 1.75% to 2.50% per annumwith respect to LIBOR-based borrowings, depending on our leverage ratio. The applicable margin for revolving loan borrowings, underthe Expanded 2006 Credit Facility ranges from 0.50% to 1.25% per annum with respect to base rate borrowings and from 1.50% to2.25% per annum with respect to LIBOR-based borrowings, depending upon our leverage ratio. As of September 30, 2008, our applicablemargin for term loan was 1.25% for base rate borrowings and 2.25% for LIBOR-based borrowings. We are required to pay a commitmentfee for unutilized commitments under the revolving credit facility at a rate ranging from 0.375% to 0.50% per annum, based upon ourleverage ratio. As of September 30, 2008, the commitment fee rate was 0.5% and the effective interest rate was 4.72%.We capitalized debt issuance costs related to the Expanded 2006 Credit Facility and are amortizing the costs to interest expense usingthe effective interest rate method through March 2012 for costs associated with the revolving credit facility and through March 2013 forcosts associated with the term loan. As of September 30, 2008 and 2007, the ending unamortized deferred financing fees were$10.0 million and $12.3 million, respectively and are included in other assets in our accompanying balance sheet.The Expanded 2006 Credit Facility is subject to repayment in four equal quarterly installments of 1% per annum ($6.7 million peryear, not including interest, which is also payable quarterly), and an annual excess cash flow sweep, as defined in the Expanded 2006Credit Facility, which is payable beginning in the first quarter of each fiscal year, beginning in fiscal 2008, based on the excess cash flowgenerated in the previous fiscal year. No payment under the excess cash flow sweep provision was due in the first quarter of either fiscal2008 or fiscal 2009 as there was no excess cash flow generated in either of the respective prior fiscal years. We will continue to evaluate theextent to which a payment is due in the first quarter of future fiscal years excess cash flow generation. At the current time, we are unable topredict the amount of the outstanding principal, if any, that we may be required to repay in future fiscal years pursuant to the excess cashflow sweep provisions. Any term loan borrowings not paid through the baseline repayment, the excess cash flow sweep, or any othermandatory or optional payments that we may36Table of Contentsmake, will be repaid upon maturity. If only the baseline repayments are made, the annual aggregate principal amount of the term loansrepaid would be as follows (in millions):Year Ending September 30, Amount 2009 $6.7 2010 6.7 2011 6.7 2012 6.7 2013 630.2 Total $657.0 Our obligations under the Expanded 2006 Credit Facility are unconditionally guaranteed by, subject to certain exceptions, each ofour existing and future direct and indirect wholly-owned domestic subsidiaries. The Expanded 2006 Credit Facility and the guaranteesthereof are secured by first priority liens and security interests in the following: 100% of the capital stock of substantially all of ourdomestic subsidiaries and 65% of the outstanding voting equity interests and 100% of the non-voting equity interests of first-tier foreignsubsidiaries, all material tangible and intangible assets of us and the guarantors, and any present and future intercompany debt. TheExpanded 2006 Credit Facility also contains provisions for mandatory prepayments of outstanding term loans upon receipt of thefollowing, and subject to certain exceptions: 100% of net cash proceeds from asset sales, 100% of net cash proceeds from issuance orincurrence of debt, and 100% of extraordinary receipts. We may voluntarily prepay the Expanded 2006 Credit Facility without premiumor penalty other than breakage costs, as defined with respect to LIBOR-based loans.We believe that cash flows from future operations in addition to cash and marketable securities on hand will be sufficient to meet ourworking capital, investing, financing and contractual obligations and the contingent payments for acquisitions, if any are realized, asthey become due for the foreseeable future. We also believe that in the event future operating results are not as planned, that we could takeactions, including restructuring actions and other cost reduction initiatives, to reduce operating expenses to levels which, in combinationwith expected future revenue, will continue to generate sufficient operating cash flow. In the event that these actions are not effective ingenerating operating cash flows we may be required to issue equity or debt securities on terms that may be less favorable.37Table of ContentsOff-Balance Sheet Arrangements, Contractual Obligations, Contingent Liabilities and CommitmentsContractual ObligationsThe following table outlines our contractual payment obligations as of September 30, 2008 (in millions): Payments Due by Fiscal Year Ended September 30, 2010 2012 Contractual Obligations Total 2009 and 2011 and 2013 Thereafter Expanded 2006 Credit Facility(2) $657.0 $6.7 $13.4 $636.9 $— 2.75% Convertible Senior Debentures(1) 250.0 — — — 250.0 Interest payable under Expanded 2006 Credit Facility(2) 136.5 30.9 60.8 44.8 — Interest payable under 2.75% Convertible Senior Debentures(3) 41.4 6.9 13.8 13.8 6.9 Lease obligations and other liabilities: Capital leases and other liabilities 0.3 0.2 0.1 — — Operating leases 98.5 15.6 27.9 24.2 30.8 Other lease obligations associated with the closing of duplicatefacilities related to restructurings and acquisitions(4) 6.7 3.1 2.6 1.0 — Pension, minimum funding requirement(5) 4.7 1.6 3.1 — — Purchase commitments(6) 3.0 3.0 — — — Other long-term liabilities assumed(7) 66.8 13.7 28.9 16.3 7.9 Total contractual cash obligations $1,264.9 $81.7 $150.6 $737.0 $295.6 (1)Holders of the 2.75% Senior Convertible Debentures have the right to require us to repurchase the debentures on August 15, 2014,2017 and 2022.(2)Interest is due and payable monthly under the credit facility, and principal is paid on a quarterly basis. The amounts included asinterest payable in this table are based on the effective interest rate as of September 30, 2008 related to the Expanded 2006 CreditFacility excluding the effect of our interest rate swaps.(3)Interest is due and payable semi-annually under the 2.75% convertible senior debentures.(4)Obligations include contractual lease commitments related to two facilities that were part of restructuring plans entered into in fiscal2005 and 2008. As of September 30, 2008, total gross lease obligations are $3.0 million and are included in the contractual obligationsherein. The remaining $3.7 million in obligations represent contractual lease commitments associated with the implemented plans toeliminate duplicate facilities in conjunction with our acquisitions. As of September 30, 2008, we have subleased certain of thefacilities to unrelated third parties with total sublease income of $3.4 million through fiscal 2013.(5)Our U.K. pension plan has a minimum funding requirement of £859,900 ($1.6 million based on the exchange rate at September 30,2008) for each of the next 3 years, through fiscal 2011.(6)These amounts include non-cancelable purchase commitments for inventory in the normal course of business to fulfill customers’orders currently scheduled in our backlog.(7)Obligations include assumed long-term liabilities relating to restructuring programs initiated by the predecessor companies prior to ouracquisition of SpeechWorks International, Inc. in August 2003, and our acquisition of Former Nuance in September 2005. Theserestructuring programs related to the closing of two facilities with lease terms set to expire in 2016 and 2012, respectively. Totalcontractual obligations under these two leases are $66.8 million. As of September 30, 2008, we have sub-leased certain of the officespace related to these two facilities to unrelated third parties. Total sublease income under contractual terms is expected to be$21.1 million, which ranges from $1.7 million to $4.0 million on an annualized basis through 2016.On October 1, 2008, we completed our acquisition of SNAPin Software, Inc. The SNAPin acquisition will further enable ourcapabilities to deliver innovative, highly scalable mobile customer care solutions that transform38Table of Contentsthe way mobile operators and enterprises interact with consumers in real-time on mobile devices. The announced estimated aggregateconsideration for this acquisition is approximately 10.6 million shares of our common stock including 1.1 million shares of our commonstock to be placed in escrow for 12 months to satisfy any claims we may have. The aggregate consideration will additionally include ourassumption of all of SNAPin’s outstanding employee stock options and restricted stock awards.As a result of our adoption of FIN 48 “Accounting for Uncertainty in Income Taxes — an Interpretation of FASB StatementNo. 109” (“FIN 48”) on October 1, 2007 our gross liability for unrecognized tax benefits was approximately $2.5 million. The grossliability as of September 30, 2008 was $2.7 million. We estimate that approximately $1.6 million of this amount may be paid within thenext two years and we are currently unable to reasonably estimate the timing of payments for the remainder of the liability.Contingent Liabilities and CommitmentsIn connection with certain of our acquisitions, we have agreed to make contingent cash payments to the former shareholders ofcertain of the acquired companies. The following represents the contingent cash payments that we may be required to make.In connection with our acquisition of Phonetic Systems Ltd. (“Phonetic”), we agreed to make contingent earnout payments of up to$35.0 million upon the achievement of certain established financial and performance targets through December 31, 2007, in accordancewith the merger agreement. We have notified the former shareholders of Phonetic that the financial and performance targets for thescheduled payments for all periods through December 31, 2007 were not achieved. Accordingly, we have not recorded any obligationsrelative to these measures as of September 30, 2008. The former shareholders of Phonetic have objected to this determination and havefiled for arbitration.In connection with our acquisition of BeVocal, we agreed to make contingent earnout payments of up to $65.1 million upon theachievement of certain financial targets through December 31, 2007. A portion of the total amount of the earnout payments is furtherconditioned on continued employment provisions. Subsequent to September 30, 2008, based on the final measurement of the financialtargets, and on the currently measurable forfeiture provisions relating to continued employment requirements, we agreed with the BeVocalshareholder representative on total earnout payments of $49.1 million. The majority of these payments are due upon the finalmeasurement of the financial targets. We have included this amount in current liabilities as of September 30, 2008; a preliminary estimateof the amount, $44.2 million, was included in long-term liabilities as of September 30, 2007. Of this total amount, $46.1 million ispayable in cash and $3.0 million is payable in either shares of stock or as a cash payment, at our option.In connection with our acquisition of Commissure, we agreed to make contingent earnout payments of up to $8.0 million upon theachievement of certain financial targets for the fiscal years ended September 30, 2008, 2009 and 2010, in accordance with the mergeragreement. $2.0 million of this earnout relates to performance measures for fiscal 2008, we are currently evaluating the calculations forthese fiscal 2008 targets, and have not recorded any earnout obligation as of September 30, 2008. Payments, if any, may be made in theform of cash or shares of our common stock, at our sole discretion.In connection with our acquisition of Vocada, we agreed to make contingent earnout payments of up to an additional $21.0 millionupon the achievement of certain performance targets through 2010 measured over defined periods through December 31, 2010, inaccordance with the merger agreement. We have not recorded any obligation relative to these measures as of September 30, 2008.Payments, if any, will be made in the form of cash or shares of our common stock, at our sole discretion.In connection with our acquisition of Viecore, we guaranteed a minimum market value of $20.43 per share when the escrow sharesare released. If the market value is less than $20.43 per share on the date of release, the Company is required to pay the difference, if any,and limited to $1.8 million, in cash. Based on the closing market value per share of $12.19 on September 30, 2008, we would berequired to pay to the former shareholders of Viecore $1.8 million, which would be recorded as a reduction of additional paid in capital.In connection with the escrow relating to the eScription acquisition, we have guaranteed a minimum market value of $17.7954 pershare when the escrow shares are released. If the market value is less than $17.7954 per share39Table of Contentson the date of release, we are required to pay the difference, if any and limited to $5.0 million, in cash. Based on the closing market valueper share of $12.19 on September 30, 2008, we would be required to pay to the former shareholders of eScription $5.0 million, whichwould be recorded as a reduction of additional paid in capital.In connection with our acquisition of Multi-Vision, we agreed to make contingent earnout payments of up to $15.0 million upon theachievement of certain financial targets for the period from August 1, 2008 to July 31, 2009, in accordance with the merger agreement. Inaddition to the performance targets, two-thirds of the earnout is further conditioned on continued employment; accordingly, up to$10.0 million of any earnout payments that become payable will be recorded to compensation expense, and up to $5.0 million will berecorded as additional purchase price and allocated to goodwill. We have not recorded any obligation relative to these measures as ofSeptember 30, 2008. Payments, if any, will be made in the form of cash or shares of our common stock, at our sole discretion.In connection with our acquisition of PSRS in September 2008, a deferred cash payment of €44.3 million ($64.0 million based onthe exchange rate as of September 30, 2008) is to be paid in cash on September 21, 2009. Subsequent to September 30, 2008, we enteredinto a cash flow hedge with respect to the €44.3 million payment. The September 2009 payment is subject to acceleration under certainconditions including change in control of Nuance (as defined), or the acceleration of our payment obligations under our March 2006credit agreement, as amended. Additionally, the purchase price is subject to adjustment (increase or decrease), based on the workingcapital provision as defined in the share purchase agreement the measurement is expected to be completed in the first quarter offiscal 2009.In connection with our acquisition of SNAPin, on October 1, 2008, we agreed to make contingent earnout payments of up to$45.0 million in cash, and an additional $2.5 million in cash or stock, at our sole discretion, upon the achievement of certain financialtargets for the period from October 1, 2008 to December 31, 2009, in accordance with the merger agreement.Pension and Post-Retirement Benefit PlansWe assumed defined benefit pension plans as part of the acquisition of Dictaphone Corporation on March 31, 2006, which providecertain retirement and death benefits for former Dictaphone employees located in the United Kingdom and Canada. These plans requireperiodic cash contributions. The Canadian plan is fully funded and expected to remain fully funded during fiscal 2009, withoutadditional funding by us. In fiscal 2008, total cash funding for the UK pension plan was $1.7 million. For the UK pension plan, wehave a minimum funding requirement of £859,900 (approximately $1.6 million based on the exchange rate at September 30, 2008) foreach of the next three years, through fiscal 2011.We have also assumed a post-retirement health care and life insurance benefit plan in connection with the acquisition of Dictaphone.The plan, which is closed to new participants, provides certain post-retirement health care and life insurance benefits and consists of afixed subsidy for qualifying employees in the United States and Canada. The plan is non-funded and cash contributions are made eachyear to cover claim costs incurred in that year. Total cash paid during fiscal 2008 for the post-retirement health care and life insurancebenefit plan was not material.Off-Balance Sheet ArrangementsThrough September 30, 2008, we have not entered into any off-balance sheet arrangements or material transactions withunconsolidated entities or other persons.CRITICAL ACCOUNTING POLICIES, JUDGMENTS AND ESTIMATESThe preparation of financial statements in conformity with U.S. generally accepted accounting principles, requires management tomake estimates and assumptions that affect the reported amounts of assets and liabilities, and the disclosure of contingent assets andliabilities at the date of the financial statements, and the reported amounts of revenue and expenses during the reporting period. On anongoing basis, we evaluate our estimates, assumptions and judgments, including those related to revenue recognition; allowance fordoubtful accounts and returns; accounting for patent legal defense costs; the costs to complete the development of custom software40Table of Contentsapplications; the valuation of goodwill, intangible assets and tangible long-lived assets; accounting for business combinations; share-based payments; interest rate swaps which are characterized as derivative instruments; accounting for income taxes and related valuationallowances; and loss contingencies. Our management bases its estimates on historical experience and various other factors that arebelieved to be reasonable under the circumstances. Actual results could differ from these estimates.We believe the following critical accounting policies most significantly affect the portrayal of its financial condition and results ofoperations and require its most difficult and subjective judgments.Revenue Recognition. We recognize product and licensing revenue in accordance with Statement of Position, or SOP, 97-2,“Software Revenue Recognition,” and SOP 98-9, Modification of SOP 97-2, “Software Revenue Recognition, with Respect to CertainTransactions,” and related authoritative literature. The application of SOP 97-2 requires judgment, including whether a softwarearrangement includes multiple elements, and if so, whether vendor-specific objective evidence, or VSOE, of fair value exists for thoseelements. Our software arrangements generally include software and post contract support which includes telephone support and the rightto receive unspecified upgrades/enhancements on a when-and-if-available basis, typically for one to three years. Changes to the elements ina software arrangement, the ability to identify VSOE for those elements and the fair value of the respective elements could materiallyimpact the amount of earned and unearned revenue. Judgment is also required to assess whether future releases of certain softwarerepresent new products or upgrades and enhancements to existing products. In accordance with SOP 97-2, revenue is recognized when(i) persuasive evidence of an arrangement exists, (ii) delivery has occurred, (iii) the fee is fixed or determinable and (iv) collectibility isprobable.Non-software revenue is recognized in accordance with, the Securities and Exchange Commission’s Staff Accounting Bulletin, orSAB, 104, “Revenue Recognition in Financial Statements.” Under SAB 104, we recognize revenue when (i) persuasive evidence of anarrangement exists, (ii) delivery has occurred or services have been rendered, (iii) the fees are fixed or determinable and (iv) collectibility isreasonably assured.Revenue from products offered on a subscription and/or hosting basis is recognized in the period the services are provided, based ona fixed minimum fee and/or variable fees based on the volume of activity. We recognize variable subscription and hosting revenue whenwe are notified by the customer or through management reports that such revenue is due, provided that all other revenue recognitioncriteria are met.Set-up fees from arrangements containing hosting services, as well as the associated direct and incremental costs, are deferred andrecognized ratably over the longer of the contractual lives, or the expected lives of the customer relationships.Professional services revenue is recognized in accordance with SOP 81-1, “Accounting for Performance of Construction Type andCertain Performance Type Contracts,” on the percentage-of-completion method. We generally determine the percentage-of-completion bycomparing the labor hours incurred to date to the estimated total labor hours required to complete the project. We consider labor hours to bethe most reliable, available measure of progress on these projects. Adjustments to estimates to complete are made in the periods in whichfacts resulting in a change become known. When the estimate indicates that a loss will be incurred, such loss is recorded in the periodidentified. Significant judgments and estimates are involved in determining the percent complete of each contract. Different assumptionscould yield materially different results.We make estimates of sales returns based on historical experience. In accordance with Statement of Financial Accounting Standards,or SFAS 48, “Revenue Recognition When Right of Return Exists,” the provision for these estimated returns is recorded as a reduction ofrevenue and accounts receivable at the time that the related revenue is recorded. We also make estimates and reduce revenue recognized forprice protection and rebates, and certain marketing allowances at the time the related revenue is recorded. If actual results differsignificantly from our estimates, such differences could have a material impact on our results of operations for the period in which theactual results become known.Our revenue recognition policies require management to make significant estimates. Management analyzes various factors, includinga review of specific transactions, historical experience, creditworthiness of customers and current market and economic conditions.Changes in judgments based upon these factors could impact the timing and amount of revenue and cost recognized and thus affects ourresults of operations and financial condition.41Table of ContentsBusiness Combinations. In accordance with SFAS 141, “Business Combinations,” we allocate the purchase price of acquiredcompanies to the tangible and intangible assets acquired and liabilities assumed as well as to in-process research and development basedupon their estimated fair values at the acquisition date. The purchase price allocation process requires management to make significantestimates and assumptions, especially at acquisition date with respect to intangible assets, support obligations assumed, estimatedrestructuring liabilities and pre-acquisition contingencies.Although we believe the assumptions and estimates we have made in the past have been reasonable and appropriate, they are basedin part on historical experience and information obtained from the management of the acquired companies and are inherently uncertain.Examples of critical estimates in valuing certain of the intangible assets we have acquired or may acquire in the future include but are notlimited to: • future expected cash flows from software license sales, support agreements, consulting contracts, other customer contracts andacquired developed technologies and patents; • expected costs to develop in-process research and development projects into commercially viable products and the estimated cashflows from the projects when completed; • the acquired company’s brand and competitive position, as well as assumptions about the period of time the acquired brand willcontinue to be used in the combined company’s product portfolio; and • discount rates.Unanticipated events and circumstances may occur which may affect the accuracy or validity of such assumptions, estimates oractual results.In connection with the purchase price allocations for our acquisitions, we estimate the fair market value of legal performancecommitments to customers, which are classified as deferred revenue. The estimated fair market value of these obligations is determinedand classified in accordance with the provisions of EITF 01-03, “Accounting in a Business Combination for Deferred Revenue ofAcquiree.”Other significant estimates associated with the accounting for business combinations include restructuring costs. Restructuring costsare typically comprised of severance costs, costs of consolidating duplicate facilities and contract termination costs. Restructuringexpenses are based upon plans that have been committed to by management, but are generally subject to refinement during the purchaseprice allocation period (generally within one year of the acquisition date). To estimate restructuring expenses, management utilizesassumptions of the number of employees that would be involuntarily terminated and of future costs to operate and eventually vacateduplicate facilities. Estimated restructuring expenses may change as management executes the approved plan.For a given acquisition, we may identify certain pre-acquisition contingencies. If, during the purchase price allocation period, we areable to determine the fair value of a pre-acquisition contingency, we will include that amount in the purchase price allocation. If, as of theend of the purchase price allocation period, we are unable to determine the fair value of a pre-acquisition contingency, we will evaluatewhether to include an amount in the purchase price allocation based on whether it is probable a liability had been incurred and whether anamount can be reasonably estimated. With the exception of unresolved income tax matters, after the end of the purchase price allocationperiod, any adjustment to amounts recorded for a pre-acquisition contingency will be included in our operating results in the period inwhich the adjustment is determined.In fiscal 2010, we will adopt SFAS 141 (revised 2007), Business Combinations. Refer to Note 2 of Notes to Consolidated FinancialStatements for additional information.Goodwill, Intangible Assets and Impairment Assessments. We have significant long-lived tangible and intangible assets,including goodwill and intangible assets with indefinite lives, which are susceptible to valuation adjustments as a result of changes invarious factors or conditions. The most significant long-lived tangible and intangible assets are fixed assets, licensed technology, patentsand core technology, completed technology, customer relationships and trademarks. All finite-lived intangible assets are amortized basedupon patterns in which the economic benefits are expected to be utilized. The values of intangible assets determined in connection with abusiness combination, with the exception of goodwill, were initially determined by a risk-adjusted,42Table of Contentsdiscounted cash flow approach. We assess the potential impairment of intangible assets and fixed assets whenever events or changes incircumstances indicate that the carrying values may not be recoverable and at least annually. Factors we consider important, which couldtrigger an impairment of such assets, include the following: • significant underperformance relative to historical or projected future operating results; • significant changes in the manner of or use of the acquired assets or the strategy for Nuance’s overall business; • significant negative industry or economic trends; • significant decline in our stock price for a sustained period; and • a decline in our market capitalization below net book value.Future adverse changes in these or other unforeseeable factors could result in an impairment charge that would materially impactfuture results of operations and financial position in the reporting period identified.In accordance with SFAS 142, “Goodwill and Other Intangible Assets,” we test goodwill and intangible assets with indefinite livesfor impairment on an annual basis as of July 1, and between annual tests if indicators of potential impairment exist. The impairment testfor goodwill and intangible assets with indefinite lives compares the fair value of the reporting unit to its carrying amount to assesswhether impairment is present. We have reviewed the provisions of SFAS 142 with respect to the criteria necessary to evaluate the numberof reporting units that exist. Based on our review, we have determined that we operate in one reporting unit. Intangible assets withindefinite lives are not amortized, but are required to be evaluated periodically to ensure that their current fair value exceeds the stated bookvalue. Based on our assessments, we have not had any impairment charges during its history as a result of our impairment evaluation ofgoodwill and other indefinite-lived intangible assets under SFAS 142.In accordance with SFAS 144, “Accounting for the Impairment or Disposal of Long-Lived Assets,” we periodically review long-livedassets for impairment whenever events or changes in business circumstances indicate that the carrying amount of the assets may not befully recoverable or that the useful lives of those assets are no longer appropriate. Each impairment test is based on a comparison of theundiscounted cash flows to the recorded carrying value for the asset. If impairment is indicated, the asset is written down to its estimatedfair value based on a discounted cash flow analysis. In fiscal 2008, based on its review of the carrying amount of each asset to the futureundiscounted cash flows, we recorded impairment charges of $3.9 million, of which $0.3 million was included in cost of revenue fromamortization of intangible assets, and $3.6 million was included in amortization of intangible assets. There were no charges recorded infiscal 2007 or 2006 relating to assessment of historic carrying amount of intangible assets. Additionally, during fiscal 2008, 2007 and2006, we recorded charges of $2.7 million, $0 and $2.6 million, respectively, relating to the historic portion of settlement and licenseagreements that we entered into with vendors licensing technology to us.Significant judgments and estimates are involved in determining the useful lives of our long-lived assets, determining what reportingunits exist and assessing when events or circumstances would require an interim impairment analysis of goodwill or other long-livedassets to be performed. Changes in our organization or management reporting structure, as well as other events and circumstances,including but not limited to technological advances, increased competition and changing economic or market conditions, could result in(a) shorter estimated useful lives, (b) additional reporting units, which may require alternative methods of estimating fair values or greaterdisaggregation or aggregation in our analysis by reporting unit, and/or (c) other changes in previous assumptions or estimates. In turn,this could have a significant impact on our consolidated financial statements through accelerated amortization and/or impairment charges.Capitalized Patent Defense Costs. We monitor the anticipated outcome of legal actions, and if we determine that the success of thedefense of a patent is probable, and so long as we believe that the future economic benefit of the patent will be increased, we then capitalizeexternal legal costs incurred in the defense of these patents, up to the level of the expected increased future economic benefit. If changes inthe anticipated outcome occur, we write off any capitalized costs in the period the change is determined. As of September 30, 2008 and2007, capitalized patent defense costs recorded in other assets totaled $6.7 million and $6.4 million, respectively.43Table of ContentsResearch and Development Costs. We account for the internal costs relating to research and development activities in accordancewith SFAS 2, “Accounting for Research and Development Costs,” and SFAS 86, “Accounting for the Costs of Computer Software to beSold, Leased, or Otherwise Marketed.” Research and development costs incurred for new software products and enhancements to existingproducts, other than certain software development costs that qualify for capitalization, are expensed as incurred. Software developmentcosts incurred subsequent to the establishment of technological feasibility, but prior to the general release of the product, are capitalizedand amortized to cost of revenue over the estimated useful life of the related products. Judgment is required in determining whentechnological feasibility of a product is established. We have determined that technological feasibility is reached shortly before the generalrelease of our software products. Costs incurred after technological feasibility is established have not been material, and accordingly, wehave expensed the internal costs relating to research and development when incurred.Accounting for Share-Based Payments. We account for share-based payments in accordance with SFAS 123R, “Share-BasedPayment.” Under the fair value recognition provisions of this statement, share-based compensation cost is measured at the grant datebased on the value of the award and is recognized as expense over the requisite service period which is generally the vesting period.Determining the fair value of share-based awards at the grant date requires judgment, including estimating expected dividends, share pricevolatility and the amount of share-based awards that are expected to be forfeited. If actual results differ significantly from these estimates,share-based compensation expense and our results of operations could be materially impacted.Income Taxes. Deferred tax assets and liabilities are determined based on differences between the financial statement and tax basesof assets and liabilities using enacted tax rates in effect in the years in which the differences are expected to reverse. We do not provide forU.S. income taxes on the undistributed earnings of our foreign subsidiaries, which we consider to be indefinitely reinvested outside of theU.S. in accordance with Accounting Principles Board (APB) Opinion No. 23, “Accounting for Income Taxes — Special Areas.”We make judgments regarding the realizability of our deferred tax assets. In accordance with SFAS 109, “Accounting for IncomeTaxes,” the carrying value of the net deferred tax assets is based on the belief that it is more likely than not that we will generate sufficientfuture taxable income to realize these deferred tax assets after consideration of all available evidence. We regularly review our deferred taxassets for recoverability considering historical profitability, projected future taxable income, and the expected timing of the reversals ofexisting temporary differences and tax planning strategies.Valuation allowances have been established for U.S. deferred tax assets, which we believe do not meet the “more likely than not”criteria established by SFAS 109. If we are subsequently able to utilize all or a portion of the deferred tax assets for which a valuationallowance has been established, then we may be required to recognize these deferred tax assets through the reduction of the valuationallowance which would result in a material benefit to its results of operations in the period in which the benefit is determined, excludingthe recognition of the portion of the valuation allowance which relates to net deferred tax assets acquired in a business combination orcreated as a result of share-based payments. The recognition of the portion of the valuation allowance which relates to net deferred taxassets resulting from share-based payments will be recorded as additional paid-in-capital. The recognition of the portion of the valuationallowance which relates to net deferred tax assets acquired in a business combination will reduce goodwill, intangible assets, and to theextent remaining, the provision for income taxes.Loss Contingencies. We are subject to legal proceedings, lawsuits and other claims relating to labor, service and other mattersarising in the ordinary course of business, as discussed in Note 18 of Notes to our Consolidated Financial Statements. Quarterly, wereview the status of each significant matter and assess our potential financial exposure. If the potential loss from any claim or legalproceeding is considered probable and the amount can be reasonably estimated, we accrue a liability for the estimated loss. Significantjudgment is required in both the determination of probability and the determination as to whether an exposure is reasonably estimable.Because of uncertainties related to these matters, accruals are based only on the best information available at the time. As additionalinformation becomes available, we reassess the potential liability related to our pending claims and litigation and may revise our estimates.Such revisions in the estimates of the potential liabilities could have a material impact on our results of operations and financial position.44Table of ContentsRECENTLY ISSUED ACCOUNTING PRONOUNCEMENTSIn May 2008, the FASB issued FASB Staff Position (“FSP”) No. APB 14-1, or FSP 14-1, “Accounting for Convertible DebtInstruments that may be Settled in Cash upon Conversion.” FSP 14-1 requires the issuer of certain convertible debt instruments that maybe settled in cash (or other assets) on conversion to separately account for the liability (debt) and equity (conversion option) components ofthe instrument in a manner that reflects the issuer’s nonconvertible debt borrowing rate. FSP 14-1 will significantly affect the accountingfor instruments commonly referred to as Instruments B and C in EITF No. 90-19, “Convertible Bonds with Issuer Option to Settle forCash upon Conversion,” which is nullified by FSP 14-1, and any other convertible debt instruments that require or permit settlement inany combination of cash and shares at the issuer’s option, such as those sometimes referred to as “Instrument X.” FSP 14-1 is effectivefor financial statements issued for fiscal years beginning after December 15, 2008, with early adoption prohibited. The Company isrequired to adopt the pronouncement in its first quarter of fiscal 2010. FSP 14-1 is required to be applied retrospectively to all periodspresented. We are evaluating the impact that FSP 14-1 will have on our consolidated financial statements.In April 2008, the FASB issued FSP 142-3 “Determination of the Useful Life of Intangible Assets.” FSP 142-3 amends the factorsthat should be considered in developing renewal or extension assumptions used to determine the useful life of a recognized intangible assetunder SFAS 142. The intent of this FSP is to improve the consistency between the useful life of a recognized intangible asset underSFAS 142 and the period of expected cash flows used to measure the fair value of the asset under SFAS 141, and other U.S. generallyaccepted accounting principles (GAAP). FSP142-3 is effective for financial statements issued for fiscal years beginning afterDecember 15, 2008, and may not be adopted early. We are required to adopt the pronouncement in its first quarter of fiscal 2010. We areevaluating the impact, if any, that FSP 142-3 may have on our consolidated financial statements.In March 2008, the FASB issued SFAS 161, “Disclosures about Derivative Instruments and Hedging Activities, an amendment ofFASB Statement No. 133.” SFAS 161 improves financial reporting about derivative instruments and hedging activities by requiringenhanced disclosures to enable investors to better understand their effects on an entity’s financial position, financial performance, andcash flows. SFAS 161 is effective for financial statements issued for fiscal years and interim periods beginning after November 15,2008. We expect to adopt SFAS 161 in the second quarter of fiscal 2009. We do not expect the issuance of SFAS 161 to have a materialimpact on our consolidated financial statements.In December 2007, the FASB issued SFAS 141 (revised), “Business Combinations” (“SFAS 141R”). The standard changes theaccounting for business combinations including the measurement of acquirer shares issued in consideration for a business combination,the recognition of contingent consideration, the accounting for pre-acquisition gain and loss contingencies, the recognition of capitalized in-process research and development, the accounting for acquisition-related restructuring cost accruals, the treatment of acquisition relatedtransaction costs and the recognition of changes in the acquirer’s income tax valuation allowance. SFAS 141R is effective for fiscal yearsbeginning after December 15, 2008, with early adoption prohibited. We are required to adopt SFAS 141R for any business combinationsentered into beginning in fiscal 2010. We are evaluating the impact, if any, that SFAS 141R may have on our consolidated financialstatements.In February 2007, the FASB issued SFAS 159, “The Fair Value Option for Financial Assets and Financial Liabilities.” SFAS 159has as its objective to reduce both complexity in accounting for financial instruments and volatility in earnings caused by measuringrelated assets and liabilities differently. It also establishes presentation and disclosure requirements designed to facilitate comparisonsbetween companies that choose different measurement attributes for similar types of assets and liabilities. The statement is effective as ofthe beginning of an entity’s first fiscal year beginning after November 15, 2007, with early adoption permitted provided that the entitymakes that choice in the first 120 days of that fiscal year. We did not elect to early adoption and are required to adopt SFAS 159 in thefirst quarter of fiscal 2009. We do not believe that the adoption of SFAS 159 will have any material impact to our consolidated financialstatements.In September 2006, the FASB issued SFAS 157, “Fair Value Measurements.” SFAS 157 establishes a framework for measuringfair value and expands fair value measurement disclosures. SFAS 157 is effective for fiscal years beginning after November 15, 2007. InFebruary 2008, the FASB agreed to a one-year deferral for the implementation of SFAS 157 for non-financial assets and liabilities. We arerequired to adopt SFAS 157 in the first45Table of Contentsquarter of fiscal 2009 for financial assets and liabilities and the first quarter of fiscal 2010 for all other assets and liabilities. We do notbelieve that our adoption of SFAS 157 will have any material impact to our consolidated financial statements.Item 7A. Quantitative and Qualitative Disclosures about Market RiskWe are exposed to market risk from changes in foreign currency exchange rates and interest rates, which could affect operatingresults, financial position and cash flows. We manage our exposure to these market risks through our regular operating and financingactivities and, when appropriate, through the use of derivative financial instruments.Exchange Rate SensitivityWe are exposed to changes in foreign currency exchange rates. Any foreign currency transaction, defined as a transactiondenominated in a currency other than the U.S. dollar, will be reported in U.S. dollars at the applicable exchange rate. Assets and liabilitiesare translated into U.S. dollars at exchange rates in effect at the balance sheet date and income and expense items are translated at averagerates for the period. The primary foreign currency denominated transactions include revenue and expenses and the resulting accountsreceivable and accounts payable balances reflected on our balance sheet. Therefore, the change in the value of the U.S. dollar compared toforeign currencies will have either a positive or negative effect on our financial position and results of operations. Historically, our primaryexposure has related to transactions denominated in the Euro, British Pound, Canadian Dollar, Japanese Yen, Israeli New Shekel, IndianRupee and Hungarian Forint.A hypothetical change of 10% in appreciation or depreciation in foreign currency exchange rates from the quoted foreign currencyexchange rates at September 30, 2008 would not have a material impact on our revenue, operating results or cash flows.Occasionally, we have entered into forward exchange contracts to hedge against foreign currency fluctuations. These foreign currencyexchange contracts are entered into as economic hedges, but are not designated as hedges for accounting purposes as defined underSFAS 133. The notional contract amount of these outstanding foreign currency exchange contracts was not material at September 30, 2008and a hypothetical change of 10% in exchange rates would not have a material impact on our financial results. During the fiscal year 2008and 2007, we recorded foreign exchange losses of $0.3 million and gains of $0.8 million, respectively.Interest Rate SensitivityWe are exposed to interest rate risk as a result of our significant cash and cash equivalents, and the outstanding debt under theExpanded 2006 Credit Facility.At September 30, 2008, we held approximately $261.5 million of cash and cash equivalents primarily consisting of cash andmoney-market funds and $0.1 million of short-term marketable securities. Due to the low current market yields and the short-term natureof our investments, a hypothetical change in market rates of one percentage point would not have a material effect on the fair value of ourportfolio or results of operations.At September 30, 2008, our total outstanding debt balance exposed to variable interest rates was $657.0 million. To partially offsetthis variable interest rate exposure, we entered into a three-year interest rate swap with a notional value of $100 million in March 2006.The interest rate swap is structured to offset period changes in the variable interest rate without changing the characteristics of theunderlying debt instrument. A hypothetical change in market rates would have a significant impact on the interest expense and amountspayable relating to the $557.0 million of debt that is not offset by the interest rate swap; assuming a one percentage point change ininterest rates, the interest expense would increase $5.6 million per annum. Subsequent to September 30, 2008, we entered into twoadditional two-year interest rate swaps with a total notional value of $200 million.Item 8. Financial Statements and Supplementary DataNuance Communications, Inc. Consolidated Financial Statements46 NUANCE COMMUNICATIONS, INC.INDEX TO FINANCIAL STATEMENTS PageReports of Independent Registered Public Accounting Firm 48 Consolidated Balance Sheets 51 Consolidated Statements of Operations 52 Consolidated Statements of Stockholders’ Equity and Comprehensive Loss 53 Consolidated Statements of Cash Flows 54 Notes to Consolidated Financial Statements 55 47Table of ContentsREPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRMBoard of Directors and StockholdersNuance Communications, Inc.Burlington, MassachusettsWe have audited the accompanying consolidated balance sheets of Nuance Communications, Inc. (the “Company”) as ofSeptember 30, 2008 and 2007, and the related consolidated statements of operations, stockholders’ equity and comprehensive loss, andcash flows for each of the three years in the period ended September 30, 2008. These financial statements are the responsibility of theCompany’s management. Our responsibility is to express an opinion on these financial statements based on our audits.We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States).Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are freeof material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financialstatements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well asevaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position ofNuance Communications, Inc. at September 30, 2008 and 2007, and the results of its operations and its cash flows for each of the threeyears in the period ended September 30, 2008, in conformity with U.S. generally accepted accounting principles.As described in note 19 of the Notes to Consolidated Financial Statements, the Company adopted Statement of FinancialAccounting Standards No. 158, “Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans — An amendmentof FASB Statements No. 87, 88, 106 and 132(R),” effective September 30, 2007. Also, as described in note 20 of the Notes toConsolidated Financial Statements, the Company adopted the provisions of Financial Accounting Standards Board Interpretation (“FIN”)48, “Accounting for Uncertainty in Income Taxes — an Interpretation of FASB Statement No. 109” effective October 1, 2007.We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States),Nuance Communications, Inc.’s internal control over financial reporting as of September 30, 2008, based on criteria established inInternal Control — Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (theCOSO Criteria), and our report dated December 1, 2008 expressed an unqualified opinion thereon./s/ BDO SEIDMAN, LLPBDO Seidman, LLPBoston, MassachusettsDecember 1, 200848Table of ContentsREPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRMBoard of Directors and ShareholdersNuance Communications, Inc.Burlington, MassachusettsWe have audited Nuance Communication Inc.’s internal control over financial reporting as of September 30, 2008, based on criteriaestablished in Internal Control — Integrated Framework issued by the Committee of Sponsoring Organizations of the TreadwayCommission (the COSO criteria). Nuance Communications, Inc.’s management is responsible for maintaining effective internal controlover financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in theaccompanying Item 9A, Management’s Report on Internal Control Over Financial Reporting. Our responsibility is to express an opinionon the Company’s internal control over financial reporting based on our audit.We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States).Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control overfinancial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control overfinancial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness ofinternal control based on the assessed risk. Our audit also included performing such other procedures as we considered necessary in thecircumstances. We believe that our audit provides a reasonable basis for our opinion.A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliabilityof financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accountingprinciples. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenanceof records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company;(2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordancewith generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance withauthorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timelydetection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financialstatements.Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also,projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because ofchanges in conditions, or that the degree of compliance with the policies or procedures may deteriorate.As indicated in the accompanying Item 9A, “Management’s Report on Internal Control over Financial Reporting”, management’sassessment of and conclusion on the effectiveness of internal control over financial reporting did not include the internal controls ofVocada, Inc., which the Company acquired on November 2, 2007, Viecore, Inc., which the Company acquired on November 26, 2007,eScription, Inc., which the Company acquired on May 20, 2008, Multi-Vision Communications Inc., which the Company acquired onJuly 3l, 2008 and Philips Speech Recognition Systems GMBH, a business unit of Royal Philips Electronics, which the Companyacquired on September 26, 2008 (collectively the “2008 Acquisitions”), all of which are included in the consolidated balance sheets ofNuance Communications, Inc. as of September 30, 2008, and the related consolidated statements of operations, stockholders’ equity andcomprehensive loss, and cash flows for the year then ended. Management did not assess the effectiveness of internal control over financialreporting of the 2008 Acquisitions because of the timing of the acquisitions which were completed during the year ended September 30,2008. The internal control over financial reporting excluded from management’s assessment for the 2008 Acquisitions constituted 1.6% oftotal assets as of September 30, 2008, and 8.1% of total revenues for the year then ended. Our audit of internal control over financialreporting of Nuance Communications, Inc. also did not include an evaluation of the internal control over financial reporting of the 2008Acquisitions.In our opinion, Nuance Communications, Inc. maintained, in all material respects, effective internal control over financial reportingas of September 30, 2008, based on the COSO criteria.49Table of ContentsWe also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), theconsolidated balance sheets of Nuance Communications, Inc. as of September 30, 2008 and 2007, and the related consolidated statementsof operations, stockholders’ equity and comprehensive loss, and cash flows for each of the three years in the period ended September 30,2008 and our report dated December 1, 2008 expressed an unqualified opinion thereon./s/ BDO SEIDMAN, LLPBDO Seidman, LLPBoston, MassachusettsDecember 1, 200850Table of ContentsNUANCE COMMUNICATIONS, INC.CONSOLIDATED BALANCE SHEETS September 30, September 30, 2008 2007 (In thousands, except share and per share amounts) ASSETSCurrent assets: Cash and cash equivalents $261,540 $184,335 Marketable securities 56 2,628 Accounts receivable, less allowances of $20,638 and $22,074, respectively 203,542 174,646 Acquired unbilled accounts receivable 14,457 35,061 Inventories, net 7,152 8,013 Prepaid expenses and other current assets 26,833 16,489 Deferred tax assets 1,703 444 Total current assets 515,283 421,616 Land, building and equipment, net 46,485 37,618 Goodwill 1,655,773 1,249,642 Intangible assets, net 585,023 391,190 Other assets 43,635 72,721 Total assets $2,846,199 $2,172,787 LIABILITIES AND STOCKHOLDERS’ EQUITYCurrent liabilities: Current portion of long-term debt and obligations under capital leases $7,006 $7,430 Contingent and deferred acquisition payments 113,074 — Accounts payable 31,517 55,659 Accrued expenses 102,099 83,245 Current portion of accrued business combination costs 9,166 14,547 Deferred maintenance revenue 80,521 68,075 Unearned revenue and customer deposits 38,381 27,787 Total current liabilities 381,764 256,743 Long-term debt and obligations under capital leases, net of current portion 894,184 899,921 Accrued business combination costs, net of current portion 32,012 35,472 Deferred revenue, net of current portion 18,134 13,185 Deferred tax liability 46,745 26,038 Other liabilities 48,452 63,161 Total liabilities 1,421,291 1,294,520 Commitments and contingencies (Notes 3, 6, and 18) Stockholders’ equity: Series B preferred stock, $0.001 par value; 15,000,000 shares authorized; 3,562,238 shares issued andoutstanding (liquidation preference $4,631) 4,631 4,631 Common stock, $0.001 par value; 560,000,000 shares authorized; 232,592,372 and 196,368,445 sharesissued and 229,370,053 and 193,178,708 shares outstanding, respectively 232 196 Additional paid-in capital 1,658,512 1,078,020 Treasury stock, at cost (3,222,319 and 3,189,737 shares, respectively) (16,070) (15,418)Accumulated other comprehensive income 12,739 14,979 Accumulated deficit (235,136) (204,141)Total stockholders’ equity 1,424,908 878,267 Total liabilities and stockholders’ equity $2,846,199 $2,172,787 The accompanying notes are an integral part of these consolidated financial statements.51Table of ContentsNUANCE COMMUNICATIONS, INC.CONSOLIDATED STATEMENTS OF OPERATIONS Year Ended September 30, 2008 2007 2006 (In thousands, except per share amounts) Revenue: Product and licensing $414,360 $311,847 $235,825 Professional services, subscription and hosting 305,540 165,520 81,320 Maintenance and support 148,562 124,629 71,365 Total revenue 868,462 601,996 388,510 Costs and Expenses: Cost of revenue: Cost of product and licensing 45,746 43,162 29,733 Cost of professional services, subscription and hosting 214,031 114,228 62,752 Cost of maintenance and support 31,477 27,461 15,647 Cost of revenue from amortization of intangible assets 24,389 13,090 12,911 Total cost of revenue 315,643 197,941 121,043 Gross margin 552,819 404,055 267,467 Operating expenses: Research and development 114,986 80,024 59,403 Sales and marketing 231,244 184,948 128,412 General and administrative 105,910 75,564 55,343 Amortization of intangible assets 58,245 24,596 17,172 In-process research and development 2,601 — — Restructuring and other charges (credits), net 7,219 (54) (1,233)Total operating expenses 520,205 365,078 259,097 Income from operations 32,614 38,977 8,370 Other income (expense): Interest income 8,032 5,991 3,305 Interest expense (55,196) (36,501) (17,614)Other (expense) income, net (964) 20 (1,132)Income (loss) before income taxes (15,514) 8,487 (7,071)Provision for income taxes 14,554 22,502 15,144 Loss before cumulative effect of accounting change (30,068) (14,015) (22,215)Cumulative effect of accounting change — — 672 Net loss $(30,068) $(14,015) $(22,887)Basic and diluted earnings per share: Loss before cumulative effect of accounting change $(0.14) $(0.08) $(0.13)Cumulative effect of accounting change — — (0.01)Net loss per share $(0.14) $(0.08) $(0.14)Weighted average common shares outstanding: Basic and diluted 209,801 176,424 163,873 The accompanying notes are an integral part of these consolidated financial statements.52Table of ContentsNUANCE COMMUNICATIONS, INC.CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY AND COMPREHENSIVE LOSS Accumulated Additional Other Total Preferred Stock Common Stock Paid-In Treasury Stock Deferred Comprehensive Accumulated Stockholders’ Comprehensive Shares Amount Shares Amount Capital Shares Amount Compensation Income (loss) Deficit Equity Loss (In thousands, except share amounts) Balance at September 30, 2005 3,562,238 $4,631 159,431,907 $160 $699,427 2,846,861 $(11,432) $(8,782) $(2,100) $(167,239) $514,665 Issuance of common stock under employee stock-basedcompensation plans 8,002,211 8 31,163 31,171 Issuance of restricted stock 1,194,958 1 1 Cancellation of restricted stock, and repurchase of common stockat cost for employee tax withholding (43,680) (392) 183,322 (1,427) (1,819) Issuance of common stock to non-employee for service 9,700 — 59 59 Issuance of common stock upon conversion of convertibledebenture 4,587,334 5 27,519 27,524 Share-based payments, including cumulative effect of accountingchange 13,757 8,782 22,539 Excess tax benefit from share-based payment plans 1,726 1,726 Additional offering costs related to 2005 issuance of stock andwarrants in private placements (139) (139) Comprehensive loss: Net loss (22,887) (22,887) $(22,887)Unrealized gain on marketable securities 42 42 42 Unrealized losses on cash flow hedge derivatives (570) (570) (570)Foreign currency translation adjustment 4,284 4,284 4,284 Comprehensive loss $(19,131)Balance at September 30, 2006 3,562,238 4,631 173,182,430 174 773,120 3,030,183 (12,859) — 1,656 (190,126) 576,596 Issuance of common stock under employee stock-basedcompensation plans 6,383,051 6 30,654 30,660 Issuance of restricted stock 958,124 1 — 1 Cancellation of restricted stock, and repurchase of common stockat cost for employee tax withholding (164,300) (1) (2,219) 159,554 (2,559) (4,779) Share-based payments 48,135 48,135 Excess tax benefit from share-based payment plans 4,172 4,172 Issuance of common stock in connection with acquisitions 14,794,848 15 227,337 227,352 Issuance of common stock to escrow agent in connection withacquisitions 1,400,091 1 (1) — Repurchase of shares (261,422) — (3,178) (3,178) Issuance of common stock in connection with exercise of warrants 75,623 — — — Comprehensive loss: Net loss (14,015) (14,015) $(14,015)Unrealized losses on cash flow hedge derivatives (355) (355) (355)Foreign currency translation adjustment 9,628 9,628 9,628 Adjustment to initially apply SFAS 158, net of tax 4,050 4,050 — Comprehensive loss $(4,742)Balance at September 30, 2007 3,562,238 4,631 196,368,445 196 1,078,020 3,189,737 (15,418) — 14,979 (204,141) 878,267 Issuance of common stock under employee stock-basedcompensation plans 6,513,027 7 28,424 28,431 Issuance of restricted stock 3,315,736 3 (3) — Cancellation of restricted stock, and repurchase of common stockat cost for employee tax withholding (911,031) (1) (17,007) 32,582 (652) (17,660) Share-based payments 68,631 68,631 Excess tax benefit from share-based payment plans 5,200 5,200 Issuance of common stock in connection with equity offerings, netof expenses 19,158,369 19 330,398 330,417 Issuance of common stock in connection with acquisitions 6,382,809 6 132,245 132,251 Issuance of common stock to escrow agent in connection withacquisitions 1,765,017 2 (2) — Vested options for the purchase of common stock, assumed inconnection with acquisitions 32,606 32,606 Cumulative effect of adoption of FIN 48 (927) (927) Comprehensive loss: Net loss (30,068) (30,068) $(30,068)Unrealized gains on cash flow hedge derivatives 50 50 50 Foreign currency translation adjustment 3,291 3,291 3,291 Unrealized losses on pensions and other post-retirement benefits (5,581) (5,581) (5,581)Comprehensive loss $(32,308)Balance at September 30, 2008 3,562,238 $4,631 232,592,372 $232 $1,658,512 3,222,319 $(16,070) $— $12,739 $(235,136) $1,424,908 The accompanying notes are an integral part of these consolidated financial statements.53Table of ContentsNUANCE COMMUNICATIONS, INC.CONSOLIDATED STATEMENTS OF CASH FLOWS Year Ended September 30, 2008 2007 2006 (In thousands) Cash flows from operating activities Net loss $(30,068) $(14,015) $(22,887)Adjustments to reconcile net loss to net cash provided by operating activities: Depreciation of property and equipment 16,366 12,148 8,366 Amortization of intangible assets 82,634 37,685 30,083 In-process research and development 2,601 — — Accounts receivable allowances 4,173 2,449 1,407 Non-cash portion of restructuring charges — — 1,233 Share-based payments, including cumulative effect of accounting change 68,631 48,135 22,539 Non-cash interest expense 5,208 4,169 3,862 Deferred tax provision 491 14,068 8,811 Other 1,799 465 1,485 Changes in operating assets and liabilities, net of effects from acquisitions: Accounts receivable 62,034 (14,217) 16,599 Inventories 1,125 (624) (1,781)Prepaid expenses and other assets (2,546) (4,413) (1,019)Accounts payable (11,946) 10,736 7,534 Accrued expenses and other liabilities (14,251) 9,233 (3,063)Deferred maintenance revenue, unearned revenue and customer deposits 9,948 603 (11,186)Net cash provided by operating activities 196,199 106,422 61,983 Cash flows from investing activities Capital expenditures for property and equipment (17,716) (12,656) (8,447)Payments for acquisitions, net of cash acquired (392,527) (528,495) (392,826)Payments for escrow on acquisitions — (35,800) — Payment for minority investment (2,172) — — Payments for capitalized patent defense costs and licensing agreements (36,479) (7,501) (4,189)Proceeds from maturities of marketable securities 2,577 5,714 24,159 Change in restricted cash balances 238 1,023 11,131 Net cash used in investing activities (446,079) (577,715) (370,172)Cash flows from financing activities Payments of note payable and capital leases (7,771) (6,768) (2,234)Deferred acquisition payments — (18,650) (14,433)Proceeds from credit facility and convertible debentures, net of discount and issuance costs — 551,447 346,032 Proceeds from issuance of common stock and common stock warrants, net of issuance costs 330,603 — (139)Purchase of treasury stock (652) (2,559) (1,427)Repurchase of shares — (3,178) — Payments on other long-term liabilities (11,379) (11,419) (11,573)Excess tax benefits from share-based payments 5,200 4,172 1,726 Net proceeds from issuance of common stock under employee share-based payment plans 11,138 28,441 30,780 Net cash provided by financing activities 327,139 541,486 348,732 Effects of exchange rate changes on cash and cash equivalents (54) 1,808 104 Net increase in cash and cash equivalents 77,205 72,001 40,647 Cash and cash equivalents at beginning of year 184,335 112,334 71,687 Cash and cash equivalents at end of year $261,540 $184,335 $112,334 The accompanying notes are an integral part of these consolidated financial statements.54Table of ContentsNUANCE COMMUNICATIONS, INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS1. Organization and PresentationNuance Communications, Inc. (the “Company” or “Nuance”) is a leading provider of speech-based solutions for businesses andconsumers worldwide. The Company’s speech solutions are designed to transform the way people interact with information systems,mobile devices and services. Nuance leverages its global professional services organization and its extensive network of partners to designand deploy innovative speech and imaging solutions for businesses and organizations around the globe. The Company markets anddistributes its products indirectly through a global network of resellers, including system integrators, independent software vendors,value-added resellers, hardware vendors, telecommunications carriers and distributors, and directly through its dedicated sales force andthrough its e-commerce website.The Company was incorporated in 1992 as Visioneer, Inc. In 1999, the Company changed its name to ScanSoft, Inc., andchanged its ticker symbol to SSFT. In October 2005, the Company changed its name to Nuance Communications, Inc. and changed itsticker symbol to NUAN in November 2005.The Company has built a portfolio of speech solutions through both internal development and acquisitions, and expects to continueto pursue opportunities to broaden its solutions and customer base through acquisitions. During fiscal 2008, 2007 and 2006, theCompany acquired the following businesses: • September 26, 2008 — Philips Speech Recognition Systems GMBH, a business unit of Royal Philips Electronics (“PSRS”); • July 31, 2008 — Multi-Vision Communications Inc. (“Multi-Vision”); • May 20, 2008 — eScription, Inc. (“eScription”); • November 26, 2007 — Viecore, Inc. (“Viecore”); • November 2, 2007 — Vocada, Inc. (“Vocada”); • September 28, 2007 — Commissure Inc. (“Commissure”); • August 24, 2007 — Voice Signal Technologies, Inc. (“VoiceSignal”); • August 24, 2007 — Tegic Communications, Inc. (“Tegic”); • April 24, 2007 — BeVocal, Inc. (“BeVocal”); • March 26, 2007 — Bluestar Resources Limited, the parent of Focus Enterprises Limited and Focus India Private Limited(collectively “Focus”); • December 29, 2006 — Mobile Voice Control, Inc. (“MVC”); and • March 31, 2006 — Dictaphone Corporation (“Dictaphone”).The results of operations from the acquired businesses have been included in the Company’s consolidated financial statements sincethe acquisition dates. See Note 3 for additional disclosure related to each of these acquisitions.On October 1, 2008 the Company also completed its acquisition of SNAPin Software, Inc. (“SNAPin”).2. Summary of Significant Accounting PoliciesUse of EstimatesThe preparation of financial statements in conformity with U.S. generally accepted accounting principles, requires management tomake estimates and assumptions that affect the reported amounts of assets and liabilities, and the disclosure of contingent assets andliabilities at the date of the financial statements, and the reported amounts of revenue and expenses during the reporting period. On anongoing basis, the Company evaluates its55Table of ContentsNUANCE COMMUNICATIONS, INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)estimates, assumptions and judgments, including those related to revenue recognition; allowance for doubtful accounts and returns;accounting for patent legal defense costs; the costs to complete the development of custom software applications; the valuation of goodwill,intangible assets and tangible long-lived assets; accounting for business combinations; share-based payments; accounting for long-termfacility obligations; interest rate swaps which are characterized as derivative instruments; accounting for income taxes and relatedvaluation allowances; and loss contingencies. The Company bases its estimates on historical experience and various other factors that arebelieved to be reasonable under the circumstances. Actual amounts could differ significantly from these estimates.Basis of ConsolidationThe consolidated financial statements include the accounts of the Company and its wholly-owned domestic and foreign subsidiaries.Intercompany transactions and balances have been eliminated.Revenue RecognitionThe Company derives revenue from the following sources: (1) software license agreements, including royalty- based arrangements,(2) post-contract customer support, (3) fixed and variable fee hosting arrangements and (4) professional services. Our revenue recognitionpolicies for these revenue streams are discussed below.The Company recognizes revenue from the sale of software products and licensing of technology in accordance with Statement ofPosition (“SOP”) 97-2, “Software Revenue Recognition,” and SOP 98-9, “Modification of SOP 97-2, ‘Software Revenue Recognition’,with Respect to Certain Transactions,” and related authoritative literature. In select situations, the Company sells or licenses intellectualproperty in conjunction with, or in place of, embedding its intellectual property in software. In accordance with SOP 97-2, revenue isrecognized when (i) persuasive evidence of an arrangement exists, (ii) delivery has occurred, (iii) the fee is fixed or determinable and(iv) collectibility is probable. The Company in general has established vendor-specific objective evidence (“VSOE”) of fair value of post-contract customer support (“PCS”), professional services, and training based on the prices charged by the Company when the sameelements are sold separately.Revenue from royalties on sales of the Company’s software products by original equipment manufacturers (“OEMs”), where noservices are included, is recognized in the quarter earned so long as the Company has been notified by the OEM that such royalties aredue, and provided that all other revenue recognition criteria are met.Software arrangements generally include PCS which includes telephone support and the right to receive unspecifiedupgrades/enhancements on a when-and-if-available basis, typically for one to three years. When VSOE exists, revenue from PCS isrecognized ratably on a straight-line basis over the term that the maintenance service is provided.Non-software revenue, such as arrangements containing hosting services, is recognized in accordance with the Securities andExchange Commission’s Staff Accounting Bulletin (“SAB”) 104, “Revenue Recognition in Financial Statements.” Under SAB 104, theCompany recognizes revenue when (i) persuasive evidence of an arrangement exists, (ii) delivery has occurred or services have beenrendered, (iii) the fees are fixed or determinable and (iv) collectibility is reasonably assured.For revenue arrangements with multiple elements outside of the scope of SOP 97-2, the Company accounts for the arrangements inaccordance with Emerging Issues Task Force (“EITF”) Issue 00-21, “Revenue Arrangements with Multiple Elements,” and allocates anarrangement’s fees into separate units of accounting based on fair value. The Company supports fair value of its deliverables based uponthe prices the Company charges when it sells similar elements separately.Revenue from products offered on a subscription and/or hosting basis is recognized in the period the services are provided, based ona fixed minimum fee and/or variable fees based on the volume of activity. Variable56Table of ContentsNUANCE COMMUNICATIONS, INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)subscription and hosting revenue is recognized as the Company is notified by the customer or through management reports that suchrevenue is due, provided that all other revenue recognition criteria are met.Set-up fees from arrangements containing hosting services, as well as the associated direct and incremental costs, are deferred andrecognized ratably over the longer of the contractual lives, or the expected lives of the customer relationships.When the Company provides professional services considered essential to the functionality of the software, it recognizes revenuefrom the professional services as well as any related software licenses on a percentage-of-completion basis in accordance with SOP 81-1,“Accounting for Performance of Construction Type and Certain Performance Type Contracts.” In these circumstances, the Companyseparates license revenue from professional service revenue for income statement presentation by classifying the fair value of professionalservice revenue as professional service revenue and the residual portion as license revenue. The Company generally determines thepercentage-of-completion by comparing the labor hours incurred to date to the estimated total labor hours required to complete the project.The Company considers labor hours to be the most reliable, available measure of progress on these projects. Adjustments to estimates tocomplete are made in the periods in which facts resulting in a change become known. When the estimate indicates that a loss will beincurred, such loss is recorded in the period identified. Significant judgments and estimates are involved in determining the percentcomplete of each contract. Different assumptions could yield materially different results.When products are sold through distributors or resellers, title and risk of loss generally passes upon shipment, at which time thetransaction is invoiced and payment is due. Shipments to distributors and resellers without right of return are recognized as revenue uponshipment by the Company. Certain distributors and value-added resellers have been granted rights of return for as long as the distributorsor resellers hold the inventory. The Company cannot estimate historical returns from these distributors and resellers to have a basis uponwhich to estimate future sales returns. As a result, the Company recognizes revenue from sales to these distributors and resellers when theproducts are sold through to retailers and end-users. Based on reports from distributors and resellers of their inventory balances at the endof each period, the Company records an allowance against accounts receivable and reduces revenue for all inventories subject to return atthe sales price.When products are sold directly to end-users, the Company also makes an estimate of sales returns based on historical experience.In accordance with Statement of Financial Accounting Standards (“SFAS”) 48, “Revenue Recognition When Right of Return Exists,” theprovision for these estimated returns is recorded as a reduction of revenue and accounts receivable at the time that the related revenue isrecorded. If actual returns differ significantly from the Company’s estimates, such differences could have a material impact on theCompany’s results of operations for the period in which the actual returns become known.When maintenance and support contracts renew automatically, the Company provides a reserve based on historical experience forcontracts expected to be cancelled for non-payment. All known and estimated cancellations are recorded as a reduction to revenue andaccounts receivable.The Company follows the guidance of EITF 01-09, “Accounting for Consideration Given by a Vendor (Including a Reseller of theVendor’s Products),” and records consideration given to a reseller as a reduction of revenue to the extent the Company has recordedcumulative revenue from the customer or reseller. However, when the Company receives an identifiable benefit in exchange for theconsideration and can reasonably estimate the fair value of the benefit received, the consideration is recorded as an operating expense.The Company follows the guidance of EITF 01-14, “Income Statement Characterization of Reimbursements for ‘Out-of-Pocket’Expenses Incurred,” and records reimbursements received for out-of-pocket expenses as revenue, with offsetting costs recorded as cost ofrevenue. Out-of-pocket expenses generally include, but are not limited to, expenses related to transportation, lodging and meals.57Table of ContentsNUANCE COMMUNICATIONS, INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)The Company follows the guidance of EITF 00-10, “Accounting for Shipping and Handling Fees and Costs,” and records shippingand handling costs billed to customers as revenue with offsetting costs recorded as cost of revenue.Business CombinationsThe Company determines and allocates the purchase price of an acquired company to the tangible and intangible assets acquiredand liabilities assumed as well as to in-process research and development as of the business combination date in accordance withSFAS 141, “Business Combinations.” The purchase price allocation process requires the Company to use significant estimates andassumptions, including fair value estimates, as of the business combination date including: • estimated fair values of intangible assets; • expected costs to complete any in-process research and development projects; • estimated fair market values of legal performance commitments to customers, assumed from the acquiree under existingcontractual obligations (classified as deferred revenue) at the date of acquisition; • estimated fair market values of stock awards assumed from the acquiree that are included in the purchase price; • estimated value of restructuring liabilities to reorganize the acquiree’s pre-acquisition operations; • estimated income tax assets and liabilities assumed from the acquiree; and • estimated fair value of pre-acquisition contingencies assumed from the acquiree.While the Company uses its best estimates and assumptions as a part of the purchase price allocation process to accurately valueassets acquired and liabilities assumed at the business combination date, its estimates and assumptions are inherently uncertain andsubject to refinement. As a result, during the purchase price allocation period, which is generally one year from the business combinationdate, the Company records adjustments to the assets acquired and liabilities assumed, with the corresponding offset to goodwill.Generally, with the exception of unresolved income tax matters, subsequent to the purchase price allocation period any adjustment toassets acquired or liabilities assumed is included in operating results in the period in which the adjustment is determined. For changes inthe valuation of intangible assets between preliminary and final purchase price allocation, the related amortization is adjusted on aprospective basis.In fiscal 2010, the Company will adopt SFAS 141R, “Business Combinations.” Refer to Recently Issued Accounting Standards(below) for additional information.Goodwill, Intangible Assets and Impairment AssessmentsGoodwill represents the excess of the purchase price in a business combination over the fair value of net tangible and intangibleassets acquired. Intangible assets with indefinite lives are not amortized but are required to be evaluated periodically to ensure that theircurrent fair value exceeds the carrying value. Intangible assets with finite lives are amortized over their estimated useful lives.Each period the Company evaluates the estimated remaining useful life of acquired intangible assets and licensed intangible assets todetermine whether events or changes in circumstances warrant a revision to the remaining period of amortization.The carrying amounts of these assets are periodically reviewed for impairment (at least annually for goodwill and indefinite livedintangible assets) whenever events or changes in circumstances indicate that the carrying value of these assets may not be recoverable.Goodwill and indefinite lived intangibles are evaluated under the provisions of SFAS 142 “Goodwill and Other Intangible Assets,” whichcompares the fair value of the assets to their net book58Table of ContentsNUANCE COMMUNICATIONS, INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)value, and amortizable intangible assets are evaluated under the provisions of SFAS 144 “Accounting for the Impairment or Disposal ofLong-Lived Assets,” under which their recoverability is measured by comparison of the carrying amount of each asset to the futureundiscounted cash flows the asset is expected to generate. If an intangible asset is considered to be impaired, the amount of anyimpairment is measured as the difference between the carrying value and the fair value of the impaired asset. No impairments of goodwillor indefinite lived intangibles have been recorded in fiscal 2008, 2007 or 2006. In fiscal 2008, based on its impairment analysis ofamortizable intangible assets, the Company recorded impairment charges of $3.9 million, of which $0.3 million was included in cost ofrevenue from amortization of intangible assets, and $3.6 million was included in amortization of intangible assets within operatingexpenses. There were no impairment charges for amortizable intangible assets recorded in fiscal 2007 or 2006.The Company also includes in its amortizable intangible assets, certain technology that is licensed from third parties. As ofSeptember 30, 2008 and 2007, intangible assets included $33.5 million and $2.4 million of licensed technology, respectively. In fiscal2008, 2007 and 2006, the Company has included $2.7 million, $0 and $2.6 million in cost of revenue from amortization of intangibleassets, relating to the historic portion of settlement and license agreements from third parties.Cash and Cash EquivalentsCash and cash equivalents consists of cash on hand, including money market funds and commercial paper with original maturitiesof 90 days or less.Marketable Securities and Minority InvestmentMarketable Securities: The Company accounts for its marketable equity securities in accordance with SFAS 115 “Accounting forCertain Investments in Debt and Equity Securities.” Investments are classified as available-for-sale and are recorded on the balance sheetat fair value with unrealized gains or losses reported as a separate component of accumulated other comprehensive income, net of tax.Minority Investment: In fiscal 2008, the Company invested $2.2 million in a privately-held company that offers advertiser-supported free directory assistance services. The Company does not have a controlling interest or significant influence in the equityinvestment, which is recorded at cost and included in other assets in the accompanying consolidated balance sheet as of September 30,2008.Allowances against Accounts ReceivableAllowance for Doubtful Accounts: The Company maintains an allowance for doubtful accounts for the estimated probable losseson uncollectible accounts receivable. The allowance is based upon the credit worthiness of its customers, its historical experience, the ageof the receivable and current market and economic conditions. Receivables are written off against these allowances in the period they aredetermined to be uncollectible.Allowance for Distribution and Resellers: For sell-through arrangements with certain distributors or resellers for whom theCompany does not have sufficient history to estimate returns, the Company maintains an allowance against accounts receivable for allproduct subject to return at the sales price. The allowance is recorded as a reduction in revenue based upon the ending product balanceheld by these distributors or resellers at the end of each reporting period. Receivables are written off against these allowances in the periodthe product is returned. When the products are sold through to retailers and end-users, the Company reverses the allowance to revenue.Allowance for Sales Returns: The Company maintains an allowance for sales returns from customers for which it has the abilityto estimate returns based on historical experience. The returns allowance is recorded as a reduction in revenue and accounts receivable atthe time the related revenue is recorded. Receivables are written off against the allowance in the period the return is received.59Table of ContentsNUANCE COMMUNICATIONS, INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)For the years ended September 30, 2008, 2007 and 2006, the allowances against accounts receivables were as follows (inthousands): Allowance for Allowance for Distribution and Allowance for Doubtful Accounts Resellers Sales Returns Balance at September 30, 2005 $2,995 $5,798 $4,325 Bad debt expenses 1,407 — — Write-offs, net of recoveries (296) — — Reductions (additions) made to revenue, net — 3,999 1,979 Balance at September 30, 2006 4,106 9,797 6,304 Bad debt expenses 2,449 — — Write-offs, net of recoveries (400) — — Reductions (additions) made to revenue, net — (1,201) 1,019 Balance at September 30, 2007 6,155 8,596 7,323 Bad debt expenses 4,173 — — Write-offs, net of recoveries (3,403) — — Reductions (additions) made to revenue, net — (1,246) (960)Balance at September 30, 2008 $6,925 $7,350 $6,363 The decrease in the Allowance for Distribution and Resellers as of September 30, 2008 compared to September 30, 2007 wasprimarily due to higher inventory volumes with certain resellers and distributors at September 30, 2007. This is a result of the timing ofshipments and the related sell-through of the Company’s products by its distributors. The decrease in Allowance for Sales Returns as ofSeptember 30, 2008 compared to September 30, 2007 was due to lower volumes of mail-in rebates and other incentives, primarily relatedto the Company’s Dragon NaturallySpeaking product line.InventoriesInventories are stated at the lower of cost, computed using the first-in, first-out method, or market. The Company regularly reviewsinventory quantities on hand and records a provision for excess and/or obsolete inventory primarily based on future purchasecommitments with its suppliers, and the estimated utility of its inventory as well as other factors including technological changes and newproduct development.Land, Building and EquipmentLand, building and equipment are stated at cost. Building and equipment are depreciated over their estimated useful lives. Leaseholdimprovements are depreciated over the shorter of the lease term or the estimated useful life. Computer software developed or obtained forinternal use is accounted for under SOP 98-1, “Accounting for the Costs of Computer Software Developed or Obtained for Internal Use,”and is depreciated over the estimated useful life of the software. Depreciation is computed using the straight-line method. Significantimprovements are capitalized and repairs and maintenance costs are expensed as incurred. The cost and related accumulated depreciationof sold or retired assets are removed from the accounts and any gain or loss is included in operations.Research and Development CostsInternal costs relating to research and development costs incurred for new software products and enhancements to existing products,other than certain software development costs that qualify for capitalization, are expensed as incurred. Software development costsincurred subsequent to the establishment of technological60Table of ContentsNUANCE COMMUNICATIONS, INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)feasibility, but prior to the general release of the product, are capitalized and amortized to cost of revenue over the estimated useful life ofthe related products. The Company has determined that technological feasibility is reached shortly before the general release of its softwareproducts. Costs incurred after technological feasibility is established have not been material, and accordingly, the Company has expensedthe internal costs relating to research and development when incurred.Capitalized Patent Defense CostsThe Company monitors the anticipated outcome of legal actions, and if it determines that the success of the defense of a patent isprobable, and so long as the Company believes that the future economic benefit of the patent will be increased, the Company capitalizesexternal legal costs incurred in the defense of these patents, up to the level of the expected increased future economic benefit. If changes inthe anticipated outcome occur, the Company writes off any capitalized costs in the period the change is determined. Upon successfuldefense of the patent, the amounts previously capitalized are amortized over the remaining life of the patent. As of September 30, 2008 and2007, capitalized patent defense costs recorded in other assets totaled $6.7 million and $6.4 million, respectively.Advertising CostsAdvertising costs are expensed as incurred and are classified as sales and marketing expenses. Cooperative advertising programsreimburse customers for marketing activities for certain of the Company’s products, subject to defined criteria. Cooperative advertisingobligations are accrued and the costs expensed at the same time the related revenue is recognized. Cooperative advertising expenses arerecorded as expense to the extent that an advertising benefit separate from the revenue transaction can be identified and the cash paid doesnot exceed the fair value of that advertising benefit received. Any excess of cash paid over the fair value of the advertising benefit receivedis recorded as a reduction in revenue. The Company incurred advertising costs of $20.9 million, $19.2 million and $16.4 million forfiscal 2008, 2007 and 2006, respectively.Income TaxesDeferred tax assets and liabilities are determined based on differences between the financial statement and tax bases of assets andliabilities using enacted tax rates in effect in the years in which the differences are expected to reverse. The Company does not provide forU.S. income taxes on the undistributed earnings of its foreign subsidiaries, which the Company considers to be indefinitely reinvestedoutside of the U.S. in accordance with Accounting Principles Board (“APB”) Opinion 23, “Accounting for Income Taxes — SpecialAreas.”The Company makes judgments regarding the realizability of its deferred tax assets. In accordance with SFAS 109, “Accounting forIncome Taxes,” the carrying value of the net deferred tax assets is based on the belief that it is more likely than not that the Company willgenerate sufficient future taxable income to realize these deferred tax assets after consideration of all available evidence. The Companyregularly reviews its deferred tax assets for recoverability considering historical profitability, projected future taxable income, and theexpected timing of the reversals of existing temporary differences and tax planning strategies.Valuation allowances have been established for U.S. deferred tax assets, which the Company believes do not meet the “more likelythan not” criteria established by SFAS 109. If the Company is subsequently able to utilize all or a portion of the deferred tax assets forwhich a valuation allowance has been established, then the Company may be required to recognize these deferred tax assets through thereduction of the valuation allowance which would result in a material benefit to its results of operations in the period in which the benefitis determined, excluding the recognition of the portion of the valuation allowance which relates to net deferred tax assets acquired in abusiness combination or created as a result of share-based payments. The recognition of the portion of the valuation allowance whichrelates to net deferred tax assets resulting from share-based payments will be recorded as additional paid-in-capital; the recognition of theportion of the valuation allowance which relates to net deferred tax assets acquired in a business combination will reduce goodwill,intangible assets, and to the extent remaining, the61Table of ContentsNUANCE COMMUNICATIONS, INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)provision for income taxes, until the Company adopts SFAS 141R in its fiscal year 2010; after which time the reductions in theallowance, if any, will be recorded as a benefit in the statement of operations.On October 1, 2007, the Company adopted Financial Accounting Standards Board (“FASB”) Interpretation No. 48 (“FIN 48”),“Accounting for Uncertainty in Income Taxes — an Interpretation of FASB Statement 109.” In accordance with FIN 48 the Companyestablished reserves for tax uncertainties that reflect the use of the comprehensive model for the recognition and measurement of uncertaintax positions.Comprehensive LossTotal comprehensive loss, net of taxes, was approximately $32.3 million, $4.7 million and $19.1 million for fiscal 2008, 2007, and2006, respectively. Comprehensive loss consists of net loss, current period foreign currency translation adjustments, unrealized gains(losses) on cash flow hedge derivatives, and unrealized gains (losses) on pensions. For the purposes of comprehensive loss disclosures,the Company does not record tax provisions or benefits for the net changes in the foreign currency translation adjustment, as theCompany intends to reinvest undistributed earnings in its foreign subsidiaries permanently.The components of accumulated other comprehensive loss, reflected in the Consolidated Statements of Stockholders’ Equity andComprehensive Loss, consisted of the following (in thousands): 2008 2007 2006 Foreign currency translation adjustment $15,145 $11,854 $2,226 Net unrealized gains (losses) on cash flow hedge derivatives (875) (925) (570)Net unrealized gains (losses) on pensions and other post-retirement benefits (1,531) 4,050 — $12,739 $14,979 $1,656 Concentration of RiskFinancial instruments that potentially subject the Company to significant concentrations of credit risk principally consist of cash,cash equivalents, and trade accounts receivable. The Company places its cash and cash equivalents with financial institutions with highcredit ratings. As part of its cash and investment management processes, the Company performs periodic evaluations of the creditstanding of the financial institutions, and has not sustained any credit losses. For trade accounts receivable, the Company performsongoing credit evaluations of its customers’ financial condition and limit the amount of credit extended when deemed appropriate but doesnot require collateral. At September 30, 2008 and 2007, no customer accounted for greater than 10% of the Company’s net accountsreceivable balance. No customer composed more than 10% of revenue for fiscal 2008, 2007 and 2006.Fair Value of Financial InstrumentsFinancial instruments include cash equivalents, marketable securities, accounts receivable, long-term debt and cash flow hedgederivative instruments and are carried in the financial statements at amounts that approximate their fair value.Foreign Currency TranslationThe Company has foreign operations and transacts business in various foreign currencies. In general, the functional currency of aforeign operation is the local country’s currency. Non-functional currency monetary balances are remeasured into the functional currencyof the subsidiary with any related gain or loss recorded in other income (expense), net, in the accompanying consolidated statements ofoperations. Assets and liabilities of operations outside the United States, for which the functional currency is the local currency, aretranslated into United States dollars using period-end exchange rates. Revenue and expenses are translated at the average62Table of ContentsNUANCE COMMUNICATIONS, INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)exchange rates in effect during each fiscal month during the year. The effects of foreign currency translation adjustments are included as acomponent of accumulated other comprehensive income in the accompanying consolidated balance sheets.Financial Instruments and Hedging ActivitiesThe Company follows the requirements of SFAS 133, “Accounting for Derivative Instruments and Hedging Activities,” whichestablishes accounting and reporting standards for derivative instruments. To achieve hedge accounting, the criteria specified inSFAS 133 must be met, including (i) ensuring at the inception of the hedge that formal documentation exists for both the hedgingrelationship and the entity’s risk management objective and strategy for undertaking the hedge and (ii) at the inception of the hedge and onan ongoing basis, the hedging relationship is expected to be highly effective in achieving offsetting changes in fair value attributed to thehedged risk during the period that the hedge is designated. Further, an assessment of effectiveness is required whenever financialstatements or earnings are reported. Absent meeting these criteria, changes in fair value are recognized in other expense, net of tax, in thestatement of operations. Once the underlying forecasted transaction is realized, the gain or loss from the derivative designated as a hedge ofthe transaction is reclassified from accumulated other comprehensive income (loss) to the statement of operations, in the related revenue orexpense caption, as appropriate. Any ineffective portion of the derivatives designated as cash flow hedges is recognized in currentearnings.Accounting for Share-Based PaymentsEffective October 1, 2005, the Company adopted SFAS 123 (revised 2004), “Share-Based Payment,” (“SFAS 123R”), under whichit accounts for share-based payments to employees and directors, including grants of employee stock options, purchases under employeestock purchase plans, awards in the form of restricted shares (“Restricted Stock”) and awards in the form of units of stock purchaserights (“Restricted Units”). The Restricted Stock and Restricted Units are collectively referred to as “Restricted Awards.” SFAS 123Rrequires the recognition of the fair value of share-based payments as a charge against earnings. The Company recognizes share-basedpayment expense over the requisite service period. The cumulative effect of the change in accounting principle that was recorded at theadoption date was $0.7 million, which is included in the accompanying statement of operations for fiscal 2006.Net Income (Loss) Per ShareThe Company computes net income (loss) per share in accordance with SFAS 128, “Earnings per Share” and EITF 03-06,“Participating Securities and Two — Class Method under FASB Statement No. 128, ‘Earnings per Share’.” EITF 03-06 providesguidance on the meaning of “participating security” for purposes of computing earnings per share including when using the two-classmethod for computing basic earnings per share. The Company has determined that its outstanding Series B convertible preferred stockrepresents a participating security and as such they are excluded from basic earnings per share.Under the two-class method, basic net income per share is computed by dividing the net income available to common stockholdersby the weighted-average number of common shares outstanding during the period. Net losses are not allocated to preferred stockholders.Diluted net income per share is computed using the more dilutive of (a) the two-class method, or (b) the if-converted method. TheCompany allocates net income first to preferred stockholders based on dividend rights and then to common and preferred stockholdersbased on ownership interests. The weighted-average number of common shares outstanding gives effect to all potentially dilutive commonequivalent shares, including outstanding stock options and restricted stock, shares held in escrow, contingently issuable shares underearnout agreements once earned, warrants, and potential issuance of stock upon conversion of convertible debentures. On August 13,2007, the Company issued $250.0 million of 2.75% convertible debentures which are considered Instrument C securities as defined byEITF 90-19, “Convertible Bonds with Issuer Option to Settle for Cash upon Conversion.” Therefore, only the shares of common stockpotentially issuable with respect to the excess of the conversion value63Table of ContentsNUANCE COMMUNICATIONS, INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)over its principal amount, if any, is considered as dilutive potential common shares for purposes of calculating diluted net income pershare. The conversion value for the convertible debentures was less than the principal amount since its issuance date and no shares wereassumed to be issued for purposes of computing the diluted net loss per share.Common equivalent shares are excluded from the computation of diluted net income (loss) per share if their effect is anti-dilutive.Potentially dilutive common equivalent shares aggregating to 23.5 million shares, 23.0 million shares and 19.3 million shares for theyears ended September 30, 2008, 2007 and 2006, respectively, have been excluded from the computation of diluted net loss per sharebecause their inclusion would be anti-dilutive.Recently Issued Accounting StandardsIn May 2008, the FASB issued Staff Position (“FSP”) No. APB 14-1, or FSP 14-1, “Accounting for Convertible Debt Instrumentsthat may be Settled in Cash upon Conversion.” FSP 14-1 requires the issuer of certain convertible debt instruments that may be settled incash (or other assets) on conversion to separately account for the liability (debt) and equity (conversion option) components of theinstrument in a manner that reflects the issuer’s nonconvertible debt borrowing rate. FSP 14-1 will significantly affect the accounting forinstruments commonly referred to as Instruments B and C in EITF 90-19, “Convertible Bonds with Issuer Option to Settle for Cashupon Conversion,” which is nullified by FSP 14-1, and any other convertible debt instruments that require or permit settlement in anycombination of cash and shares at the issuer’s option, such as those sometimes referred to as “Instrument X.” FSP 14-1 is effective forfinancial statements issued for fiscal years beginning after December 15, 2008. with early adoption prohibited. The Company is requiredto adopt the pronouncement in its first quarter of fiscal 2010. FSP 14-1 is required to be applied retrospectively to all periods presented.The Company is evaluating the impact that FSP 14-1 will have on its consolidated financial statements.In April 2008, the FASB issued FSP 142-3 “Determination of the Useful Life of Intangible Assets.” FSP 142-3 amends the factorsthat should be considered in developing renewal or extension assumptions used to determine the useful life of a recognized intangible assetunder SFAS 142. The intent of this FSP is to improve the consistency between the useful life of a recognized intangible asset underSFAS 142 and the period of expected cash flows used to measure the fair value of the asset under SFAS 141, and other U.S. generallyaccepted accounting principles (GAAP). FSP142-3 is effective for financial statements issued for fiscal years beginning afterDecember 15, 2008, and may not be adopted early. The Company is required to adopt the pronouncement in its first quarter of fiscal2010. The Company is evaluating the impact, if any, that FSP 142-3 may have on its consolidated financial statements.In March 2008, the FASB issued SFAS 161, “Disclosures about Derivative Instruments and Hedging Activities, an amendment ofFASB Statement No. 133.” SFAS 161 improves financial reporting about derivative instruments and hedging activities by requiringenhanced disclosures to enable investors to better understand their effects on an entity’s financial position, financial performance, andcash flows. SFAS 161 is effective for financial statements issued for fiscal years and interim periods beginning after November 15,2008. The Company expects to adopt SFAS 161 in the second quarter of fiscal 2009. The Company does not expect the issuance ofSFAS 161 to have a material impact on its consolidated financial statements.In December 2007, the FASB issued SFAS 141 (revised), “Business Combinations” (“SFAS 141R”). The standard changes theaccounting for business combinations including the measurement of acquirer shares issued in consideration for a business combination,the recognition of contingent consideration, the accounting for pre-acquisition gain and loss contingencies, the recognition of capitalized in-process research and development, the accounting for acquisition-related restructuring cost accruals, the treatment of acquisition relatedtransaction costs and the recognition of changes in the acquirer’s income tax valuation allowance. SFAS 141R is effective for fiscal yearsbeginning after December 15, 2008, with early adoption prohibited. The Company is required to adopt SFAS 141R for any businesscombinations entered into beginning in fiscal 2010. The Company is evaluating the impact, if any, that SFAS 141R may have on itsconsolidated financial statements.64Table of ContentsNUANCE COMMUNICATIONS, INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)In February 2007, the FASB issued SFAS 159, “The Fair Value Option for Financial Assets and Financial Liabilities.” SFAS 159has as its objective to reduce both complexity in accounting for financial instruments and volatility in earnings caused by measuringrelated assets and liabilities differently. It also establishes presentation and disclosure requirements designed to facilitate comparisonsbetween companies that choose different measurement attributes for similar types of assets and liabilities. The statement is effective forfiscal years beginning after November 15, 2007, with early adoption permitted provided that the entity makes that choice in the first120 days of that fiscal year. The Company did not elect early adoption and is required to adopt SFAS 159 in its first quarter of fiscal2009. The Company does not believe the adoption of SFAS 159 will have any material impact to its consolidated financial statements.In September 2006, the FASB issued SFAS 157, “Fair Value Measurements.” SFAS 157 establishes a framework for measuringfair value and expands fair value measurement disclosures. SFAS 157 is effective for fiscal years beginning after November 15, 2007. InFebruary 2008, the FASB agreed to a one-year deferral for the implementation of SFAS 157 for non-financial assets and liabilities. TheCompany is required to adopt SFAS 157 in its first quarter of fiscal 2009 for financial assets and liabilities and the first quarter of fiscal2010 for all other assets and liabilities. The Company does not believe the adoption of SFAS 157 will have any material impact to itsconsolidated financial statements.3. Business AcquisitionsAcquisition of PSRSOn September 26, 2008, the Company acquired PSRS, a business unit of Royal Philips Electronics, a provider of speechrecognition solutions, primarily in the European healthcare market, for total consideration of $102.5 million, consisting of: cashconsideration of €66.0 million, which equates to $96.6 million based on the exchange rate as of the acquisition date, and transactioncosts of $5.9 million. $31.6 million was paid at the acquisition date and the remaining deferred acquisition payment of €44.3 million($64.0 million based on the exchange rate as of September 30, 2008) is due on September 21, 2009. The deferred acquisition payment ispayable in cash and is subject to acceleration under certain conditions including change in control of the Company (as defined), or theacceleration of the Company’s payment obligations under its March 2006 credit agreement, as amended. The Company has also agreed toreserve approximately 4.5 million shares of its common stock as security against the deferred acquisition payment. The purchase price issubject to adjustment (increase or decrease), based on the working capital provision as defined in the share purchase agreement, themeasurement is expected to be completed in the first quarter of fiscal 2009. The acquisition was a taxable event.The results of operations of the acquired business have been included in the consolidated financial statements of the Company sincethe date of acquisition. The Company is currently finalizing the valuation of the assets acquired and liabilities assumed; therefore the fairvalues set forth below are subject to adjustment as additional65Table of ContentsNUANCE COMMUNICATIONS, INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)information is obtained. A summary of the preliminary purchase price allocation for the acquisition of PSRS is as follows (in thousands):Total purchase consideration: Cash $96,606 Transaction costs 5,850 Total purchase consideration $102,456 Allocation of the purchase consideration: Accounts receivable $8,273 Other assets 3,571 Identifiable intangible assets 54,098 In-process research and development 2,601 Goodwill 56,362 Total assets acquired 124,905 Accounts payable and accrued expenses (6,052)Other liabilities (16,397)Total liabilities assumed (22,449)Net assets acquired $102,456 Other assets include accounts receivable, refundable research and development credits, refundable value added tax payments,prepaid expenses and inventory. Other liabilities assumed primarily relate to deferred tax liabilities, statutory benefits due to PSRSemployees and deferred revenue.The value assigned to in-process research and development was determined using an income approach by estimating the costs todevelop the acquired technologies into commercially viable products, estimating the resulting net cash flows from the projects anddiscounting the net cash flows to their present values. At the date of acquisition, the development of these projects had not yet reachedtechnological feasibility, and the research and development in progress had no alternative future uses. Due to the nature of the forecastsand the risks associated with the projected growth and profitability of these projects, discount rates of 25% to 35% were used to discountthe net cash flows to their present value. The Company anticipates costs to complete the development of these projects will beapproximately $4.4 million, and will be completed between April 2009 and December 2009. Risks related to the completion of technologyunder development include the inherent difficulties and uncertainties in achieving technological feasibility, anticipated levels of marketacceptance and penetration, market growth rates and risks to the impact of potential changes in future target markets.Customer relationships are amortized based upon patterns in which their economic benefits are expected to be utilized. Other finite-lived identifiable intangible assets are amortized on a straight-line basis. The following are the identifiable intangible assets acquired andtheir respective weighted average lives (dollars in thousands): Weighted Average Amount Life (In years) Customer relationships $45,196 9.0 Core and completed technology 7,924 6.7 Tradename 978 9.0 Total $54,098 66Table of ContentsNUANCE COMMUNICATIONS, INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)Acquisition of Multi-VisionOn July 31, 2008, the Company acquired all of the outstanding capital stock of Multi-Vision, a provider of technology for proactivenotification which can be implemented as a hosted application or on a customer’s premises, for total purchase consideration ofapproximately $9.9 million including 0.5 million shares of the Company’s common stock valued at $15.59 per share, transaction costsof $1.2 million and assumed debt of $0.3 million. In addition, $1.0 million was retained by the Company as holdback to satisfy anyclaims the Company may have. The holdback is payable in stock, or cash, solely at the Company’s discretion and is due 15 monthsfrom the date of acquisition. The Company cannot make a determination, beyond a reasonable doubt, that the holdback will becomepayable to the former shareholders of Multi-Vision, and accordingly has not included the holdback as a component of the purchase price.At such time, if any, that the holdback is paid, the amount will be recorded as additional purchase price and allocated to goodwill.The Company may also be required to issue up to an additional $15.0 million, payable in stock, or cash, solely at the Company’sdiscretion, relating to earnout provisions as described in the share purchase agreement. Two-thirds of the earnout is conditioned on bothperformance targets, as well as continued employment; accordingly, up to $10.0 million of any earnout payments that become payablewill be recorded to compensation expense, and up to $5.0 million will be recorded as additional purchase price and allocated to goodwill.The Company cannot make a determination, beyond a reasonable doubt, that the earnout will become payable to the former shareholdersof Multi-Vision, and accordingly has not included the earnout as a component of the purchase price, nor has it recorded compensationexpense. The acquisition was a taxable event.The results of operations of the acquired business have been included in the consolidated financial statements of the Company sincethe date of acquisition. The Company is currently finalizing the valuation of the assets acquired and liabilities assumed; therefore the fairvalues set forth below are subject to adjustment as additional information is obtained. A summary of the preliminary purchase priceallocation for the acquisition of Multi-Vision is as follows (in thousands):Total purchase consideration: Common stock issued $8,348 Debt assumed 331 Transaction costs 1,189 Total purchase consideration $9,868 Allocation of the purchase consideration: Accounts receivable and acquired unbilled accounts receivable $2,330 Other assets 671 Identifiable intangible assets 9,630 Goodwill 2,492 Total assets acquired 15,123 Accounts payable and accrued expenses (1,886)Other liabilities (3,369)Total liabilities assumed (5,255)Net assets acquired $9,868 Other liabilities include deferred tax liabilities and deferred revenue.67Table of ContentsNUANCE COMMUNICATIONS, INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)Customer relationships are amortized based upon patterns in which their economic benefits are expected to be utilized. Other finite-lived identifiable intangible assets are amortized on a straight-line basis. The following are the identifiable intangible assets acquired andtheir respective weighted average lives (dollars in thousands): Weighted Average Amount Life (In years) Customer relationships $7,200 8.9 Core and completed technology 2,400 6.5 Non-compete 30 4.0 Total $9,630 Acquisition of eScriptionOn May 20, 2008, the Company acquired all of the outstanding capital stock of eScription, a provider of hosted and premises-based computer-aided medical transcription solutions, for total consideration of $380.6 million, consisting of $335.2 million in cash toshareholders, 0.2 million shares of the Company’s common stock valued at $17.98 per share, the issuance of the Company’s stockoptions and restricted stock that replaced all of eScription’s vested outstanding employee stock options and restricted stock, with a fairvalue of $32.6 million, and transaction costs of $9.7 million. In connection with the Company’s acquisition of eScription, the mergeragreement required 1.1 million shares of the Company’ common stock, valued at $20.2 million as of the date of acquisition, to be placedinto escrow for 12 months from the date of acquisition, to satisfy any claims the Company may have. The Company cannot make adetermination, beyond a reasonable doubt, that the escrow will become payable to the former shareholders of eScription, and accordinglyhas not included the escrow as a component of the purchase price. Upon satisfaction of the contingency, the escrowed amount will berecorded as additional purchase price and allocated to goodwill. The Company may elect to treat this acquisition as an asset purchaseunder provisions contained in the Internal Revenue Code. If this election were to be made, additional cash payments approximating$21.5 million would be recorded as additional purchase consideration and allocated to goodwill. See Note 20 for further discussion ofthis election.The results of operations of the acquired business have been included in the consolidated financial statements of the Company sincethe date of acquisition. The Company is currently finalizing the valuation of the assets acquired and liabilities assumed; therefore the fairvalues set forth below are subject to adjustment as additional68Table of ContentsNUANCE COMMUNICATIONS, INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)information is obtained. A summary of the preliminary purchase price allocation for the acquisition of eScription is as follows (inthousands):Total purchase consideration: Cash $335,165 Common stock issued 3,074 Stock options and restricted stock units assumed 32,606 Transaction costs 9,735 Total purchase consideration $380,580 Allocation of the purchase consideration: Cash $4,520 Accounts receivable and acquired unbilled accounts receivable 9,838 Other assets 6,265 Property and equipment 2,758 Identifiable intangible assets 157,700 Goodwill 212,839 Total assets acquired 393,920 Accounts payable and accrued expenses (1,025)Other liabilities (12,315)Total liabilities assumed (13,340)Net assets acquired $380,580 Other assets include prepaid expenses and other current assets. Other liabilities assumed primarily relate to deferred tax liabilities,deferred revenue and amounts accrued relating to excess facilities accrued as a component of accrued business combination costs.The Company assumed vested and unvested stock options for the purchase of 2,846,118 shares of the Company’s common stock,and restricted stock units that may convert to 806,044 shares of the Company’s common stock, in connection with its acquisition ofeScription. These stock options and restricted stock units are governed by the original equity compensation plan and agreements underwhich they were issued under the eScription Stock Option Plan, but are now exercisable for, or will vest into, shares of the Company’scommon stock. Assumed vested stock options and restricted stock units as of the date of acquisition are included in the purchase priceabove. The fair value of the assumed vested stock options is calculated under the Black-Scholes option pricing model, with the followingweighted-average assumptions: dividend yield of 0.0%, expected volatility of 50.8%, average risk-free interest rate of 2.3% and an expectedterm of 1.9 years. Assumed unvested stock options and restricted stock units as of the date of acquisition will be recorded ascompensation expense over the requisite service period as disclosed in Note 17, “Share-Based Payment.”69Table of ContentsNUANCE COMMUNICATIONS, INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)Customer relationships are amortized based upon patterns in which their economic benefits are expected to be utilized. Other finite-lived identifiable intangible assets are amortized on a straight-line basis. The following are the identifiable intangible assets acquired andtheir respective weighted average lives (dollars in thousands): Weighted Average Amount Life (In years) Customer relationships $130,300 9.0 Core and completed technology 24,300 5.0 Non-compete 2,500 3.0 Tradenames 600 5.0 Total $157,700 Acquisition of ViecoreOn November 26, 2007, the Company acquired all of the outstanding capital stock of Viecore, a consulting and systems integrationfirm, for total purchase consideration of approximately $109.2 million, including 4.4 million shares of the Company’s common stockvalued at $21.01 per share, cash to shareholders of $8.9 million, transaction costs of $6.8 million and the assumption of $0.4 million ofdebt. In connection with the Company’s acquisition of Viecore, the merger agreement required 0.6 million shares of the Company’scommon stock, valued at $12.3 million as of the date of acquisition, to be placed into escrow for 15 months from the date of acquisition,to satisfy any claims the Company may have. The Company cannot make a determination, beyond a reasonable doubt, that the escrowwill become payable to the former shareholders of Viecore, and accordingly has not included the escrow as a component of the purchaseprice. Upon satisfaction of the contingency, the escrowed amount will be recorded as additional purchase price and allocated to goodwill.The acquisition was a non-taxable event for the Company.The results of operations of the acquired business have been included in the consolidated financial statements of the Company sincethe date of acquisition. The Company is currently finalizing the valuation of the assets acquired and liabilities assumed; therefore the fairvalues set forth below are subject to adjustment as additional information is obtained. A summary of the preliminary purchase priceallocation for the acquisition of Viecore is as follows (in thousands):Total purchase consideration: Common stock issued $93,132 Cash 8,874 Transaction costs 6,809 Debt assumed 384 Total purchase consideration $109,199 Allocation of the purchase consideration: Cash $5,491 Accounts receivable 13,848 Acquired unbilled accounts receivable 18,772 Other assets 1,530 Property and equipment 1,327 Identifiable intangible assets 22,770 Goodwill 69,133 Total assets acquired 132,871 Accounts payable and accrued expenses (7,414)Deferred revenue (16,258)Total liabilities assumed (23,672)Net assets acquired $109,199 70Table of ContentsNUANCE COMMUNICATIONS, INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)The Company records deferred revenue under the provisions of EITF 01-03, “Accounting in a Business Combination for DeferredRevenue of Acquiree.” Under EITF 01-03, deferred revenue represents the fair value of the legal performance commitments assumed by theCompany, to its customers.Customer relationships are amortized based upon patterns in which their economic benefits are expected to be utilized. Other finite-lived identifiable intangible assets are amortized on a straight-line basis. The following are the identifiable intangible assets acquired andtheir respective weighted average lives (dollars in thousands): Weighted Average Amount Life (In years) Customer relationships $22,390 8.0 Tradename 380 1.0 Total $22,770 Acquisition of VocadaOn November 2, 2007, the Company acquired all of the outstanding capital stock of Vocada, a provider of software and services formanaging critical medical test results for total purchase consideration of approximately $21.9 million including 0.9 million shares of theCompany’s common stock valued at $20.47 per share, cash to shareholders of $3.2 million and transaction costs of $1.0 million. Inconnection with the Company’s acquisition of Vocada, the merger agreement required 0.1 million shares of the Company’s commonstock, valued at $1.2 million as of the date of acquisition, to be placed into escrow for 15 months from the date of acquisition, to satisfyany claims the Company may have. Upon satisfaction of the contingency, the escrowed amount may be recorded as additional purchaseprice and allocated to goodwill. The Company also agreed to make contingent earnout payments of up to $21.0 million upon theachievement of certain financial targets measured over defined periods through December 31, 2010, in accordance with the mergeragreement. Payments, if any, may be made in the form of cash or shares of the Company’s common stock, at the sole discretion of theCompany. The Company cannot make a determination, beyond a reasonable doubt, that the escrow or the earnout will become payable tothe former shareholders of Vocada, and accordingly has not recorded these as incremental purchase price as of September 30, 2008. Theacquisition was a non-taxable event.71Table of ContentsNUANCE COMMUNICATIONS, INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)The results of operations of the acquired business have been included in the consolidated financial statements of the Company sincethe date of acquisition. The Company is currently finalizing the valuation of the assets acquired and liabilities assumed; therefore the fairvalues set forth below are subject to adjustment as additional information is obtained. A summary of the preliminary purchase priceallocation for the acquisition of Vocada is as follows (in thousands):Total purchase consideration: Common stock issued $17,738 Cash 3,186 Transaction costs 1,022 Total purchase consideration $21,946 Allocation of the purchase consideration: Accounts receivable and acquired unbilled accounts receivable $2,964 Other assets 429 Identifiable intangible assets 5,930 Goodwill 14,822 Total assets acquired 24,145 Accounts payable and other liabilities (305)Deferred revenue (1,894)Total liabilities assumed (2,199)Net assets acquired $21,946 Customer relationships are amortized based upon patterns in which their economic benefits are expected to be utilized. Other finite-lived identifiable intangible assets are amortized on a straight-line basis. The following are the identifiable intangible assets acquired andtheir respective weighted average lives (dollars in thousands): Weighted Average Amount Life (In years) Customer relationships $3,800 10.0 Core and completed technology 2,000 5.0 Trademark 90 5.0 Non-compete 40 3.0 Total $5,930 Acquisition of CommissureOn September 28, 2007, the Company acquired all of the outstanding capital stock of Commissure, a medical imaging softwarecompany that provides speech-enabled radiology workflow optimization and data analysis solutions for total purchase consideration ofapproximately $25.6 million including $2.3 million in transaction costs and 1.2 million shares of the Company’s common stock valuedat $19.49 per share. In connection with the Company’s acquisition of Commissure, the purchase and sale agreement required 0.2 millionshares of the Company’s common stock, valued at $3.4 million, to be placed into escrow for 15 months from the date of acquisition, inconnection with certain standard representations and warranties. The Company cannot make a determination, beyond a reasonable doubt,that the escrow will become payable to the former shareholders of Commissure, and accordingly has not included the escrow as acomponent of the purchase price. Upon satisfaction72Table of ContentsNUANCE COMMUNICATIONS, INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)of the contingency, the escrowed amount will be recorded as additional purchase price and allocated to goodwill. In addition, the mergeragreement includes a contingent earnout payment of up to $8.0 million upon the achievement of certain financial targets for fiscal years2008, 2009 and 2010. $2.0 million of this earnout relates to performance measures for fiscal 2008, the Company is currently evaluatingthe calculations for these fiscal 2008 financial targets, and has not recorded any earnout obligation as of September 30, 2008. Payments,if any, may be made in the form of cash or shares of the Company’s common stock, solely at the Company’s discretion. The acquisitionwas a non-taxable event.The results of operations of the acquired business have been included in the consolidated financial statements of the Company sincethe date of acquisition. A summary of the purchase price allocation for the acquisition of Commissure is as follows (in thousands):Total purchase consideration: Common stock issued $23,293 Transaction costs 2,260 Total purchase consideration $25,553 Allocation of the purchase consideration: Current assets $3,493 Identifiable intangible assets 5,650 Goodwill 19,629 Total assets acquired 28,772 Total liabilities assumed (3,219)Net assets acquired $25,553 Current assets acquired primarily relate to cash, accounts receivable, prepaid expenses, and acquired unbilled accounts receivable.Liabilities assumed primarily relate to accounts payable, accrued expenses, and deferred revenue.Customer relationships are amortized based upon patterns in which the economic benefits are expected to be utilized. Other finite-lived identifiable assets are amortized on a straight-line basis. The following are the identifiable intangible assets acquired and theirrespective weighted average lives (dollars in thousands): Weighted Average Amount Life (In years) Customer relationships $3,000 7.0 Core and completed technology 2,010 4.8 Non-compete 590 4.0 Trademark 50 2.0 Total $5,650 Acquisition of VoiceSignalOn August 24, 2007, the Company acquired all of the outstanding capital stock of VoiceSignal, a software company that providesspeech technology for cell phones and other mobile devices. The purchase consideration consisted of total cash payment of$204.5 million, 5.8 million shares of the Company’s common stock valued at $15.57 per share and transaction costs of $24.0 million.The total cash consideration includes $30.0 million released from escrow which was recorded as incremental purchase price in August2008 (as of September 30, 2007, the73Table of ContentsNUANCE COMMUNICATIONS, INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)$30.0 million cash was held by the escrow agent and included in other assets in the accompanying consolidated balance sheet). Theacquisition was a taxable event.The results of operations of the acquired business have been included in the consolidated financial statements of the Company sincethe date of acquisition. A summary of the purchase price allocation for the acquisition of VoiceSignal is as follows (in thousands):Total purchase consideration: Cash $204,490 Common stock issued 90,851 Transaction costs 23,962 Total purchase consideration $319,303 Allocation of the purchase consideration: Cash $10,874 Accounts receivable, including acquired unbilled accounts receivable 15,493 Other assets 1,646 Identifiable intangible assets 71,700 Goodwill 230,362 Total assets acquired 330,075 Accounts payable and accrued expenses (5,873)Other liabilities (4,899)Total liabilities assumed (10,772)Net assets acquired $319,303 Other liabilities include deferred tax liabilities and deferred revenue.Customer relationships are amortized based upon patterns in which their economic benefits are expected to be utilized. Other finite-lived identifiable assets are amortized on a straight-line basis. The following are the identifiable intangible assets acquired and theirrespective weighted average lives (dollars in thousands): Weighted Average Amount Life (In years) Customer relationships $60,700 7.0 Core and completed technology 11,000 6.0 Total $71,700 Acquisition of TegicOn August 24, 2007, the Company acquired all of the outstanding capital stock of Tegic, a developer of embedded software formobile devices. The purchase consideration consisted of cash payment of $265.0 million and transaction costs of $3.3 million. Theacquisition was a taxable event.74Table of ContentsNUANCE COMMUNICATIONS, INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)The results of operations of the acquired business have been included in the consolidated financial statements of the Company sincethe date of acquisition. A summary of the purchase price allocation for the acquisition of Tegic is as follows (in thousands):Total purchase consideration: Cash $265,000 Transaction costs 3,304 Total purchase consideration $268,304 Allocation of the purchase consideration: Accounts receivable, including acquired unbilled accounts receivable $58,421 Other assets 548 Identifiable intangible assets 52,490 Goodwill 165,222 Total assets acquired 276,681 Accounts payable and accrued expenses (3,971)Other liabilities (4,406)Total liabilities assumed (8,377)Net assets acquired $268,304 Other liabilities include deferred tax liabilities and deferred revenue.Customer relationships are amortized based upon patterns in which their economic benefits are expected to be utilized. Other finite-lived identifiable assets are amortized on a straight-line basis. The following are the identifiable intangible assets acquired and theirrespective weighted average lives (dollars in thousands): Weighted Average Amount Life (In years) Customer relationships $34,490 5.4 Core and completed technology 16,400 9.6 Trademark 1,600 10.0 Total $52,490 Acquisition of BeVocalOn April 24, 2007, the Company acquired all of the outstanding capital stock of BeVocal, a provider of on-demand self-servicecustomer care solutions that address the unique business requirements of the mobile communications market and its customers. The totalpurchase price was $178.6 million, which consists of 7.0 million shares of common stock valued at $104.4 million, a cash payment of$34.2 million including transaction costs and contingent consideration related to earnout provisions in the merger agreement of$40.0 million payable to shareholders and option holders (see below for further discussion). The acquisition was a non-taxable event. Inconnection with this acquisition 1.2 million shares of the Company’s common stock, valued at $18.3 million, as of the date ofacquisition, were placed into escrow in connection with certain standard representations and warranties. The escrow was scheduled to bereleased on July 24, 2008. The Company filed a claim against the escrow related to the breach of certain representations and warrantiesmade in the merger agreement. The Company expects the escrow shares to remain in escrow until the settlement of contingent liabilities isfinalized. At that time, the escrow75Table of ContentsNUANCE COMMUNICATIONS, INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)shares distributable to the former BeVocal shareholders, if any, would be released to the shareholders and accounted for as an increase topurchase price.Under the terms of the merger agreement, the Company agreed to make contingent earnout payments of up to $65.1 million upon theachievement of certain financial targets through December 31, 2007. A portion of the total amount of the earnout payments is furtherconditioned on continued employment provisions. Subsequent to September 30, 2008, based on the final measurement of the financialtargets, and on the currently measurable forfeiture provisions relating to continued employment requirements, the Company and theBeVocal shareholder representative have agreed to total earnout payments of $49.1 million. Of this total amount, $46.1 million is payablein cash and $3.0 million is payable in either shares of stock or as a cash payment, at the Company’s option. $40.0 million of the totalearnout payment has been recorded as an increase to purchase price and the remaining $9.1 million is being recorded to compensationexpense from the date of acquisition to April 2011 (the period of service required under the merger agreement), with $1.5 millionremaining unamortized as of September 30, 2008. The unamortized amount continues to be subject to continued employment. If theemployment conditions are not met, the amount will not be paid, and will be reversed from the deferred compensation asset and from theliability recorded. The Company has included this final earnout amount in current liabilities as of September 30, 2008; a preliminaryestimate of the earnout liability of $44.2 million was included in long-term liabilities as of September 30, 2007.The results of operations of the acquired business have been included in the consolidated financial statements of the Company sincethe date of acquisition. A summary of the purchase price allocation for the acquisition of BeVocal is as follows (in thousands):Total purchase consideration: Common stock issued $104,405 Cash 30,000 Contingent earnout consideration 40,025 Transaction costs 4,161 Total purchase consideration $178,591 Allocation of the purchase consideration: Cash $9,266 Accounts receivable and acquired unbilled accounts receivable 11,018 Other assets 3,415 Identifiable intangible assets 41,200 Goodwill 141,204 Total assets acquired 206,103 Accounts payable and accrued expenses (24,215)Deferred revenue (3,297)Total liabilities assumed (27,512)Net assets acquired $178,591 76Table of ContentsNUANCE COMMUNICATIONS, INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)Customer relationships are amortized based upon patterns in which their economic benefits are expected to be utilized. Other finite-lived identifiable intangible assets are amortized on a straight-line basis. The following are the identifiable intangible assets acquired andtheir respective weighted average lives (dollars in thousands): Weighted Average Amount Life (In years) Customer relationships $34,700 7.0 Core and completed technology 6,400 4.6 Non-compete 100 2.0 Total $41,200 Acquisition of FocusOn March 26, 2007, the Company acquired all of the outstanding capital stock of Focus which provides medical transcriptionservices with operations in the United States and India. The purchase price consisted of $58.7 million in cash, including transactioncosts, and the assumption of certain obligations. The acquisition was a taxable event. The purchase and sale agreement required$5.8 million in cash to be placed into escrow for 12 months from the date of acquisition, in connection with certain standardrepresentations and warranties. The $5.8 million was included in other assets in the accompanying consolidated balance sheet atSeptember 30, 2007. The Company determined in March 2008, that it was beyond a reasonable doubt that the entire $5.8 million held inescrow would be paid to either satisfy liabilities indemnified under the agreement or paid directly to the former shareholders of Focus.Accordingly, the escrow was reclassified to goodwill in March 2008.The results of operations of the acquired business have been included in the consolidated financial statements of the Company sincethe date of acquisition. A summary of the purchase price allocation for the acquisition of Focus is as follows (in thousands):Total purchase consideration: Cash $54,477 Debt assumed 2,060 Transaction costs 2,132 Total purchase consideration $58,669 Allocation of the purchase consideration: Accounts receivable $3,940 Other assets 2,607 Identifiable intangible assets 23,700 Goodwill 31,804 Total assets acquired 62,051 Accounts payable and accrued expenses (2,181)Other liabilities (1,201)Total liabilities assumed (3,382)Net assets acquired $58,669 77Table of ContentsNUANCE COMMUNICATIONS, INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)Customer relationships are amortized based upon patterns in which their economic benefits are expected to be utilized. Other finite-lived identifiable intangible assets are amortized on a straight-line basis. The following are the identifiable intangible assets acquired andtheir respective weighted average lives (dollars in thousands): Weighted Average Amount Life (In years) Customer relationships $19,800 9.5 Core and completed technology 2,900 7.3 Non-compete 1,000 6.2 Total $23,700 Acquisition of MVCOn December 29, 2006, the Company acquired all of the outstanding capital stock of MVC, a provider of speech-enabled mobilesearch and messaging services, for $20.7 million. The initial purchase price consisted of $4.5 million in cash including transactioncosts, and 0.8 million shares of the Company’s common stock valued at $8.3 million.Additionally, under the agreement, the Company agreed to make additional earnout payments of up to 1,700,839 shares of theCompany’s common stock in contingent purchase price upon achievement of established targets. 566,946 of these shares wereapportioned to calendar 2007 targets, and 1,133,893 shares to calendar 2008 targets. As of March 31, 2008, the Company determinedthat 377,964 shares of the calendar 2007 earnout were earned and these shares were issued to the former shareholders of MVC. The totalvalue of these shares was $8.0 million and was recorded as additional purchase price and allocated to goodwill in fiscal 2008. Followingthis determination, the earnout requirements of the MVC merger agreement was amended, such that the former shareholders of MVC mayearn the remaining 188,962 shares of the calendar 2007 earnout, if certain conditions are met at December 31, 2008. Based on theCompany’s review of this amendment, it was determined to be beyond a reasonable doubt that these 188,962 shares would be earned,and the Company has valued those shares at $3.0 million; of which $1.0 million has been recorded to goodwill as incremental purchaseprice, and the remaining $2.0 million is being amortized as compensation expense from May 2008 to December 2008. In November 2008,a second amendment to the merger agreement was signed pursuant to which the earnout period for the calendar 2008 earnout was extendedsuch that the same aggregate amount of shares may now be earned based on the achievement of calendar 2008 and 2009 targets. The stockpayments, if any, that are made based on the provisions of this second amendment will be recorded to goodwill, as incremental purchaseprice. The acquisition was a non-taxable event.78Table of ContentsNUANCE COMMUNICATIONS, INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)The results of operations of the acquired business have been included in the consolidated financial statements of the Company sincethe date of acquisition. A summary of the purchase price allocation for the acquisition of MVC, including the impact of certaincomponents of the earnout, as amended, is as follows (in thousands):Total purchase consideration: Common stock issued $8,300 Contingent earnout consideration 7,983 Cash 4,104 Transaction costs 362 Total purchase consideration $20,749 Allocation of the purchase consideration: Other assets $79 Identifiable intangible assets 2,700 Goodwill 18,136 Total assets acquired 20,915 Total liabilities assumed (166)Net assets acquired $20,749 Customer relationships are amortized based upon patterns in which their economic benefits are expected to be utilized. Other finite-lived identifiable intangible assets are amortized on a straight-line basis. The following are the identifiable intangible assets acquired andtheir respective weighted average lives (dollars in thousands): Weighted Average Amount Life (In years) Customer relationships $1,300 5.0 Completed technology 1,100 4.0 Non-compete 300 3.0 Total $2,700 Acquisition of DictaphoneOn March 31, 2006, the Company acquired all of the outstanding capital stock of Dictaphone, a leading healthcare informationtechnology company, for approximately $365.0 million in cash, including approximately $5.7 million in transaction costs. TheCompany acquired Dictaphone to expand its product portfolio, market reach and revenue streams in the healthcare markets. Theacquisition was a taxable event. The results of operations of the acquired business have been included in the consolidated financialstatements of the Company since the date of79Table of ContentsNUANCE COMMUNICATIONS, INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)acquisition. A summary of the purchase price allocation for the acquisition of Dictaphone is as follows (in thousands):Total purchase consideration: Cash $359,240 Transaction costs 5,716 Total purchase consideration $364,956 Allocation of the purchase consideration: Cash $7,742 Accounts receivables, net 33,386 Acquired unbilled accounts receivable 42,496 Inventories 3,429 Other current assets 4,420 Property and equipment 13,863 Other assets 4,587 Identifiable intangible assets 155,760 Goodwill 241,576 Total assets acquired 507,259 Accounts payable and accrued expenses (35,740)Accrued business combination costs (2,489)Deferred revenue (39,631)Unearned revenue and customer deposits (43,320)Deferred income tax liabilities (12,394)Pension, postretirement and other liabilities (8,729)Total liabilities assumed (142,303)Net assets acquired $364,956 The Company records deferred revenue under the provisions of EITF 01-03, “Accounting in a Business Combination for DeferredRevenue of Acquiree” (“EITF 01-03”). Under EITF 01-03, deferred revenue represents the fair value of the legal performance commitmentsassumed by the Company, to its customers.As of September 30, 2008, approximately $14.3 million of the $241.6 million of goodwill will be deductible for income taxpurposes. Customer relationships are amortized based upon patterns in which their economic benefits are expected to be utilized. Otherfinite-lived identifiable intangible assets are amortized on a straight-line basis. The following are the identifiable intangible assets acquiredand their respective weighted average lives (dollars in thousands): Weighted Average Amount Life (In years) Customer relationships $105,800 10.0 Existing technology 21,500 6.6 Trade name, subject to amortization 660 4.5 Subtotal 127,960 Trade name, indefinite life 27,800 n/a Total $155,760 80Table of ContentsNUANCE COMMUNICATIONS, INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)4. Pro Forma Results (Unaudited)The following table reflects unaudited pro forma results of operations of the Company assuming that the Focus, BeVocal,VoiceSignal, Tegic, Commissure, Viecore, eScription and PSRS acquisitions had occurred on October 1, 2006 (in thousands, except pershare amounts): 2008 2007 Revenue $945,809 $842,708 Net loss $(53,285) $(55,837)Net loss per share $(0.24) $(0.27)The Company has not furnished pro forma financial information relating to the MVC, Vocada and Multi-Vision acquisitionsbecause such information is not material to the Company’s financial results. The unaudited pro forma results of operations are notnecessarily indicative of the actual results that would have occurred had the transactions actually taken place at the beginning of theperiods indicated.On October 1, 2008, the Company completed its acquisition of SNAPin Software, Inc. The SNAPin acquisition will further enablethe Company’s capabilities to deliver innovative, highly scalable mobile customer care solutions that transform the way mobile operatorsand enterprises interact with consumers in real-time on mobile devices. The announced estimated aggregate consideration for thisacquisition is approximately 10.6 million shares of Nuance’s common stock including 1.1 million shares of common stock to be placedin escrow for 12 months to satisfy any claims Nuance have. The aggregate consideration will additionally include Nuance’s assumptionof all of SNAPin’s outstanding employee stock options and restricted stock awards.5. Goodwill and Intangible AssetsThe Company has evaluated the provisions of SFAS 142 and determined that it operates in one reporting unit. The changes in thecarrying amount of goodwill for fiscal years 2008 and 2007, are as follows (in thousands):Balance as of September 30, 2006 $699,333 Goodwill acquired 549,475 Purchase accounting adjustments (6,566)Effect of foreign currency translation 7,400 Balance as of September 30, 2007 1,249,642 Goodwill acquired 355,648 Escrow amounts released 30,000 Purchase price increases due to earnout achievements 12,501 Purchase accounting adjustments 3,327 Effect of foreign currency translation 4,655 Balance as of September 30, 2008 $1,655,773 Purchase accounting adjustments recorded in fiscal 2007 were primarily related to the utilization of acquired deferred tax assets inconnection with certain of the Company’s prior acquisitions.Purchase accounting adjustments recorded in fiscal 2008 consisted primarily of the following increases: $15.4 million relating to theestimated fair value of contingent liabilities assumed in connection with the acquisition of BeVocal, $7.6 million due to a revised estimateof the fair value of the intangible assets for customer relationships relating to the acquisition of Tegic, $10.4 million relating to anadjustment of assumed deferred tax liabilities and $5.8 million related to the escrow associated with the Company’s acquisition of Focus(see Note 3). In addition, the Company increased goodwill by $2.8 million to correct an error in the acquired balance sheet of Dictaphonefor contractual liabilities to a certain customer, incurred prior to the acquisition date of March 31, 2006.81Table of ContentsNUANCE COMMUNICATIONS, INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)These increases to goodwill were partially offset by decreases which included $23.8 million of additional acquired unbilled accountsreceivable identified in connection with the acquisition of Tegic, and by $16.6 million related to the utilization of acquired deferred taxassets in connection with certain of the Company’s prior acquisitions.Intangible assets consist of the following (in thousands): September 30, 2008 Weighted Average Gross Carrying Accumulated Net Carrying Remaining Amount Amortization Amount Life (Years) Customer relationships $503,800 $(93,285) $410,515 7.5 Technology and patents 192,341 (55,344) 136,997 7.6 Tradenames and trademarks, subject to amortization 9,546 (3,584) 5,962 6.2 Non-competition agreements 5,169 (1,420) 3,749 3.0 Subtotal 710,856 (153,633) 557,223 Tradename, indefinite life 27,800 — 27,800 n/a Total $738,656 $(153,633) $585,023 September 30, 2007 Weighted Average Gross Carrying Accumulated Net Carrying Remaining Amount Amortization Amount Life (Years) Customer relationships $309,188 $(44,009) $265,179 7.0 Technology and patents 134,133 (43,357) 90,776 5.9 Tradenames and trademarks, subject to amortization 8,602 (3,245) 5,357 6.5 Non-competition agreements 2,614 (536) 2,078 5.1 Subtotal 454,537 (91,147) 363,390 Tradename, indefinite life 27,800 — 27,800 n/a Total $482,337 $( 91,147) $391,190 Amortization expense for the acquired technology and patents are included in the cost of revenue from amortization of intangibleassets in the accompanying statements of operations and amounted to $24.4 million, $13.1 million and $12.9 million in fiscal 2008,2007 and 2006, respectively. Amortization expense for customer relationships, tradenames and trademarks, and non-competitionagreements are included in operating expenses was $58.2 million, $24.6 million and $17.2 million in fiscal 2008, 2007 and 2006,respectively. Estimated amortization expense for each of the five succeeding years as of September 30, 2008, is as follows (in thousands): Other Cost of Operating Year Ending September 30, Revenue Expenses Total 2009 $26,289 $72,956 $99,245 2010 24,299 70,819 95,118 2011 22,908 62,995 85,903 2012 19,144 54,499 73,643 2013 14,234 45,642 59,876 Thereafter 30,123 113,315 143,438 Total $136,997 $420,226 $557,223 82Table of ContentsNUANCE COMMUNICATIONS, INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)6. Contingent and Deferred Acquisition PaymentsDeferred PaymentsIn connection with the Company’s acquisition of PSRS in September 2008, a deferred cash payment of €44.3 million ($64.0 millionbased on the exchange rate as of September 30, 2008) is to be paid in cash on September 21, 2009. Subsequent to September 30, 2008,the Company entered into a cash flow hedge with respect to the €44.3 million payment. The September 2009 payment is subject toacceleration under certain conditions including change in control of the Company (as defined), or the acceleration of the Company’spayment obligations under its March 2006 credit agreement, as amended. Additionally, the purchase price is subject to adjustment(increase or decrease), based on the working capital provision as defined in the share purchase agreement the measurement is expected tobe completed in the first quarter of fiscal 2009.Earnout PaymentsIn connection with the Company’s acquisition of Phonetic Systems Ltd. (“Phonetic”) in February 2005, a deferred payment of$17.5 million was due and paid to the former shareholders of Phonetic on February 1, 2007. The Company also agreed to makecontingent earnout payments of $35.0 million upon achievement of certain established financial and performance targets throughDecember 31, 2007, in accordance with the merger agreement. The Company has notified the former shareholders of Phonetic that thefinancial and performance targets for the scheduled payments for all periods through December 31, 2007 were not achieved. Accordingly,the Company has not recorded any obligations relative to these measures as of September 30, 2008. The former shareholders of Phonetichave objected to this determination and have filed for arbitration.In connection with the Company’s acquisition of MVC, the Company agreed to make additional earnout payments of up to1,700,839 shares of the Company’s common stock in contingent purchase price upon achievement of established targets. 566,946 ofthese shares were apportioned to calendar 2007 targets, and 1,133,893 shares to calendar 2008 targets. As of March 31, 2008, theCompany determined that 377,964 shares of the calendar 2007 earnout were earned and these shares were issued to the formershareholders of MVC. The total value of these shares was $8.0 million and was recorded as additional purchase price and allocated togoodwill in fiscal 2008. Following this determination, the earnout requirements of the MVC merger agreement were amended, such that theformer shareholders of MVC may earn the remaining 188,962 shares of the calendar 2007 earnout, if certain conditions are met atDecember 31, 2008. Based on the Company’s review of this amendment, it was determined to be beyond a reasonable doubt that these188,962 shares would be earned, and the Company has valued those shares at $3.0 million; of which $1.0 million has been recorded togoodwill as incremental purchase price, and the remaining $2.0 million is being amortized as compensation expense from May 2008 toDecember 2008. In November 2008, a second amendment to the merger agreement was signed pursuant to which the earnout period for thecalendar 2008 earnout was extended such that the same aggregate amount of shares may now be earned based on the achievement ofcalendar 2008 and 2009 targets. The stock payments, if any, that are made based on the provisions of this second amendment will berecorded to goodwill, as incremental purchase price.In connection with the Company’s acquisition of BeVocal, the Company agreed to make contingent earnout payments of up to$65.1 million upon the achievement of certain financial targets through December 31, 2007. A portion of the total amount of the earnoutpayments is further conditioned on continued employment provisions. Subsequent to September 30, 2008, based on the finalmeasurement of the financial targets, and on the currently measurable forfeiture provisions relating to continued employmentrequirements, the Company and the BeVocal shareholder representative have agreed to total earnout payments of $49.1 million. Themajority of these payments are due upon the final measurement of the financial targets. The Company has included this amount incurrent liabilities as of September 30, 2008; a preliminary estimate of the amount, $44.2 million, was included in long-term liabilities asof September 30, 2007. Of this total amount, $46.1 million is payable in cash and $3.0 million is payable in either shares of stock or asa cash payment, at the Company’s option.83Table of ContentsNUANCE COMMUNICATIONS, INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)In connection with the Company’s acquisition of Commissure on September 28, 2007, the Company agreed to make contingentearnout payments of up to $8.0 million upon the achievement of certain financial targets for the fiscal years ended September 30, 2008,2009 and 2010, in accordance with the merger agreement. The Company has not recorded any obligation relative to these measures as ofSeptember 30, 2008. Payments, if any, may be made in the form of cash or shares of the Company’s common stock, at the solediscretion of the Company.In connection with the Company’s acquisition of Vocada on November 2, 2007, the Company agreed to make contingent earnoutpayments of up to $21.0 million upon the achievement of certain financial targets measured over defined periods through December 31,2010, in accordance with the merger agreement. The Company has not recorded any obligation relative to these measures as ofSeptember 30, 2008. Payments, if any, may be made in the form of cash or shares of the Company’s common stock, at the solediscretion of the Company.In connection with the Company’s acquisition of Multi-Vision on July 31, 2008, the Company agreed to make contingent earnoutpayments of up to $15.0 million upon the achievement of certain financial targets for the period from August 1, 2008 to July 31, 2009, inaccordance with the share purchase agreement. In addition to the financial targets, two-thirds of the earnout is further conditioned oncontinued employment of certain Multi-Vision employees; accordingly, up to $10.0 million of any earnout payments that become payablewill be recorded as compensation expense, and up to $5.0 million will be recorded as additional purchase price and allocated to goodwill.The Company has not recorded any obligation relative to these measures as of September 30, 2008. Payments, if any, may be made in theform of cash or shares of the Company’s common stock, at the sole discretion of the Company.In connection with the Company’s acquisition of SNAPin, on October 1, 2008, the Company agreed to make contingent earnoutpayments of up to $45.0 million in cash, and an additional $2.5 million in cash or stock, at the Company’s sole discretion, upon theachievement of certain financial targets for the period from October 1, 2008 to December 31, 2009, in accordance with the mergeragreement.Escrow and Holdback ArrangementsIn connection with certain of the Company’s acquisitions it has placed either cash or shares of its common stock in escrow tosatisfy any claims the Company may have. If no claims are made, the escrowed amounts will be released to the former shareholders of theacquired companies. Generally, the Company cannot make a determination, beyond a reasonable doubt, whether the escrow will becomepayable to the former shareholders of these companies until the escrow period has expired. Accordingly these amounts have been treated ascontingent purchase price until it is determined that the escrow will be payable, at which time the escrowed amounts may be recorded asadditional purchase price and allocated to goodwill.The following table summarizes the terms of the escrow arrangements that have not been released as of September 30, 2008 (dollarsin thousands): Initially Scheduled Escrow Share Payment — Release Date Cash Payment Number of Shares Focus(a) March 26, 2008 $5,800 — BeVocal(b) July 24, 2008 n/a 1,225,490 Commissure December 28, 2008 n/a 174,601 Vocada February 2, 2009 n/a 56,205 Viecore February 26, 2009 n/a 584,924 eScription May 20, 2009 n/a 1,123,888 Total $5,800 3,165,108 Discussion of amounts held in escrow following their initially scheduled release date:(a)In March 2008, the Company filed a claim against the escrow in the Focus acquisition, related to breach of certain representationsand warranties made in the share purchase agreement for the transaction (see Note 3).84Table of ContentsNUANCE COMMUNICATIONS, INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)(b)The share escrow relating to the BeVocal acquisition was scheduled to be released on July 24, 2008. The Company filed a claimagainst the escrow related to the breach of certain representations and warranties made in the merger agreement for the transaction.The Company expects the entire 1,225,490 shares that are held in escrow, and valued at $16.25 million under the mergeragreement, to remain in escrow until the settlement of contingent liabilities is finalized. At that time, the escrow shares distributableto the former BeVocal shareholders, if any, would be released to the shareholders and accounted for as an increase to purchase price.In connection with the escrow relating to the Viecore acquisition, the Company guaranteed a minimum market value of $20.43 pershare when the escrow shares are released. If the market value is less than $20.43 per share on the date of release, the Company isrequired to pay the difference, if any, and limited to $1.8 million, in cash. Based on the closing market value per share of $12.19 onSeptember 30, 2008, the Company would be required to pay to the former shareholders of Viecore $1.8 million, which would be recordedas a reduction of additional paid in capital.In connection with the escrow relating to the eScription acquisition, the Company guaranteed a minimum market value of $17.7954per share when the escrow shares are released. If the market value is less than $17.7954 per share on the date of release, the Company isrequired to pay the difference, if any, and limited to $5.0 million, in cash. Based on the closing market value per share of $12.19 onSeptember 30, 2008, the Company would be required to pay to the former shareholders of eScription $5.0 million, which would berecorded as a reduction of additional paid in capital.In connection with the Company’s acquisition of Multi-Vision, the Company may be required to issue an additional $1.0 millionpursuant to holdback provisions, this is payable in stock, or cash, solely at the Company’s discretion. The holdback period isscheduled for October 31, 2009. If paid in stock, the number of shares payable is based on a rate, as defined in the share purchaseagreement, which approximates the then-current fair value.7. Accounts ReceivableAccounts receivable, excluding acquired unbilled accounts receivable, consisted of the following (in thousands): September 30, September 30, 2008 2007 Gross accounts receivable $224,180 $196,720 Less — allowance for doubtful accounts (6,925) (6,155)Less — allowance for distribution and reseller accounts receivable (7,350) (8,596)Less — allowance for sales returns (6,363) (7,323) $203,542 $174,646 The September 30, 2007 “allowance for distribution and reseller accounts receivable” and “allowance for sales returns” have beenreclassified to conform to the current period’s presentation.85Table of ContentsNUANCE COMMUNICATIONS, INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)8. Inventories, netInventories, net of allowances, consisted of the following (in thousands): September 30, September 30, 2008 2007 Components and parts $4,429 $4,605 Inventory at customers 1,585 2,726 Finished products 1,138 682 $7,152 $8,013 Inventory at customers reflects equipment related to in-process installations of solutions with customers. These contracts have notbeen recorded as revenue as of the balance sheet date, and therefore the related equipment is recorded in inventory until installation iscomplete.9. Land, Building and Equipment, NetLand, building and equipment, net at September 30, 2008 and 2007 were as follows (in thousands): September 30, September 30, Useful Life 2008 2007 (In years) Land — $2,400 $2,400 Building 30 5,117 5,117 Machinery & equipment 3-5 4,435 2,532 Computers, software and equipment 3-5 60,679 47,457 Leasehold improvements 2-10 13,491 7,738 Furniture and fixtures 5 9,071 7,416 Subtotal 95,193 72,660 Less: Accumulated depreciation (48,708) (35,042)Land, building and equipment, net $46,485 $37,618 Depreciation expense, associated with building and equipment, for fiscal 2008, 2007 and 2006 was $16.4 million, $12.1 millionand $8.4 million, respectively.10. Accrued ExpensesAccrued expenses consisted of the following (in thousands): September 30, September 30, 2008 2007 Accrued compensation and benefits $45,316 $35,875 Income taxes payable 16,047 6,853 Accrued acquisition costs and liabilities 8,574 4,153 Accrued professional fees 5,009 5,591 Accrued sales and marketing incentives 4,705 4,067 Accrued other 22,448 26,706 $102,099 $83,245 86Table of ContentsNUANCE COMMUNICATIONS, INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)11. Credit Facilities and DebtAt September 30, 2008 and 2007, the Company had the following borrowing obligations (in thousands): September 30, September 30, 2008 2007 2.75% Convertible Debentures, net $243,699 $242,634 Expanded 2006 Credit Facility 656,963 663,663 Obligations under capital leases 489 841 Other 39 213 Total long-term debt 901,190 907,351 Less: current portion 7,006 7,430 Non-current portion of long-term debt $894,184 $899,921 2.75% Convertible DebenturesOn August 13, 2007, the Company issued $250 million of 2.75% convertible senior debentures due in 2027 (“the 2027Debentures”) in a private placement to Citigroup Global Markets Inc. and Goldman, Sachs & Co. (the “Initial Purchasers”). Totalproceeds, net of debt discount of $7.5 million and deferred debt issuance costs of $1.1 million, were $241.4 million. The 2027Debentures bear an interest rate of 2.75% per annum, payable semi-annually in arrears beginning on February 15, 2008, and mature onAugust 15, 2027 subject to the right of the holders of the 2027 Debentures to require the Company to redeem the 2027 Debentures onAugust 15, 2014, 2017 and 2022. The related debt discount and debt issuance costs are being amortized to interest expense using theeffective interest rate method through August 2014. As of September 30, 2008 and 2007, the ending unamortized discount was$6.3 million and $7.4 million, respectively, and the ending unamortized deferred debt issuance costs were $0.8 million and $1.1 million,respectively. The 2027 Debentures are general senior unsecured obligations, ranking equally in right of payment to all of the Company’sexisting and future unsecured, unsubordinated indebtedness and senior in right of payment to any indebtedness that is contractuallysubordinated to the 2027 Debentures. The 2027 Debentures are effectively subordinated to the Company’s secured indebtedness to theextent of the value of the collateral securing such indebtedness and are structurally subordinated to indebtedness and other liabilities of theCompany’s subsidiaries. If converted, the principal amount of the 2027 Debentures is payable in cash and any amounts payable inexcess of the $250 million principal amount, will (based on an initial conversion rate, which represents an initial conversion price of$19.47 per share, subject to adjustment as defined) be paid in cash or shares of the Company’s common stock, at the Company’selection, only in the following circumstances and to the following extent: (i) on any date during any fiscal quarter beginning afterSeptember 30, 2007 (and only during such fiscal quarter) if the closing sale price of the Company’s common stock was more than 120%of the then current conversion price for at least 20 trading days in the period of the 30 consecutive trading days ending on the last tradingday of the previous fiscal quarter; (ii) during the five consecutive business-day period following any five consecutive trading-day periodin which the trading price for $1,000 principal amount of the Debentures for each day during such five trading-day period was less than98% of the closing sale price of the Company’s common stock multiplied by the then current conversion rate; (iii) upon the occurrence ofspecified corporate transactions, as described in the indenture for the 2027 Debentures; and (iv) at the option of the holder at any time onor after February 15, 2027. Additionally, the Company may redeem the 2027 Debentures, in whole or in part, on or after August 20,2014 at par plus accrued and unpaid interest; each holder shall have the right, at such holder’s option, to require the Company torepurchase all or any portion of the 2027 Debentures held by such holder on August 15, 2014, August 15, 2017 and August 15, 2022.Upon conversion, the Company will pay cash and shares of its common stock (or, at its election, cash in lieu of some or all of suchcommon stock), if any. If the Company undergoes a fundamental change (as described in the indenture for the 2027 Debentures) prior tomaturity, holders will have the option to require the Company to repurchase all or any portion of their debentures for cash at a price87Table of ContentsNUANCE COMMUNICATIONS, INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)equal to 100% of the principal amount of the debentures to be purchased plus any accrued and unpaid interest, including any additionalinterest to, but excluding, the repurchase date. As of September 30, 2008, no conversion triggers were met. If the conversion triggers weremet, the Company could be required to repay all or some of the principal amount in cash prior to the maturity date.Expanded 2006 Credit FacilityThe Company has entered into a credit facility which consists of a $75 million revolving credit line including letters of credit, a$355 million term loan entered into on March 31, 2006, a $90 million term loan entered into on April 5, 2007 and a $225 million termloan entered into on August 24, 2007 (the “Expanded 2006 Credit Facility”). The term loans are due March 2013 and the revolving creditline is due March 2012. As of September 30, 2008, $657.0 million remained outstanding under the term loans, there were $16.6 millionof letters of credit issued under the revolving credit line and there were no other outstanding borrowings under the revolving credit line.The Expanded 2006 Credit Facility contains covenants, including, among other things, covenants that restrict the ability of theCompany and its subsidiaries to incur certain additional indebtedness, create or permit liens on assets, enter into sale-leasebacktransactions, make loans or investments, sell assets, make certain acquisitions, pay dividends, or repurchase stock. The agreement alsocontains events of default, including failure to make payments of principal or interest, failure to observe covenants, breaches ofrepresentations and warranties, defaults under certain other material indebtedness, failure to satisfy material judgments, a change ofcontrol and certain insolvency events. As of September 30, 2008, the Company was in compliance with the covenants under theExpanded 2006 Credit Facility.Borrowings under the Expanded 2006 Credit Facility bear interest at a rate equal to the applicable margin plus, at the Company’soption, either (a) the base rate (which is the higher of the corporate base rate of UBS AG, Stamford Branch, or the federal funds rate plus0.50% per annum) or (b) LIBOR (equal to (i) the British Bankers’ Association Interest Settlement Rates for deposits in U.S. dollarsdivided by (ii) one minus the statutory reserves applicable to such borrowing). The applicable margin for term loan borrowings under theExpanded 2006 Credit Facility ranges from 0.75% to 1.50% per annum with respect to base rate borrowings and from 1.75% to 2.50%per annum with respect to LIBOR-based borrowings, depending on the Company’s leverage ratio. The applicable margin for revolvingloan borrowings under the Expanded 2006 Credit Facility ranges from 0.50% to 1.25% per annum with respect to base rate borrowingsand from 1.50% to 2.25% per annum with respect to LIBOR-based borrowings, depending upon the Company’s leverage ratio. As ofSeptember 30, 2008, the Company’s applicable margin for the term loan was 1.25% for base rate borrowings and 2.25% for LIBOR-based borrowings. The Company is required to pay a commitment fee for unutilized commitments under the revolving credit facility at arate ranging from 0.375% to 0.50% per annum, based upon the Company’s leverage ratio. As of September 30, 2008, the commitment feerate was 0.50% and the effective interest rate was 4.72%.The Company capitalized debt issuance costs related to the Expanded 2006 Credit Facility and is amortizing the costs to interestexpense using the effective interest rate method through March 2012 for costs associated with the revolving credit facility and throughMarch 2013 for costs associated with the term loan. As of September 30, 2008 and 2007, the ending unamortized deferred financing feeswere $10.0 million and $12.3 million, respectively, and are included in other assets in the Company’s accompanying balance sheet.The Expanded 2006 Credit Facility is subject to repayment in four equal quarterly installments of 1% per annum ($6.7 million peryear, not including interest, which is also payable quarterly), and an annual excess cash flow sweep, as defined in the Expanded 2006Credit Facility, which is payable beginning in the first quarter of each fiscal year, beginning in fiscal 2008, based on the excess cash flowgenerated in the previous fiscal year. No payment under the excess cash flow sweep provision was due in the first quarter of either fiscal2008 or fiscal 2009 as there was no excess cash flow generated in either of the respective prior fiscal years. The Company will continue toevaluate the extent to which a payment is due in the first quarter of future fiscal years excess cash flow generation. At the current time, theCompany is unable to predict the amount of the outstanding principal, if any, that it may be88Table of ContentsNUANCE COMMUNICATIONS, INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)required to repay in future fiscal years pursuant to the excess cash flow sweep provisions. Any term loan borrowings not paid through thebaseline repayment, the excess cash flow sweep, or any other mandatory or optional payments that the Company may make, will berepaid upon maturity. If only the baseline repayments are made, the annual aggregate principal amount of the term loans repaid would beas follows (in thousands):Year Ending September 30, Amount 2009 $6,700 2010 6,700 2011 6,700 2012 6,700 2013 630,163 Total $656,963 The Company’s obligations under the Expanded 2006 Credit Facility are unconditionally guaranteed by, subject to certainexceptions, each of its existing and future direct and indirect wholly-owned domestic subsidiaries. The Expanded 2006 Credit Facilityand the guarantees thereof are secured by first priority liens and security interests in the following: 100% of the capital stock ofsubstantially all of the Company’s domestic subsidiaries and 65% of the outstanding voting equity interests and 100% of the non-votingequity interests of first-tier foreign subsidiaries, all material tangible and intangible assets of the Company and the guarantors, and anypresent and future intercompany debt. The Expanded 2006 Credit Facility also contains provisions for mandatory prepayments ofoutstanding term loans upon receipt of the following, and subject to certain exceptions: 100% of net cash proceeds from asset sales, 100%of net cash proceeds from issuance or incurrence of debt, and 100% of extraordinary receipts. The Company may voluntarily prepayborrowings under the Expanded 2006 Credit Facility without premium or penalty other than breakage costs, as defined with respect toLIBOR-based loans.12. Financial Instruments and Hedging ActivitiesOn March 31, 2006, the Company entered into a three-year interest rate swap with a notional value of $100 million (the “Interest RateSwap”). The Interest Rate Swap was entered into as a partial hedge of the Expanded 2006 Credit Facility to effectively change thecharacteristics of the interest rate without actually changing the debt instrument. For floating rate debt, interest rate changes generally donot affect the fair market value, but do impact future earnings and cash flows, assuming other factors are held constant. At its inception,the Company formally documented the hedging relationship and has determined that the hedge is perfectly effective and designated it as acash flow hedge of a portion of the 2006 Credit Facility as defined by SFAS 133. The Interest Rate Swap will hedge the variability of thecash flows caused by changes in U.S. dollar LIBOR interest rates. The swap is marked to market at each reporting date. The fair valueof the Interest Rate Swap at September 30, 2008 and 2007 was $0.9 million which was included in other current liabilities atSeptember 30, 2008 and other long-term liabilities at September 30, 2007. Changes in the fair value of the cash flow hedge derivative arereported in stockholders’ equity as a component of accumulated other comprehensive income (loss). Subsequent to September 30, 2008,the Company entered into two additional two-year interest rate swaps with a total notional value of $200 million.13. Accrued Business Combination CostsThe Company has, in connection with certain of its business combinations, incurred restructuring costs. Restructuring costs aretypically comprised of severance costs, costs of consolidating duplicate facilities and contract termination costs. Restructuring expensesare based upon plans that have been committed to by management, but are generally subject to refinement during the purchase priceallocation period (generally within one year of the acquisition date). In addition to plans resulting from the business combination, theCompany has historically acquired companies who have previously established restructuring charges relating to lease exit costs.Regardless of the origin of the lease exit costs, the Company is required to make assumptions relating to sublease89Table of ContentsNUANCE COMMUNICATIONS, INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)terms, sublease rates and discount rates. The Company bases its estimates and assumptions on the best information available at the timeof the obligation having arisen. These estimates are reviewed and revised as facts and circumstances dictate, with any changes beingrecorded to goodwill or restructuring and other charges (credits), net. Changes in these estimates could have a material effect on theamount accrued on the balance sheet. Discussed in detail below are two individually significant facilities which were abandoned by theacquired company prior to Nuance’s acquisition of the companies, and for which the obligations to the lessors, Nuance has assumed.In connection with the acquisitions of SpeechWorks International, Inc. in August 2003 and Former Nuance in September 2005, theCompany assumed two individually significant lease obligations that were abandoned prior to the acquisition dates. These obligationsexpire in 2016 and 2012, respectively, and the fair value of the obligations, net of estimated sublease income, was recognized as liabilitiesassumed by the Company in the allocation of the final purchase price. During fiscal 2008 the Company updated its restructuringassumptions for these two facilities and recorded a net restructuring expense of $0.2 million. The net payments have been discounted incalculating the fair value of these obligations, and the discount is being accreted through the term of the lease. Cash payments net ofsublease receipts are presented as cash used in financing activities on the consolidated statements of cash flows.Additionally, the Company has implemented restructuring plans to eliminate duplicate facilities, personnel or assets in connectionwith the business combinations. In accordance with EITF 95-3, “Recognition of Liabilities in Connection with a Purchase BusinessCombination,” costs such as these are recognized as liabilities assumed by the Company, and accordingly are included in the allocationof the purchase price, generally resulting in an increase to the recorded amount of the goodwill.The activity for the years ended September 30, 2008 and 2007, relating to all facilities and personnel recorded in accrued businesscombination costs, is as follows (in thousands): Facilities Personnel Total Balance at September 30, 2006 $59,221 $844 $60,065 Charged to goodwill 542 1,484 2,026 Charged to interest expense 1,889 — 1,889 Cash payments, net of sublease receipts (12,412) (1,549) (13,961)Balance at September 30, 2007 49,240 779 50,019 Charged to goodwill 1,586 (68) 1,518 Charged to restructuring and other charges, net 198 — 198 Charged to interest expense 1,718 — 1,718 Cash payments, net of sublease receipts (11,564) (711) (12,275)Balance at September 30, 2008 $41,178 $— $41,178 September 30, September 30, 2008 2007 Reported as: Current $9,166 $14,547 Long-term 32,012 35,472 Total $41,178 $50,019 90Table of ContentsNUANCE COMMUNICATIONS, INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)14. Restructuring and Other Charges, netFiscal 2008In fiscal 2008, the Company recorded restructuring and other charges of $7.2 million, of which $7.0 million was recorded to newrestructuring activities in fiscal 2008, and $0.2 million relates to pre-existing facilities that are included in accrued business combinationcosts which are discussed in Note 13. With respect to the $7.0 million of fiscal 2008 restructuring activities, $4.2 million related to theelimination of approximately 155 personnel across multiple functions within the Company, $1.4 million related to a non-recurring,adverse ruling arising from a vendor’s claims of underpayment of historical royalties for technology discontinued in 2005 and$1.4 million related to the consolidation or elimination of excess facilities.Fiscal 2006In fiscal 2006, the Company recorded a recovery of $1.2 million from restructuring and other charges. The recovery consisted of$1.3 million reduction to existing restructuring reserves as a result of a favorable sublease agreement signed during the second quarter offiscal 2006. The amount was offset by net adjustments of $0.1 million associated with prior years’ restructuring programs.The following table sets forth the fiscal 2008, 2007 and 2006 accrual activity relating to restructuring and other charges (inthousands): Personnel Facilities Other Total Balance at September 30, 2005 $1,786 $4,019 $— $5,805 Restructuring and other charges (credits), net (52) (1,181) — (1,233)Cash payments (1,360) (2,308) — (3,668)Balance at September 30, 2006 374 530 — 904 Restructuring and other charges (credits), net (38) (16) — (54)Cash payments (28) (514) — (542)Balance at September 30, 2007 308 — — 308 Restructuring and other charges (credits), net 4,231 1,397 1,393 7,021 Non-cash adjustment — (10) — (10)Cash payments (4,173) (628) — (4,801)Balance at September 30, 2008 $366 $759 $1,393 $2,518 15. Supplemental Cash Flow InformationCash paid for Interest and Income Taxes:During fiscal 2008, 2007 and 2006, the Company made cash payments for interest totaling $50.0 million, $31.4 million and$13.8 million, respectively.During fiscal 2008, 2007 and 2006, total net cash paid for income taxes were $5.6 million, $3.5 million and $3.4 million,respectively.91Table of ContentsNUANCE COMMUNICATIONS, INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)Non Cash Investing and Financing Activities:During fiscal 2008, 2007 and 2006, the Company issued shares of its common stock in connection with the consummation ofseveral of its acquisitions, including shares held in escrow (dollars in thousands): Shares of Common Stock Date of Acquisition Issued Value of Shares Multi-Vision(a) July 31, 2008 535,331 $8,300 eScription(b) May 20, 2008 1,294,844 $3,100 Viecore(b) November 26, 2007 5,017,126 $93,100 Vocada(b) November 2, 2007 922,561 $17,700 Commissure(b) September 28, 2007 1,369,731 $26,700 VoiceSignal August 24, 2007 5,836,506 $90,900 BeVocal(b) April 24, 2007 8,204,436 $122,700 MVC(c) December 29, 2006 784,266 $8,300 (a) Excludes shares that were withheld by the Company under the terms of the Multi-Vision merger agreement, and which may becomeissuable at the expiration of the holdback period, as defined in the merger agreement.(b) The value assumes that the escrow shares would be valued at the same price as the shares initially accounted for. This value mayincrease or decrease at the actual time of accounting recognition.(c) Excludes an additional 377,964 shares of the Company’s common stock that was issued in fiscal 2008 upon the measurement ofcertain earnout targets established for calendar 2007. These shares were valued at $7.0 million, based on the market value at the timeof their issuance.In January 2006, the Company issued 4,587,334 shares of its common stock valued at $27.5 million upon conversion of a$27.5 million convertible debenture originally issued on January 30, 2003 in connection with the Company’s acquisition of certain assetsfrom Royal Philips Electronics Speech Processing Technology and Voice Control business unit.16. Stockholders’ EquityThe Company is authorized to issue up to 40,000,000 shares of preferred stock, par value $0.001 per share. The Company hasdesignated 100,000 shares as Series A Preferred Stock and 15,000,000 shares as Series B Preferred Stock. In connection with theacquisition of ScanSoft from Xerox Corporation (“Xerox”), the Company issued 3,562,238 shares of Series B Preferred Stock to Xerox.On March 19, 2004, the Company announced that Warburg Pincus, a global private equity firm, had agreed to purchase all outstandingshares of the Company’s stock held by Xerox Corporation for approximately $80 million, including the 3,562,238 shares of Series BPreferred Stock. The Series B Preferred Stock is convertible into shares of common stock on a one-for-one basis. The Series B PreferredStock has a liquidation preference of $1.30 per share plus all declared but unpaid dividends. The holders of Series B Preferred Stock areentitled to non-cumulative dividends at the rate of $0.05 per annum per share, payable when, and if declared by the Board of Directors.To date, no dividends have been declared by the Board of Directors. Holders of Series B Preferred Stock have no voting rights, exceptthose rights provided under Delaware law. The undesignated shares of preferred stock will have rights, preferences, privileges andrestrictions, including voting rights, dividend rights, conversion rights, redemption privileges and liquidation preferences, as shall bedetermined by the Board of Directors upon issuance of the preferred stock. The Company has reserved 3,562,238 shares of its commonstock for issuance upon conversion of the Series B Preferred Stock. Other than the 3,562,238 shares of Series B Preferred Stock that areissued and outstanding, there are no other shares of preferred stock issued or outstanding as of September 30, 2008 or September 30,2007.92Table of ContentsNUANCE COMMUNICATIONS, INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)Common StockUnderwritten Public Offerings in Fiscal 2008On June 4, 2008, the Company completed an underwritten public offering in which it sold 5,575,000 shares of its common stock.Gross proceeds to the Company were $100.1 million, and the net proceeds after underwriting commissions and other offering expenseswere $99.8 million.On December 21, 2007, the Company completed an underwritten public offering in which it sold 7,823,000 shares of its commonstock. Gross proceeds from this sale were $136.9 million, and the net proceeds after underwriting commissions and other offeringexpenses were $130.3 million.Warburg Pincus Private Offerings in Fiscal 2008 and Fiscal 2005On May 20, 2008, in connection with the Company’s acquisition of eScription, the Company sold 5,760,369 shares of itscommon stock for a purchase price of $100.0 million, and warrants to purchase 3,700,000 shares of its common stock for a purchaseprice of $0.5 million, pursuant to the terms of a purchase agreement dated April 7, 2008 by and among the Company and WarburgPincus Private Equity VIII, L.P. and certain of its affiliated entities (collectively “Warburg Pincus”) (the “Purchase Agreement”). Thewarrants have an exercise price of $20.00 per share and a term of four years. Warburg Pincus also agreed not to sell any shares of Nuancecommon stock for a period of six months from the closing of the transaction contemplated by the Purchase Agreement.On May 5, 2005, the Company entered into a Securities Purchase Agreement (the “Securities Purchase Agreement”) by and amongthe Company and Warburg Pincus pursuant to which Warburg Pincus agreed to purchase, and the Company agreed to sell,3,537,736 shares of its common stock and warrants to purchase 863,236 shares of its common stock for an aggregate purchase price of$15.1 million. The warrants have an exercise price of $5.00 per share and a term of four years. On May 9, 2005, the sale of the sharesand the warrants pursuant to the Securities Purchase Agreement was completed. The Company also entered into a Stock PurchaseAgreement (the “Stock Purchase Agreement”) by and among the Company and Warburg Pincus pursuant to which Warburg Pincusagreed to purchase and the Company agreed to sell 14,150,943 shares of the Company’s common stock and warrants to purchase3,177,570 shares of the Company’s common stock for an aggregate purchase price of $60.0 million. The warrants have an exercise priceof $5.00 per share and a term of four years. The warrants provide the holder with the option to exercise the warrants on a net, or cashless,basis. On September 15, 2005, the sale of the shares and the warrants pursuant to the Securities Purchase Agreement was completed.The net proceeds from these two fiscal 2005 financings were $73.9 million.In connection with these fiscal 2005 and fiscal 2008 financings, the Company granted Warburg Pincus registration rights givingWarburg Pincus the right to request that the Company use commercially reasonable efforts to register some or all of the shares of commonstock issued to Warburg Pincus under each of the Securities Purchase Agreement, Stock Purchase Agreement and Purchase Agreement,including shares of common stock underlying the warrants. The Company has evaluated these warrants under EITF 00-19, “Accountingfor Derivative Financial Instruments Indexed to, and Potentially Settled in, a Company’s Own Stock” and has determined that thewarrants should be classified within the stockholders’ equity section of the accompanying consolidated balance sheets.Common Stock WarrantsOn May 20, 2008, the Company issued warrants for the purchase of 3,700,000 shares of its common stock to Warburg Pincus, asdescribed above. In fiscal 2005, the Company also issued to Warburg Pincus warrants for the purchase of 863,236 and3,177,570 shares of common stock, as described above.93Table of ContentsNUANCE COMMUNICATIONS, INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)In March 1999, the Company issued Xerox a ten-year warrant with an exercise price of $0.61 per share. This warrant is exercisablefor the purchase of 525,732 shares of the Company’s common stock. On March 19, 2004, the Company announced that WarburgPincus had agreed to purchase all outstanding shares of the Company’s stock held by Xerox Corporation, including this warrant, forapproximately $80 million. In connection with this transaction, Warburg Pincus acquired new warrants to purchase 2.5 millionadditional shares of the Company’s common stock for total consideration of $0.6 million. The warrants have a six-year life and anexercise price of $4.94 per share. The warrants provide the holder with the option to exercise the warrants on a net, or cashless, basis.On November 15, 2004, in connection with the acquisition of Phonetic, the Company issued unvested warrants to purchase750,000 shares of its common stock at an exercise price of $4.46 per share that were to vest, if at all, upon the achievement of certainperformance targets. Based on the Company’s assessment of the results relative to the financial and performance measures, thesewarrants to purchase shares of Nuance common stock have not vested and will not vest. The former shareholders of Phonetic haveobjected to this determination and have filed for arbitration.In connection with the acquisition of SpeechWorks in 2003, the Company issued a warrant to its investment banker, expiring onAugust 11, 2011, for the purchase of 150,000 shares of the Company’s common stock at an exercise price of $3.98 per share. Thewarrant provides the holder with the option to exercise the warrants on a net, or cashless, basis. The warrant became exercisable onAugust 11, 2005, and was valued at its issuance at $0.2 million based upon the Black-Scholes option pricing model. In October 2006,the warrant was exercised to purchase 125,620 shares of the Company’s common stock. The holder of the warrant elected a cashlessexercise resulting in a net issuance of 75,623 shares of the Company’s common stock. As of September 30, 2008, a warrant to purchase24,380 shares of the Company’s common stock remains outstanding.Based on its review of EITF 00-19, the Company has determined that each of the above-noted warrants should be classified withinthe stockholders’ equity section of the accompanying consolidated balance sheets.17. Share-Based PaymentThe Company accounts for share-based payments to employees and directors, including grants of employee stock options,purchases under employee stock purchase plans, awards in the form of restricted shares (“Restricted Stock”) and awards in the form ofunits of stock purchase rights (“Restricted Units”) in accordance with SFAS 123 (revised 2004), “Share-Based Payment,”(“SFAS 123R”). The Restricted Stock and Restricted Units are collectively referred to as “Restricted Awards.” SFAS 123R requires therecognition of the fair value of share-based payments as a charge against earnings. The Company recognizes share-based payment expenseover the requisite service period. Based on the provisions of SFAS 123R the Company’s share-based payment awards are accounted foras equity instruments. The amounts included in the consolidated statements of operations relating to share-based payments are as follows(dollars in thousands): 2008 2007 2006 Cost of product and licensing $18 $18 $88 Cost of professional services, subscription and hosting 7,991 3,816 1,873 Cost of maintenance and support 1,278 966 525 Research and development 14,325 7,160 4,578 Selling and marketing 24,394 20,293 7,332 General and administrative 20,625 15,882 7,471 Cumulative effect of accounting change — — 672 $68,631 $48,135 $22,539 94Table of ContentsNUANCE COMMUNICATIONS, INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)Stock OptionsThe Company has several share-based compensation plans under which employees, officers and directors may be granted stockoptions to purchase the Company’s common stock generally at fair market value. The Company’s plans do not allow for options to begranted at below fair market value nor can they be re-priced at anytime. Options granted under plans adopted by the Company becomeexercisable over various periods, typically two to four years and have a maximum term of seven years. The Company has also assumedoptions and option plans in connection with certain of its acquisitions. These stock options are governed by the plans and agreements thatthey were originally issued under, but are now exercisable for shares of the Company’s common stock. The table below summarizesactivity relating to stock options for the years ended September 30, 2008, 2007 and 2006: Weighted Weighted Average Average Remaining Aggregate Number of Exercise Contractual Intrinsic Shares Price Term Value(1) Outstanding at September 30, 2005 27,114,849 $4.10 Granted 3,417,064 $8.59 Exercised (7,582,650) $3.79 Forfeited (1,138,454) $4.53 Expired (1,156,726) $6.54 Outstanding at September 30, 2006 20,654,083 $4.80 Assumed from BeVocal and VoiceSignal 795,994 $4.14 Granted 3,183,450 $14.14 Exercised (5,742,274) $4.32 Forfeited (555,724) $7.57 Expired (94,807) $3.23 Outstanding at September 30, 2007 18,240,722 $6.48 Assumed from eScription 2,846,118 $4.35 Granted 636,440 $15.45 Exercised (5,861,906) $3.19 Forfeited (813,972) $11.18 Expired (50,888) $6.89 Outstanding at September 30, 2008 14,996,514 $7.47 4.6 years $83.3 million Exercisable at September 30, 2008 10,473,073 $5.48 3.9 years $72.4 million Exercisable at September 30, 2007 11,017,997 Exercisable at September 30, 2006 13,026,514 (1)The aggregate intrinsic value on this table was calculated based on the positive difference, if any, between the closing market value ofthe Company’s common stock on September 30, 2008 ($12.19) and the exercise price of the underlying options.95Table of ContentsNUANCE COMMUNICATIONS, INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)As of September 30, 2008, the total unamortized fair value of stock options was $35.9 million with a weighted average remainingrecognition period of 2.1 years. A summary of weighted-average grant-date (including assumed options) fair value and intrinsic value ofstock options exercised is as follows: 2008 2007 2006 Weighted-average grant-date fair value per share $14.78 $7.69 $4.52 Total intrinsic value of stock options exercised (in millions) $89.56 $62.85 $36.67 The Company uses the Black-Scholes option pricing model to calculate the grant-date fair value of an award. The fair value of thestock options granted and unvested options assumed from acquisitions during fiscal 2008 and 2007 were calculated using the followingweighted-average assumptions: 2008 2007 2006 Dividend yield 0.0% 0.0% 0.0%Expected volatility 53.9% 49.7% 60.9%Average risk-free interest rate 3.3% 4.6% 4.8%Expected term (in years) 5.5 3.9 4.3 The dividend yield of zero is based on the fact that the Company has never paid cash dividends and has no present intention to paycash dividends. Expected volatility is based on the historical volatility of the Company’s common stock over the period commensuratewith the expected life of the options and the historical implied volatility from traded options with a term of 180 days or greater. The risk-free interest rate is derived from the average U.S. Treasury STRIPS rate during the period, which approximates the rate in effect at thetime of grant, commensurate with the expected life of the instrument. The Company estimates the expected term based on the historicalexercise behavior.Restricted AwardsThe Company is authorized to issue equity incentive awards in the form of Restricted Awards, including Restricted Units andRestricted Stock, which are individually discussed below. Unvested Restricted Awards may not be sold, transferred or assigned. The fairvalue of the Restricted Awards is measured based upon the market price of the underlying common stock as of the date of grant, reducedby the purchase price of $0.001 per share of the awards. The Restricted Awards generally are subject to vesting over a period of two tofour years, and may have opportunities for acceleration for achievement of defined goals. The Company also issued certain RestrictedAwards with vesting solely dependent on the achievement of specified performance targets. The fair value of the Restricted Awards isamortized to expense over its applicable requisite service period using the straight-line method. In the event that the employees’ employmentwith the Company terminates, or in the case of awards with only performance goals, if those goals are not met, any unvested shares areforfeited and revert to the Company.96Table of ContentsNUANCE COMMUNICATIONS, INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)Restricted Units are not included in issued and outstanding common stock until the shares are vested and released. The table belowsummarizes activity relating to Restricted Units: Number of Shares Number of Shares Underlying Underlying Restricted Units — Restricted Units — Time-Based Contingent Awards Awards Outstanding at September 30, 2005 — 849,451 Granted 22,055 2,451,168 Earned/released (1,000) (470,462)Forfeited — (101,158)Outstanding at September 30, 2006 21,055 2,728,999 Granted 813,000 4,662,923 Earned/released (1,000) (942,569)Forfeited (103,638) (369,970)Outstanding at September 30, 2007 729,417 6,079,383 Assumed from eScription 367,253 438,791 Granted 1,543,365 3,812,617 Earned/released (199,208) (2,866,528)Forfeited (26,303) (606,739)Outstanding at September 30, 2008 2,414,524 6,857,524 Weighted average remaining contractual term of outstanding Restricted Units 1.5 years 1.5 years Aggregate intrinsic value of outstanding Restricted Units(1) $29.4 million $83.6 million Restricted Units vested and expected to vest 2,007,567 5,907,382 Weighted average remaining contractual term of Restricted Units vested and expectedto vest 1.4 years 1.4 years Aggregate intrinsic value of Restricted Units vested and expected to vest(1) $24.5 million $72.0 million (1)The aggregate intrinsic value on this table was calculated based on the positive difference between the closing market value of theCompany’s common stock on September 30, 2008 ($12.19) and the exercise price of the underlying Restricted Units.The purchase price for vested Restricted Units is $0.001 per share. As of September 30, 2008, unearned share-based paymentexpense related to all unvested Restricted Units is $111.3 million, which will, based on expectations of future performance vestingcriteria, where applicable, be recognized over a weighted-average period of 1.4 years. A summary of weighted-average grant-date fair value,including those assumed in respective periods, and intrinsic value of all Restricted Units vested is as follows: 2008 2007 2006 Weighted-average grant-date fair value per share $18.01 $14.73 $9.15 Total intrinsic value of shares vested (in millions) $55.50 $13.40 $3.97 97Table of ContentsNUANCE COMMUNICATIONS, INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)Restricted Stock is included in the issued and outstanding common stock in these financial statements at date of grant. The tablebelow summarizes activity relating to Restricted Stock: Number of Shares Weighted Underlying Average Grant Restricted Date Fair Stock Value Outstanding at September 30, 2005 1,125,703 $4.60 Granted 745,145 $7.63 Vested (311,671) $5.22 Forfeited (11,836) $3.89 Outstanding at September 30, 2006 1,547,341 $5.93 Granted 17,421 $8.75 Vested (368,860) $5.29 Forfeited — $— Outstanding at September 30, 2007 1,195,902 $6.17 Granted 250,000 $15.89 Vested (820,832) $5.53 Forfeited — $— Outstanding at September 30, 2008 625,070 $10.90 The purchase price for vested Restricted Stock is $0.001 per share. As of September 30, 2008, unearned share-based paymentsexpense related to unvested Restricted Stock is $1.4 million, which will, based on expectations of future performance vesting criteria,when applicable, be recognized over a weighted-average period of 0.9 years. A summary of weighted-average grant-date fair value andintrinsic value of Restricted Stock vested are as follows: 2008 2007 2006 Weighted-average grant-date fair value per share $15.89 $8.75 $7.63 Total intrinsic value of shares vested (in millions) $16.85 $5.60 $2.24 In order to satisfy its employees’ withholding tax liability as a result of the vesting of Restricted Stock, the Company hashistorically repurchased shares upon the employees’ vesting. Similarly, in order to satisfy its employees’ withholding tax liability as aresult of the release of its employees’ Restricted Units, the Company has historically cancelled a portion of the common stock upon therelease. In fiscal 2008, the Company paid cash of $17.0 million relating to 0.9 million shares of common stock that were repurchased orcancelled. Based on the Company’s estimate of the Restricted Awards that will vest, or be released, in fiscal 2009, and further assumingthat one-third of these Restricted Awards would be repurchased or cancelled to satisfy the employee’s withholding tax liability (suchamount approximating the tax rate of the Company’s employees), the Company would have an obligation to pay cash relating toapproximately 1.1 million shares during fiscal 2009.1995 Employee Stock Purchase PlanThe Company’s 1995 Employee Stock Purchase Plan (“the Plan”), as amended and restated on April 21, 2008, authorizes theissuance of a maximum of 6,000,000 shares of common stock in semi-annual offerings to employees at a price equal to the lower of 85%of the closing price on the applicable offering commencement date or 85% of the closing price on the applicable offering termination date.Compensation expense for the employee stock purchase plan is recognized in accordance with SFAS 123R. At September 30, 2008,2,718,932 shares were reserved for future issuance. During fiscal 2008, 2007, and 2006, the Company issued 651,121, 640,777 and419,561 shares of common stock under this plan, respectively. The weighted average fair value of all purchase98Table of ContentsNUANCE COMMUNICATIONS, INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)rights granted in fiscal 2008, 2007 and 2006, were $5.09, $4.51 and $2.62. Compensation expense related to the employee stockpurchase plan was $3.4 million, $2.2 million and $1.1 million for the fiscal years ended 2008, 2007 and 2006, respectively.The fair value of the purchase rights granted under this plan was estimated on the date of grant using the Black-Scholes option-pricing model that uses the following weighted-average assumptions which were derived in a manner similar to those discussed aboverelative to stock options: 2008 2007 2006 Dividend yield 0.0% 0.0% 0.0%Expected volatility 53.1% 44.7% 55.1%Average risk-free interest rate 2.1% 4.7% 5.0%Expected term (in years) 0.5 0.5 0.5 18. Commitments and ContingenciesOperating LeasesThe Company has various operating leases for office space around the world. In connection with many of its acquisitions, theCompany assumed facility lease obligations. Among these assumed obligations are lease payments related to certain office locations thatwere vacated by certain of the acquired companies prior to the acquisition date (Note 13). Additionally, certain of the Company’s leaseobligations have been included in various restructuring charges (Note 14). The following table outlines the Company’s gross futureminimum payments under all non-cancelable operating leases as of September 30, 2008 (in thousands): Operating Leases Under Other Contractual Year Ending September 30, Leases Restructuring Obligations Assumed Total 2009 $15,643 $3,089 $13,735 $32,467 2010 14,432 1,676 14,186 30,294 2011 13,314 972 14,733 29,019 2012 12,579 619 13,172 26,370 2013 11,653 369 3,102 15,124 Thereafter 30,843 — 7,916 38,759 Total $98,464 $6,725 $66,844 $172,033 At September 30, 2008, the Company has subleased certain office space that is included in the above table to third parties. Totalsublease income under contractual terms is $24.5 million and ranges from approximately $2.0 million to $4.9 million on an annual basisthrough February 2016.Total rent expense charged to operations was approximately $15.2 million, $9.3 million and $7.2 million for the years endedSeptember 30, 2008, 2007 and 2006, respectively.Litigation and Other ClaimsLike many companies in the software industry, the Company has, from time to time been notified of claims that it may beinfringing, or contributing to the infringement of, the intellectual property rights of others. These claims have been referred to counsel, andthey are in various stages of evaluation and negotiation. If it appears necessary or desirable, the Company may seek licenses for theseintellectual property rights. There is no assurance that licenses will be offered by all claimants, that the terms of any offered licenses willbe acceptable to the Company or that in all cases the dispute will be resolved without litigation, which may be time consuming andexpensive, and may result in injunctive relief or the payment of damages by the Company.99Table of ContentsNUANCE COMMUNICATIONS, INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)In August 2001, the first of a number of complaints was filed in the United States District Court for the Southern District of NewYork, on behalf of a purported class of persons who purchased Former Nuance stock between April 12, 2000 and December 6, 2000.Those complaints have been consolidated into one action. The complaint generally alleges that various investment bank underwritersengaged in improper and undisclosed activities related to the allocation of shares in Former Nuance’s initial public offering of securities.The complaint makes claims for violation of several provisions of the federal securities laws against those underwriters, and also againstFormer Nuance and some of Former Nuance’s directors and officers. Similar lawsuits, concerning more than 250 other companies’ initialpublic offerings, were filed in 2001. In February 2003, the Court denied a motion to dismiss with respect to the claims against FormerNuance. In the third quarter of 2003, a proposed settlement in principle was reached among the plaintiffs, issuer defendants (includingFormer Nuance) and the issuers’ insurance carriers. The settlement called for the dismissal and release of claims against the issuerdefendants, including Former Nuance, in exchange for a contingent payment to be paid, if necessary, by the issuer defendants’ insurancecarriers and an assignment of certain claims. The settlement was not expected to have any material impact upon the Company, aspayments, if any, were expected to be made by insurance carriers, rather than by the Company. On December 5, 2006, the Court ofAppeals for the Second Circuit reversed the Court’s order certifying a class in several “test cases” that had been selected by theunderwriter defendants and the plaintiffs in the coordinated proceeding. The plaintiffs petitioned the Second Circuit for rehearing of theSecond Circuit’s decision, however, on April 6, 2007, the Second Circuit denied the petition for rehearing. At a status conference onApril 23, 2007, the district court suggested that the issuers’ settlement could not be approved in its present form, given the SecondCircuit’s ruling. On June 25, 2007, the district court issued an order terminating the settlement agreement. The plaintiffs in the case havesince filed amended master allegations and amended complaints and have moved for class certification, while the defendants have movedto dismiss the complaints and have filed oppositions to the motion for class certification. The Company intends to defend the litigationvigorously and believes it has meritorious defenses to the claims against Former Nuance.The Company believes that the final outcome of the current litigation matter described above will not have a significant adverse effecton its financial position and results of operations. However, even if the Company’s defense is successful, the litigation could requiresignificant management time and will be costly. Should the Company not prevail in the litigation matter, its operating results, financialposition and cash flows could be adversely impacted.Guarantees and OtherThe Company currently includes indemnification provisions in the contracts into which it enters with its customers and businesspartners. Generally, these provisions require the Company to defend claims arising out of its products’ infringement of third-partyintellectual property rights, breach of contractual obligations and/or unlawful or otherwise culpable conduct on its part. The indemnityobligations imposed by these provisions generally cover damages, costs and attorneys’ fees arising out of such claims. In most, but notall cases, the Company’s total liability under such provisions is limited to either the value of the contract or a specified, agreed uponamount. In some cases its total liability under such provisions is unlimited. In many, but not all, cases, the term of the indemnityprovision is perpetual. While the maximum potential amount of future payments the Company could be required to make under all theindemnification provisions in its contracts with customers and business partners is unlimited, it believes that the estimated fair value ofthese provisions is minimal due to the low frequency with which these provisions have been triggered.The Company has entered into agreements to indemnify its directors and officers to the fullest extent authorized or permitted underapplicable law. These agreements, among other things, provide for the indemnification of its directors and officers for expenses,judgments, fines, penalties and settlement amounts incurred by any such person in his or her capacity as a director or officer of theCompany, whether or not such person is acting or serving in any such capacity at the time any liability or expense is incurred for whichindemnification can be provided under the agreements. In connection with the terms of certain of its acquisitions that have been100Table of ContentsNUANCE COMMUNICATIONS, INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)consummated, the Company is required to indemnify the former members of the boards of directors of those companies, on similar termsas described above, for a period of six years from the acquisition date. In certain cases the Company has been required to, under the termsof the sale and purchase agreements, purchase director and officer insurance policies related to these obligations, which fully cover the sixyear periods. In connection with the acquisition of SpeechWorks, the Company indemnified the former members of the SpeechWorksboard of directors for a period of six years from the acquisition date, and purchased a director and officer policy that covered a period ofthree years from the acquisition date. To the extent that the Company does not purchase a director and officer insurance policy for the fullperiod of any contractual indemnification, it would be required to pay for costs incurred, if any, as described above.At September 30, 2008, the Company has $3.0 million of non-cancelable purchase commitments for inventory to fulfill customers’orders currently scheduled in its backlog.19. Pension and Other Post-Retirement BenefitsDefined Contribution PlanThe Company has established a retirement savings plan under Section 401(k) of the Internal Revenue Code (the “401(k) Plan”). The401(k) Plan covers substantially all U.S. employees of the Company who meet minimum age and service requirements, and allowsparticipants to defer a portion of their annual compensation on a pre-tax basis. Effective July 1, 2003, Company match of employee’scontributions was established, dollar for dollar up to 2% of salary. Employees who were hired prior to April 1, 2004 are 100% vested intothe plan as soon as they start to contribute to the plan. Employees hired April 1, 2004 and thereafter, vest one-third of the contributionannually over a three-year period. The Company’s contributions to the 401(k) Plan totaled $2.9 million, $1.8 million and $1.1 millionfor fiscal 2008, 2007 and 2006, respectively.Adoption of SFAS 158On September 30, 2007, the Company adopted SFAS 158, “Employers’ Accounting for Defined Benefit Pension and OtherPostretirement Plans.” SFAS 158 amended SFAS 87, “Employers’ Accounting for Pensions,” SFAS 106, “Employers’ Accounting forPost Retirement Benefits,” and SFAS 132(R), “Employers’ Disclosures About Pension and Other Postretirement Benefits.” SFAS 158requires companies to recognize the funded status of their postretirement benefit plans in the statement of financial position, measure thefair value of plan assets and benefit obligations as of the date of the fiscal year-end statement of financial position and provide additionaldisclosures.In accordance with the provisions set forth in SFAS 158, the Company recognized the funded status, which is the differencebetween the fair value of plan assets and the projected benefit obligations, of the Company’s postretirement benefit plans in theconsolidated balance sheet, with a corresponding adjustment to accumulated other comprehensive loss, net of tax. The adjustment toaccumulated other comprehensive loss at adoption represents the net unrecognized actuarial losses and unrecognized prior service costs,both of which were previously netted against the plans’ funded status in the Company’s consolidated balance sheet pursuant to theprovisions of SFAS 87, “Employers’ Accounting for Pensions.” These amounts will be subsequently recognized as net periodic pensionexpense.101Table of ContentsNUANCE COMMUNICATIONS, INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)The effects of adopting the provisions of SFAS 158 on the Company’s consolidated balance sheet at September 30, 2007 arepresented in the following table (in thousands): Before Application After Application of of SFAS 158 Adjustment SFAS 158 Other assets $72,169 $552 $72,721 Accrued expenses 83,158 87 83,245 Other liabilities 66,746 (3,585) 63,161 Accumulated other comprehensive income 10,929 4,050 14,979 Defined Benefit Pension Plans and Other Post-Retirement Benefit PlanIn connection with the acquisition of Dictaphone, the Company assumed the assets and obligations related to its defined benefitpension plans, which provide certain retirement and death benefits for former Dictaphone employees located in the United Kingdom andCanada. These two pension plans are closed to new participants. The Company also assumed a post-retirement health care and lifeinsurance benefit plan, which is closed to new participants and provides certain post-retirement health care and life insurance benefits, aswell as a fixed subsidy for qualified former employees in the United States and Canada.The following table shows the changes in fiscal 2008 and 2007 in the projected benefit obligation, plan assets and funded status ofthe defined benefit pension plans and the other post-retirement benefit plan (in thousands): Pension Benefits Other Post-RetirementBenefits 2008 2007 2008 2007 Change in Benefit Obligations: Benefit obligation at beginning of period $23,741 $24,157 $709 $1,374 Service cost — 77 — 105 Interest cost 1,275 1,231 41 77 Plan participants’ contributions — 22 — — Curtailments — (128) — — Actuarial loss (gain) 1,245 (2,573) 45 (695)Expenses paid (4) (2) — — Currency exchange rate changes (2,545) 2,222 — — Benefits paid (1,304) (1,265) (121) (152)Benefit obligation at end of period 22,408 23,741 674 709 Change in Plan Assets: Fair value of plan assets, beginning of period 23,366 18,713 — — Actual return on plan assets (3,021) 2,208 — — Employer contribution 1,371 1,643 121 152 Plan participants’ contribution — 22 — — Expenses paid (4) (2) — — Currency exchange rate changes (2,011) 2,047 — — Benefits paid (1,304) (1,265) (121) (152)Fair value of plan assets, end of period 18,397 23,366 — — Funded status at end of period $(4,011) $(375) $(674) $(709)102Table of ContentsNUANCE COMMUNICATIONS, INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)The amounts recognized in the Company’s consolidated balance sheets consisted of the following (in thousands): Other Post-Retirement Pension Benefits Benefits 2008 2007 2008 2007 Other assets $1,958 $3,221 $— $— Current liabilities — — (85) (87)Other liabilities ( 5,969) (3,596) (589) (622)Net liability recognized $(4,011) $(375) $(674) $(709)The amounts recognized in accumulated other comprehensive loss as of September 30, 2008 consisted of the following (inthousands): Other Post-Retirement Pension Benefits Benefits Prior service cost $— $— Actuarial gain (loss) (2,134) 603 Total amount recognized in accumulated other comprehensive loss $(2,134) $603 The following represents the amounts included in accumulated other comprehensive loss on the consolidated balance sheet as ofSeptember 30, 2008, that the Company expects to recognize in earnings during fiscal 2009 (in thousands): Other Post- Retirement Pension Benefits Benefits Prior service cost $— $— Actuarial gain (loss) (198) 37 The projected benefit obligations for the two defined benefit pension plans was $22.4 million at September 30, 2008.Included in the table below are the amounts relating to the Company’s UK pension plan and other post retirement benefits planwhich have accumulated benefit obligations and projected benefit obligations in excess of plan assets (in thousands): Other Post-Retirement Pension Benefits Benefits 2008 2007 2008 2007 Aggregate projected benefit obligations $19,426 $20,430 N/A N/A Aggregate accumulated benefit obligations 19,426 20,430 $674 $709 Aggregate fair value of plan assets 13,456 16,834 — — 103Table of ContentsNUANCE COMMUNICATIONS, INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)The components of net periodic benefit cost of the benefit plans were as follows (in thousands): Other Post- Retirement Pension Benefits Benefits 2008 2007 2008 2007 Service cost $— $77 $— $105 Interest cost 1,275 1,231 41 77 Expected return on plan assets (1,596) (1,268) — — Amortization of unrecognized gain (loss) (103) 13 (41) — Net periodic pension cost $(424) $53 $— $182 Plan Assumptions:Weighted-average assumptions used in developing the benefit obligations and net periodic benefit cost for the plans were as follows: Pension Other Post- Retirement Benefits Benefits 2008 2007 2008 2007 Discount rate 6.2% 5.6% 6.3% 6.3%Average compensation increase N/A(1) 4.0% N/A(1) N/A(1)Expected rate of return on plan assets 7.0% 6.5% N/A(2) N/A(2)(1)Rate of compensation increase is not applicable as there are no active members in the plan.(2)Expected return on plan assets is not applicable to the Company’s other benefit plan as the plan is unfunded.Because the benefit provided to retirees under the other postretirement benefit plan consists of a fixed subsidy, no health care costtrend is assumed in the measurement of the post-retirement benefit obligations and net periodic benefit costs.The Company considered several factors when developing the expected return on plan assets, including reviewing analysis ofreturns relevant to the country where each plan is in effect, historical rates of return from investments, local actuarial projections andmarket outlook from investment managers. The expected rate of return disclosed above is the weighted average of each country’s expectedreturn on plan assets.Assets Allocation and Investment Strategy:The percentages of the fair value of plan assets actually allocated and targeted for allocation, by asset category, at September 30,2008 and September 30, 2007, were as follows: Actual Target Asset Category 2008 2007 2008 2007 Equity securities 58.5% 63.2% 57.3% 57.2%Debt securities 41.5% 36.8% 42.7% 42.8%Total 100.0% 100.0% 100.0% 100.0%The Company’s investment goal for pension plan assets is designed to provide as much assurance as is possible, in the Company’sopinion, that the pension assets are available to pay benefits as they come due and minimize market risk. The expected long-term rate ofreturn for the plan assets is 7.0% for the UK pension plan and for the Canadian pension plan.104Table of ContentsNUANCE COMMUNICATIONS, INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)Employer Contributions:The Company expects to contribute $1.6 million to its pension plans in fiscal 2009. Included in this contribution is a minimumfunding requirement associated with its UK pension which requires annual minimum payment of £859,900 (approximately$1.6 million based on the exchange rate at September 30, 2008) for each of the next 3 years until fiscal 2011. Its other post-retirementbenefits plan is a non-funded plan, and cash contributions are made each year to cover claims costs incurred in that year. Total cash paidduring fiscal 2008, for the post-retirement health care and life insurance benefit plan was not material, and the Company does not expectthat the amount in fiscal 2009 will be material.Estimated Future Benefit Payments:The following benefit payments, which reflect expected future service, as appropriate, are expected to be paid (in thousands): Other Post- retirement Year Ending September 30, Pension Benefits Benefits 2009 $1,249 $88 2010 1,278 79 2011 1,308 65 2012 1,339 60 2013 1,371 68 Thereafter 7,489 227 Total $14,034 $587 20. Income TaxesFor financial reporting purposes, income (loss) before income taxes includes the following components (in thousands): 2008 2007 2006 Domestic income (loss) $(23,542) $(1,888) $(16,318)Foreign income (loss) 8,028 10,375 9,247 Income (loss) before income taxes $(15,514) $8,487 $(7,071)The components of the income tax provision (benefit) are as follows (in thousands): Year Ended Year Ended Year Ended September 30, September 30, September 30, 2008 2007 2006 Current: Federal $1,048 $1,849 $334 Foreign 2,233 2,705 1,579 State 10,782 3,880 4,420 14,063 8,434 6,333 Deferred: Federal 20,177 11,421 7,638 Foreign 1,110 1,611 1,002 State (20,796) 1,036 171 491 14,068 8,811 Provision for income taxes $14,554 $22,502 $15,144 105Table of ContentsNUANCE COMMUNICATIONS, INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)During 2008 the tax law in Massachusetts was changed, effectively reducing the tax rate in which certain of the Company’s deferredtax liabilities would be taxed at when they are reported in the tax provision in the future. As a result of this change, the company recordeda reduction in its deferred tax liabilities, as a benefit in its provision, of $20.4 million.The Company may elect to treat its acquisition of eScription as an asset purchase under provisions contained in the Internal RevenueCode. If this election were to be made, additional cash payments approximating $21.5 million would be recorded as additional purchaseconsideration and allocated to goodwill. Until such time as an election is made, the transaction is required to be treated as a stockpurchase. In connection with the Massachusetts tax law change, the deferred tax liabilities established relating to eScription intangibleswere adjusted. This represents an $8.0 million tax benefit being recorded in fiscal 2008. In the event the Company elects to treat theeScription business combination as an asset purchase, the Company will be required to reverse the tax benefit during the quarter in whichthe asset election is made. The asset purchase election is required to be made no later than February 15, 2009.In connection with the Massachusetts tax law change regulations will be issued which may affect deferred tax assets recorded forstate net operating losses. As these regulations have not been finalized no provision has been made for these regulations in 2008. Theestimated tax provision to be recorded by the Company when the regulations are issued could be up to approximately $2.0 million. Theregulations are expected to be issued during the first calendar quarter of 2009.Deferred tax assets (liabilities) consist of the following (in thousands): September 30, September 30, 2008 2007 Deferred tax assets: Net operating loss carryforwards $194,547 $270,060 Federal and state credit carryforwards 12,600 27,320 Capitalized start-up and development costs 23,302 26,845 Accrued expenses and other reserves 75,079 62,340 Deferred revenue 13,576 21,476 Deferred compensation 15,914 13,168 Depreciation 2,988 3,044 Other 9,985 16,051 Total deferred tax assets 347,991 440,304 Valuation allowance for deferred tax assets (182,961) (326,699)Net deferred tax assets 165,030 113,605 Deferred tax liabilities: Acquired intangibles (210,072) (139,199)Net deferred tax liabilities $(45,042) $(25,594)Reported as: Current deferred tax assets $1,703 $444 Long-term deferred tax liabilities (46,745) (26,038)Net deferred tax liabilities $(45,042) $(25,594)Effective October 1, 2007, the Company adopted the provisions of Financial Accounting Standards Board (“FASB”) Interpretation(“FIN”) 48, “Accounting for Uncertainty in Income Taxes — an Interpretation of FASB106Table of ContentsNUANCE COMMUNICATIONS, INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)Statement No. 109.” FIN 48 clarifies the accounting for uncertainty in income taxes recognized in a company’s financial statements inaccordance with SFAS 109, “Accounting for Income Taxes.” FIN 48 prescribes the recognition and measurement of a tax position takenor expected to be taken in a tax return. It also provides guidance on the derecognition of prior tax positions, classification, interest andpenalties, accounting in interim periods, disclosure and transition. As a result of the implementation of FIN 48, the Company recognizedan adjustment of $0.9 million in the liability for unrecognized tax benefits. In addition, the Company reduced its deferred tax assets andvaluation allowance each by $52.0 million primarily with respect to net operating loss and research credit carryforwards that are in excessof applicable limitations related to ownership changes.The liability for unrecognized tax benefits related to various federal, state, and foreign income tax matters was $2.5 million atOctober 1, 2007. At September 30, 2008, the liability for income taxes associated with uncertain tax positions was $2.7 million. Theincrease of $0.2 million during fiscal 2008 is solely attributable to interest charges recorded in the year. Included in this amount isapproximately $0.8 million of unrecognized tax benefits, which if recognized, would impact the effective tax rate. The difference betweenthe total amount of unrecognized tax benefits and the amount that would impact the effective tax rate consists of items that would be offsetthrough goodwill. The Company does not expect a significant change in the amount of unrecognized tax benefits within the next12 months.Upon adoption of FIN 48, the Company’s policy to include interest and penalties related to gross unrecognized tax benefits as part ofthe provision for income taxes did not change. As of September 30, 2008, the Company had cumulatively accrued $0.4 million of interestand penalties related to uncertain tax positions. Interest and penalties included in the provision for income taxes were not material in allperiods presented.The Company is subject to U.S. federal income tax and various state, local and international income taxes in numerousjurisdictions. The federal, state and foreign tax returns are generally subject to tax examinations for the tax years ended in 2004 through2007. In addition, amounts reported on federal tax returns filed for earlier tax periods from which operating losses and tax credits arecarried to future periods may be adjusted upon the utilization of such carryovers, but only to the extent such carryovers are applied. TheCompany has carryforwards from most federal tax years occurring between 1994 and 2007.At September 30, 2008 and 2007, the Company had United States federal net operating loss carryforwards of $546.4 million and$705.2 million, respectively, of which $194.9 million and $100.9 million, respectively, relate to tax deductions from share-basedpayments. At September 30, 2008 and 2007, the Company had state net operating loss carryforwards of $133.5 million and$92.0 million, respectively. At September 30, 2008, the Company had federal and state research and development carryforwards of$8.2 million and $6.8 million, respectively. At September 30, 2007, the Company had federal and state research and development creditcarryforwards of $16.6 million and $9.6 million, respectively. The net operating loss and credit carryforwards will expire at variousdates beginning in 2009 and extending through 2027, if not utilized.Utilization of the net operating losses and credits are subject to an annual limitation due to the ownership change limitations providedby the Internal Revenue Code of 1986 and similar state tax provisions. The annual limitation will result in the expiration of certain netoperating losses and credits before utilization.Significant management judgment is required in determining our provision for income taxes and in determining whether deferred taxassets will be realized in full or in part. When it is more likely than not that all or some portion of specific deferred tax assets such as netoperating losses or foreign tax credit carryforwards will not be realized, a valuation allowance must be established for the amount of thedeferred tax assets that are determined not likely to be realizable. Realization is based upon a number of factors, including our ability togenerate sufficient future taxable income. The valuation allowance was determined in accordance with the provisions of SFAS 109,“Accounting for Income Taxes,” which requires an assessment of both positive and negative evidence when determining whether it is morelikely than not that deferred tax assets are recoverable. Such assessment is required on a jurisdiction-by-jurisdiction basis. The Companydoes not expect to reduce its valuation allowance significantly107Table of ContentsNUANCE COMMUNICATIONS, INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)until sufficient positive evidence exists, including sustained profitability, that its deferred tax assets are more likely than not to be realized.The Company will maintain a full valuation allowance on its net U.S. deferred tax assets until sufficient positive evidence exists tosupport reversal of the valuation allowance.As of September 30, 2008, the Company’s valuation allowance for U.S. net deferred tax assets totaled $156.0 million, whichconsists of the beginning of the year allowance of $300.0 million plus 2008 charges (benefits) of $23.5 million to income from operationsand $0.3 million to other comprehensive income, less reductions to goodwill of approximately $115.0 million, and less $52.0 millionrelating to tax attribute carryforwards that are expected to expire unused. A portion of the deferred tax liabilities are created by goodwill,and are not allowed as an offset to deferred tax assets for purposes of determining the amount of valuation allowance required. Followingthe adoption of SFAS 142, deferred tax liabilities resulting from the different treatment of goodwill for book and tax purposes cannotoffset deferred tax assets in determining the valuation allowance. As a result, the Company is required to increase its valuation allowance.The valuation allowance reduces the carrying value of the deferred tax assets generated by foreign tax credits, reserves and accrualsand net operating loss (“NOL”) carryforwards, which would require sufficient future ordinary income in order to realize the tax benefits.If the Company generates taxable income through profitable operations in future years it may be required to recognize these deferred taxassets through the reduction of the valuation allowance which would result in a material benefit to its results of operations in the period inwhich the benefit is determined, excluding the recognition of the portion of the valuation allowance which relates to net deferred tax assetsacquired in a business combination and share-based payments. The valuation allowance associated with tax assets arising in connectionwith share-based payments of $7.9 million as of September 30, 2008 and 2007, and will be accounted for as additional paid in capital.The valuation allowance associated with tax assets arising from business combinations of $124.5 million and $180.7 million as ofSeptember 30, 2008 and 2007, respectively, when released, will reduce goodwill, intangible assets, and to the extent remaining, theprovision for income taxes, until the Company adopts SFAS 141R in its fiscal year 2010; after which time the reductions in theallowance, if any, will be recorded as a benefit in the statement of operations.A reconciliation of the Company’s effective tax rate to the statutory federal rate is as follows: 2008 2007 2006 Federal statutory tax rate 35.0% 35.0% 35.0%Share-based payments (30.1) 35.1 (32.1)Foreign taxes (13.8) 9.7 (8.2)Foreign benefit — refundable credits 24.9 — — State tax, net of federal benefit (48.2) 58.0 (40.9)State tax law enactment, net of federal benefit 131.6 — — Nondeductible expenditures (9.3) 6.0 (6.4)Other 3.1 3.1 (4.1)Change in valuation allowance (192.2) 103.9 (159.5)Executive compensation (1.1) 20.7 — Federal credits, net 6.3 (6.4) 2.0 (93.8)% 265.1% (214.2)%The cumulative amount of undistributed earnings of the Company’s foreign subsidiaries amounted to, $23.1 million atSeptember 30, 2008. The Company has not provided any additional federal or state income taxes or foreign withholding taxes on theundistributed earnings, as such earnings have been indefinitely reinvested in the business. An estimate of the tax consequences from therepatriation of these earnings is not practicable at this time resulting from the complexities of the utilization of foreign tax credits and othertax assets.108Table of ContentsNUANCE COMMUNICATIONS, INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)21. Segment and Geographic Information and Significant CustomersThe Company follows the provisions of SFAS 31, “Disclosures About Segments of an Enterprise and Related Information,” whichestablishes standards for reporting information about operating segments. SFAS 131 also established standards for disclosures aboutproducts, services and geographic areas. Operating segments are defined as components of an enterprise for which separate financialinformation is available and evaluated regularly by the chief operating decision maker in deciding how to allocate resources and inassessing performance. The Company’s chief operating decision maker is the Chief Executive Officer of the Company.The Company has several groups that oversee the core markets where the Company conducts its business. Specifically in 2008,these groups were referred to as Enterprise, Mobile, Healthcare and Dictation, and Imaging. Each of these groups has a president who hasdirect responsibility and oversight relating to go-to-market strategies and plans, product management and product marketing activities.These groups do not directly manage centralized or shared resources or the allocation decisions regarding the activities related to thesefunctions, which include sales and sales operations, certain research and development initiatives, business development and all generaland administrative activities. The Chief Executive Officer directly oversees each of the presidents, as well as each of the functions thatprovide the shared and centralized activities noted above. To manage the business, allocate resources and assess performance, the primaryinformation used by the chief operating decision maker are revenue data by market, consolidated gross margins and consolidatedoperating margins. Based on its review, the Company has determined that it operates in one segment.The following table presents revenue information for these core markets (in thousands): Fiscal Fiscal Fiscal 2008 2007 2006 Enterprise $283,274 $192,919 $142,848 Mobile 155,511 53,843 36,552 Healthcare and Dictation 349,744 281,290 136,707 Imaging 79,933 73,944 72,403 Total Revenue $868,462 $601,996 $388,510 Revenue, classified by the major geographic areas in which the Company’s customers are located, were as follows (in thousands): 2008 2007 2006 United States $669,239 $471,636 $288,300 International 199,223 130,360 100,210 Total $868,462 $601,996 $388,510 No country outside of the United States composed greater than 10% of total revenue.The following table summarizes the Company’s long-lived assets, including intangible assets and goodwill, by geographic location(in thousands): September 30, September 30, 2008 2007 United States $2,066,106 $1,602,370 International 264,810 148,801 Total $2,330,916 $1,751,171 109Table of ContentsNUANCE COMMUNICATIONS, INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)22. Related PartiesA member of the Company’s Board of Directors is also a partner at Wilson Sonsini Goodrich & Rosati, Professional Corporation, alaw firm that provides services to the Company. These services may from time-to-time include contingent fee arrangements. For the yearsended September 30, 2008, 2007 and 2006, the Company paid $13.1 million, $8.6 million and $2.9 million, respectively, to WilsonSonsini Goodrich & Rosati for professional services provided to the Company. As of September 30, 2008 and 2007, the Company had$2.6 million and $5.1 million, respectively, included in accounts payable and accrued expenses to Wilson Sonsini Goodrich & Rosati.Two members of the Company’s Board of Directors are employees of Warburg Pincus. On May 20, 2008, the Companyconsummated a stock purchase agreement with Warburg Pincus. Including the May 2008 stock purchase agreement, Warburg Pincusbeneficially owns 21% of the Company’s common stock. See Note 16 for further information.23. Quarterly Data (Unaudited)The following information has been derived from unaudited consolidated financial statements that, in the opinion of management,include all recurring adjustments necessary for a fair statement of such information (in thousands, except per share amounts): First Second Third Fourth Quarter Quarter Quarter Quarter Year 2008 Total revenue $195,024 $203,302 $216,744 $253,392 $868,462 Gross margin $126,183 $119,506 $137,859 $169,271 $552,819 Net income (loss) $(15,425) $(26,791) $(9,866) $22,014 $(30,068)Net income (loss) per share: Basic $(0.08) $(0.13) $(0.05) $0.10 $(0.14)Diluted $(0.08) $(0.13) $(0.05) $0.09 $(0.14)Weighted average common shares outstanding: Basic 194,528 206,348 213,683 224,568 209,801 Diluted 194,528 206,348 213,683 246,525 209,801 First Second Third Fourth Quarter Quarter Quarter Quarter Year 2007 Total revenue $133,421 $132,062 $156,639 $179,874 $601,996 Gross margin $92,792 $87,904 $104,512 $118,847 $404,055 Net loss $(1,235) $(1,731) $(7,635) $(3,414) $(14,015)Net loss per share: Basic and diluted $(0.01) $(0.01) $(0.04) $(0.02) $(0.08)Weighted average common shares outstanding: Basic and diluted 169,505 171,747 180,356 185,145 176,424 110Table of ContentsItem 9. Changes in and Disagreements with Accountants on Accounting and Financial DisclosureNot applicable.Item 9A. Controls and ProceduresDisclosure Controls and ProceduresOur management, with the participation of our Chief Executive Officer and Chief Financial Officer, has evaluated the effectivenessof our disclosure controls and procedures. Our disclosure controls and procedures are designed (i) to ensure that information required tobe disclosed by us in the reports that we file or submit under the Exchange Act is recorded, processed and summarized and reportedwithin the time periods specified in the SEC’s rules and forms and (ii) to ensure that information required to be disclosed in the reportsthe Company files or submits under the Exchange Act is accumulated and communicated to our management, including our chiefexecutive officer and chief financial officer, to allow timely decisions regarding required disclosure. Based on that evaluation, our ChiefExecutive Officer and Chief Financial Officer concluded that, as of September 30, 2008, our disclosure controls and procedures wereeffective.Management Report on Internal Control Over Financial ReportingManagement is responsible for establishing and maintaining adequate internal control over financial reporting, as defined inRules 13a-15(f) and 15d-15(f) under the Securities Exchange Act of 1934, as amended. Our internal control over financial reporting isdesigned to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements forexternal reporting purposes in accordance with generally accepted accounting principles. Our internal control over financial reportingincludes those policies and procedures that: • pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions ofour assets; • provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements inaccordance with generally accepted accounting principles, and that our receipts and expenditures are being made only inaccordance with authorizations of our management and directors; and, • provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of ourassets that could have a material effect on the financial statements.Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also,projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because ofchanges in conditions and that the degree of compliance with the policies or procedures may deteriorate.Management has assessed the effectiveness of our internal control over financial reporting as of September 30, 2008, utilizing thecriteria set forth in Internal Control — Integrated Framework issued by the Committee of Sponsoring Organizations of the TreadwayCommission (COSO). The internal controls over financial reporting for the following entities, which we acquired during the fiscal yearended September 30, 2008, were excluded from management’s assessment constituted approximately 1.6% of our consolidated assets asof September 30, 2008, and approximately 8.1% of our consolidated revenue for the fiscal year ended September 30, 2008.Company Acquisition DateVocada, Inc. November 2, 2007Viecore, Inc. November 26, 2007eScription, Inc. May 20, 2008Multi-Vision Communications Inc. July 31, 2008Philips Speech Recognition Services GmBH September 26, 2008111Table of ContentsBased on the results of this assessment, management (including our Chief Executive Officer and our Chief Financial Officer) hasconcluded that, as of September 30, 2008, our internal control over financial reporting was effective.The attestation report concerning the effectiveness of our internal control over financial reporting as of September 30, 2008 issued byBDO Seidman, LLP, an independent registered public accounting firm, appears in Item 8 of this Annual Report on Form 10-K.Changes in Internal Controls Over Financial ReportingThere have been no changes in our internal controls over financial reporting during the fourth quarter of fiscal 2008 that havematerially affected, or are reasonably likely to materially affect, our internal controls over financial reporting.Item 9B. Other InformationOn November 28, 2008, the Compensation Committee (the “Committee”) of the Board of Directors approved the following actions:(i) an increase in the annual performance bonus amount for Ms. McCann from 50% of her base salary to 60% of her base salary,(ii) amendments to two restricted stock awards previously issued to Mr. Hunt to provide for accelerated vesting of restricted stock units inthe event Mr. Hunt’s employment is terminated by the Company without cause, and (iii) the payment of cash bonuses to executive officersin accordance with the terms of the Company’s previously disclosed fiscal 2008 employee bonus plan in the following amounts: SteveChambers ($250,000), Jeanne McCann ($100,000), Paul Ricci ($345,000), John Shagoury ($100,000) and Tom Beaudoin ($31,500).The Company’s board of directors has set the close of business on December 2, 2008 as the record date for shareholders entitled toreceive notice of, and to vote at, the annual shareholders meeting scheduled for January 30, 2009. Nuance will send a definitive proxystatement to stockholders of record, which will contain important information about the meeting and the matters to be considered.Stockholders are urged to read the proxy statement when it becomes available. The meeting site and time will be communicated toshareholders in the proxy materials distributed for the annual meeting. The deadline for submitting a proposal pursuant to Rule 14a-8under the Securities Exchange Act of 1934, as amended, to be considered for inclusion in the Company’s proxy statement for the annualmeeting and for submitting a “timely” proposal for purposes of Rule 14a-4(c) under the Exchange Act is December 12, 2008. In order for aproposal to be considered timely, it must be received by the Company on or prior to such date at its principal executive offices at 1Wayside Road, Burlington, MA 01803. Proposals should be directed to the attention of the Secretary.PART IIICertain information required by Part III is omitted from this Annual Report on Form 10-K since we intend to file our definitive ProxyStatement for our next Annual Meeting of Stockholders, pursuant to Regulation 14A of the Securities Exchange Act of 1934, as amended(the “Proxy Statement”), within 120 days of the end of the end of the fiscal year covered by this report, and certain information to beincluded in the Proxy Statement is incorporated herein by reference.Item 10. Directors, Executive Officers and Corporate GovernanceThe information required by this item concerning our directors is incorporated by reference to the information set forth in the sectiontitled “Election of Directors” in our Proxy Statement. Information required by this item concerning our executive officers is incorporatedby reference to the information set forth in the section entitled “Executive Compensation, Management and Other Information” in ourProxy Statement. Information regarding Section 16 reporting compliance is incorporated by reference to the information set forth in thesection entitled “Section 16(a) Beneficial Ownership Reporting Compliance” in our Proxy Statement.112Table of ContentsOur Board of Directors adopted a Code of Business Conduct and Ethics for all of our directors, officers and employees onFebruary 24, 2004. Our Code of Business Conduct and Ethics can be found at our website: www.nuance.com. We will provide to anyperson without charge, upon request, a copy of our Code of Business Conduct and Ethics. Such a request should be made in writing andaddressed to Investor Relations, Nuance Communications, Inc., 1 Wayside Road, Burlington, MA 01803.To date, there have been no waivers under our Code of Business Conduct and Ethics. We will post any waivers, if and whengranted, of our Code of Business Conduct and Ethics on our website at www.nuance.com.Item 11. Executive CompensationThe information required by this item regarding executive compensation is incorporated by reference to the information set forth inthe sections titled “Executive Compensation, Management and Other Information” in our Proxy Statement.Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholders MattersThe information required by this item regarding security ownership of certain beneficial owners and management is incorporated byreference to the information set forth in the sections titled “Security Ownership of Certain Beneficial Owners and Management” and“Equity Compensation Plans” in our Proxy Statement.Item 13. Certain Relationships and Related Transactions, and Director IndependenceThe information required by this item regarding certain relationships and related transactions is incorporated by reference to theinformation set forth in the section titled “Certain Relationships and Related Transactions” and “Director Independence” in our ProxyStatement.Item 14. Principal Accountant Fees and ServicesThe information required by this section is incorporated by reference from the information in the section entitled “Ratification ofAppointment of Independent Auditors” in our Proxy Statement.PART IVItem 15. Exhibits and Financial Statement Schedules(a) The following documents are filed as a part of this Report:(1) Financial Statements — See Index to Financial Statements in Item 8 of this Report.(2) Financial Statement Schedules — All schedules have been omitted as the requested information is inapplicable or theinformation is presented in the financial statements or related notes included as part of this Report.(3) Exhibits — See Item 15(b) of this Report below.(b) Exhibits.113Table of ContentsSIGNATURESPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused thisAnnual Report on Form 10-K to be signed on its behalf by the undersigned, thereunto duly authorized.NUANCE COMMUNICATIONS, INC. By: /s/ Paul A. RicciPaul A. RicciChief Executive Officer and Chairman of the BoardPursuant to the requirements of the Securities Exchange Act of 1934, this Annual Report on Form 10-K has been signed by thefollowing persons in the capacities and on the dates indicated.Date: December 1, 2008 /s/ Paul A. RicciPaul A. Ricci, Chief Executive Officer andChairman of the Board(Principal Executive Officer) Date: December 1, 2008 /s/ Thomas L. BeaudoinThomas L. Beaudoin, Executive Vice President andChief Financial Officer(Principal Financial Officer) Date: December 1, 2008 /s/ Daniel D. TempestaDaniel D. Tempesta, Chief Accounting Officer andCorporate Controller (Principal Accounting Officer) Date: December 1, 2008 /s/ Robert J. FrankenbergRobert J. Frankenberg, Director Date: December 1, 2008 /s/ Jeffrey A. HarrisJeffrey A. Harris, Director Date: December 1, 2008 /s/ William H. JanewayWilliam H. Janeway, Director Date: December 1, 2008 /s/ Katharine A. MartinKatharine A. Martin, Director Date: December 1, 2008 /s/ Mark MyersMark Myers, Director Date: December 1, 2008 /s/ Philip QuigleyPhilip Quigley, Director Date: December 1, 2008 /s/ Robert G. TeresiRobert G. Teresi, DirectorTable of ContentsEXHIBIT INDEX Incorporated by ReferenceExhibit Filing FiledNumber Exhibit Description Form File No. Exhibit Date Herewith 2.1 Purchase Agreement, dated October 7, 2002,between Koninklijke Philips Electronics N.V. andthe Registrant. S-1/A 33-100647 2.4 12/6/2002 2.2 Amendment No. 1 to Purchase Agreement, dated asof December 20, 2002, between Koninklijke PhilipsElectronics N.V. and the Registrant. S-1/A 33-100647 2.5 2/7/2003 2.3 Amendment No. 2 to Purchase Agreement, dated asof January 29, 2003, between Koninklijke PhilipsElectronics N.V. and the Registrant. S-1/A 33-100647 2.6 2/7/2003 2.4 Agreement and Plan of Reorganization, datedApril 23, 2003, by and among the Registrant,Spiderman Acquisition Corporation andSpeechWorks International, Inc. S-4 33-106184 Annex A 6/17/2003 2.5 Agreement and Plan of Merger, dated as of May 4,2004, as amended on May 28, 2004, by and amongScanSoft, Inc., Tennis Acquisition Corporation,Telelogue, Inc., Pequot Venture Partners II, L.P.,PVP II Telelogue Prom Note 2 Grantor Trust,Palisade Private Partnership II, L.P., and NJTCVenture Fund SBIC LP, Martin Hale as stockholderrepresentative and U.S. Bank National Associationas escrow agent. 8-K 0-27038 2.1 6/30/2004 2.6 Agreement and Plan of Merger, dated as ofNovember 14, 2004, by and among ScanSoft,Write Acquisition Corporation, ART AdvancedRecognition Technologies, Inc., and with respectArticle I, Article VII and Article IX only, BessemerVenture Partners VI, LP, as stockholderrepresentative. 8-K 0-27038 2.1 11/18/2004 2.7 Agreement and Plan of Merger, dated as ofNovember 15, 2004, by and among PhoneticSystems, LTD., Phonetics Acquisition LTD.,ScanSoft, and Magnum CommunicationsFund L.P., as stockholder representative. 8-K 0-27038 2.2 11/18/2004 2.8 Amended and Restated Agreement and Plan ofMerger, made and entered into as of February 1,2005, and effective as of November 15, 2004, byand among ScanSoft, Phonetics Acquisition Ltd.,Phonetic Systems Ltd. and MagnumCommunications Fund L.P., as ShareholderRepresentative. 8-K 0-27038 2.1 2/7/2005 Table of Contents Incorporated by ReferenceExhibit Filing FiledNumber Exhibit Description Form File No. Exhibit Date Herewith 2.9 Agreement and Plan of Merger by and amongScanSoft, Nova Acquisition Corporation, NovaAcquisition LLC, and Nuance Communications,Inc., dated May 9, 2005. 8-K 0-27038 1.1 5/10/2005 2.10 Agreement and Plan of Merger by and amongNuance Communications, Inc., Phoenix MergerSub, Inc. and Dictaphone Corporation dated as ofFebruary 7, 2006. 8-K 0-27038 2.1 2/9/2006 2.11 Stock Purchase Agreement, dated as of June 21,2007, by and among AOL LLC, TegicCommunications, Inc. and NuanceCommunications, Inc. 8-K 0-27038 2.1 6/27/2007 2.12 Agreement and Plan of Merger by and amongNuance, Vicksburg Acquisition Corporation, VoiceSignal Technologies, Inc., U.S. Bank NationalAssociation, as Escrow Agent, and Stata VenturePartners, LLC, as Stockholder Representative,dated as of May 14, 2007. 8-K 0-27038 2.1 5/18/2007 2.13 Agreement and Plan of Merger by and amongNuance Communications, Inc., BerylliumAcquisition Corporation, Beryllium AcquisitionLLC and BeVocal, Inc. dated as of February 21,2007. 8-K 0-27038 2.1 2/27/2007 2.14 Share Purchase Agreement dated March 13, 2007by and among Nuance Communications, Inc.,Bethany Advisors Inc., Focus Softek India (Private)Limited and U.S. Bank National Association, asEscrow Agent. 8-K 0-27038 2.1 3/28/2007 2.15 Agreement and Plan of Merger by and amongNuance Communications, Inc., CsonkaAcquisition Corporation, Csonka AcquisitionLLC, Commissure Inc., U.S. Bank NationalAssociation, as escrow agent, and Michael J.Mardini, as the shareholder representative dated asof September 28, 2007. 8-K 0-27038 2.1 10/4/2007 2.16 Agreement and Plan of Merger by and amongNuance Communications, Inc., VineyardAcquisition Corporation, Vineyard AcquisitionLLC, Vocada, Inc., U.S. Bank NationalAssociation, as Escrow Agent, and John Purtell, asStockholder Representative, dated as of October 16,2007. 8-K 0-27038 2.1 10/22/2007 Table of Contents Incorporated by ReferenceExhibit Filing FiledNumber Exhibit Description Form File No. Exhibit Date Herewith 2.17 Agreement and Plan of Merger by and amongNuance Communications, Inc., VanhalenAcquisition Corporation, Vanhalen AcquisitionLLC, Viecore, Inc., U.S. Bank NationalAssociation, as Escrow Agent, and Thoma CresseyBravo, Inc., as Stockholder Representative, datedas of October 21, 2007. 8-K 0-27038 2.1 10/25/2007 2.18 Agreement and Plan of Merger by and amongNuance Communications, Inc., CsonkaAcquisition Corporation, Csonka AcquisitionLLC, Commissure, Inc., U.S. Bank NationalAssociation, as Escrow Agent, StockholderRepresentative dated as of September 28, 2007. 8-K 0-27038 2.1 10/4/07 2.19 Agreement and Plan of Merger by and amongNuance Communications, Inc., VineyardAcquisition Corporation, Vineyard AcquisitionLLC, Vocada, Inc. and U.S. Bank NationalAssociation, as Escrow Agent, StockholderRepresentative, dated as of October 16, 2007. 8-K 0-27038 2.1 10/22/07 2.20 Agreement and Plan of Merger by and amongNuance Communications, Inc., Van HalenAcquisition Corporation, Van Halen AcquisitionLLC, Viecore, Inc., U.S. Bank NationalAssociation, as Escrow Agent, ShareholderRepresentative, dated as of October 21, 2007. 8-K 0-27038 2.1 10/27/07 2.21 Agreement and Plan of Merger by and amongNuance Communications, Inc., Easton AcquisitionCorporation, Escription, Inc., U.S. Bank NationalAssociation, as Escrow Agent and Paul Egerman asStockholder Representative, dated as of April 17,2008. 8-K 0-27038 2.1 4/11/08 2.22 Purchase Agreement dated as of April 7, 2008 byand among Nuance Communications, Inc. and thePurchasers identified on Exhibit A (Warburg PincusPrivate Equity VIII, L.P., Warburg PincusNetherlands Private Equity VIII, C.V.I., WP-WPVIII Investors, L.P.) 8-K 0-27038 2.2 4/11/08 2.23 Share Purchase Agreement (Relating to shares inPhilips Speech Recognition Systems GmbH)between Koninklijke Philips Electronics N.V. andNuance Communications, Inc. dated as ofSeptember 26, 2008. 8-K 0-27038 2.1 10/3/08 Table of Contents Incorporated by ReferenceExhibit Filing FiledNumber Exhibit Description Form File No. Exhibit Date Herewith 2.24 Agreement and Plan of Merger by and amongNuance Communications, Inc., SpeakEasyAcquisition Corporation, SpeakEasy AcquisitionLLC, SNAPin Software, Inc., Thomas S. Husebyas Stockholder Representative and U.S. BankNational Association, as Escrow Agent, effective asof September 24, 2008. 8-K 0-27038 2.1 10/3/08 2.25 Amendment effective as of September 24, 2008, byand among Nuance Communications, Inc.,SpeakEasy Acquisition Corporation, SpeakEasyAcquisition LLC, SNAPin Software, Inc., ThomasS. Huseby as Stockholder Representative and U.S.Bank National Association, as Escrow Agent. 8-K 0-27038 2.2 10/3/08 2.26 Amendment No. 1, dated as of November 20,2007, by and among Nuance Communications,Inc., Vanhalen Acquisition Corporation, VanHalenAcquisition LLC, Viecore, Inc., and ThomaCressey Bravo, Inc. as Shareholder Representative. 10-Q 0-27038 2.3 2/11/08 2.27 Amendment No. 2, dated as of November 29,2007, by and among Nuance Communications,Inc. and Thoma Cressey Bravo, Inc. as therepresentative of the Company’s shareholders. 10-Q 0-27038 2.4 2/11/08 3.1 Amended and Restated Certificate of Incorporationof the Registrant. 10-Q 0-27038 3.2 5/11/2001 3.2 Certificate of Amendment of the Amended andRestated Certificate of Incorporation of theRegistrant. 10-Q 0-27038 3.1 8/9/2004 3.3 Certificate of Ownership and Merger. 8-K 0-27038 3.1 10/19/2005 3.4 Amended and Restated Bylaws of the Registrant. 8-K 0-27038 3.1 11/13/2007 3.5 Certificate of Amendment of the Amended andRestated Certificate of Incorporation of theRegistrant, as amended. S-3 333-142182 3.3 4/18/2007 4.1 Specimen Common Stock Certificate. 8-A 0-27038 4.1 12/6/1995 4.2 Common Stock Purchase Warrant. S-4 333-70603 Annex A 1/14/1999 4.3 Securities Purchase Agreement, dated March 19,2004, by and among Xerox Imaging Systems, Inc.,Warburg Pincus Private Equity VIII, L.P., WarburgPincus Netherlands Private Equity VIII I C.V.,Warburg Pincus Netherlands Private Equity VIII IIC.V., Warburg Pincus Germany Private Equity VIIIK.G., and the Registrant. 10-Q 0-27038 4.1 5/10/2004 Table of Contents Incorporated by ReferenceExhibit Filing FiledNumber Exhibit Description Form File No. Exhibit Date Herewith 4.4 Stockholders Agreement, dated March 19, 2004, byand between the Registrant and Warburg PincusPrivate Equity VIII, L.P., Warburg PincusNetherlands Private Equity VIII I C.V., WarburgPincus Netherlands Private Equity VIII II C.V., andWarburg Pincus Germany Private Equity VIII K.G. 10-Q 0-27038 4.2 5/10/2004 4.5 Common Stock Purchase Warrants, datedMarch 15, 2004, issued to Warburg Pincus PrivateEquity VIII, L.P., Warburg Pincus NetherlandsPrivate Equity VIII I C.V., Warburg PincusNetherlands Private Equity VIII II C.V., andWarburg Pincus Germany Private Equity VIII K.G. 10-Q 0-27038 4.3 5/10/2004 4.6 Stock Purchase Agreement, dated as of May 5,2005, by and between the Registrant and WarburgPincus Private Equity VIII, L.P., Warburg PincusNetherlands Private Equity VIII I C.V., WarburgPincus Netherlands Private Equity VIII II C.V., andWarburg Pincus Germany Private Equity VIII K.G. S-4/A 333-125496 Annex F 8/1/2005 4.7 Amended and Restated Stockholders Agreement,dated May 5, 2005, by and between the Registrantand Warburg Pincus Private Equity VIII, L.P.,Warburg Pincus Netherlands Private Equity VIII IC.V., Warburg Pincus Netherlands Private EquityVIII II C.V., and Warburg Pincus Germany PrivateEquity VIII K.G. S-4/A 333-125496 Annex G 8/1/2005 4.8 Common Stock Purchase Warrants, dated May 9,2005, issued to Warburg Pincus Private EquityVIII, L.P., Warburg Pincus Netherlands PrivateEquity VIII I C.V., and Warburg Pincus GermanyPrivate Equity VIII K.G. S-4 333-125496 4.11 6/3/2005 4.9 Securities Purchase Agreement, dated as of May 5,2005, by and between the Registrant and WarburgPincus Private Equity VIII, L.P., Warburg PincusNetherlands Private Equity VIII C.V. I. andWarburg Pincus Germany Private Equity VIII K.G. 10-Q 0-27038 4.2 8/9/2005 4.10 Indenture, dated as of August 13, 2007, betweenNuance Communications, Inc. and U.S. BankNational Association, as Trustee (including form of2.75% Convertible Subordinated Debentures due2027). 8-K 0-27038 4.1 8/17/2007 Table of Contents Incorporated by ReferenceExhibit Filing FiledNumber Exhibit Description Form File No. Exhibit Date Herewith 10.1 Form of Indemnification Agreement. S-8 333-108767 10.1 9/12/2003 10.2 Stand Alone Stock Option Agreement Number 1,dated as of August 21, 2000, by and between theRegistrant and Paul A. Ricci.* S-8 333-49656 4.3 11/9/2000 10.4 Caere Corporation 1992 Non-Employee Directors’Stock Option Plan.* S-8 333-33464 10.4 3/29/2000 10.5 1993 Incentive Stock Option Plan, as amended.* S-1 333-100647 10.17 10/21/2002 10.6 1995 Employee Stock Purchase Plan, as amendedand restated on April 27, 2000.* 14A 0-27038 Annex D 4/13/2004 10.7 Amended and Restated 1995 Directors’ StockOption Plan, as amended.* 14A 0-27038 10.2 3/17/2005 10.8 1997 Employee Stock Option Plan, as amended.* S-1 333-100647 10.19 10/21/2002 10.9 1998 Stock Option Plan.* S-8 333-74343 99.1 3/12/1999 10.10 Amended and Restated 2000 Stock Option Plan.* 14A 0-27038 10.1 3/17/2005 10.11 2000 NonStatutory Stock Option Plan, asamended.* S-8 333-108767 4.1 9/12/2003 10.12 ScanSoft 2003 Stock Plan.* S-8 333-108767 4.3 9/12/2003 10.13 Nuance Communications, Inc. 2001 NonstatutoryStock Option Plan.* S-8 333-128396 4.1 9/16/2005 10.14 Nuance Communications, Inc. 2000 Stock Plan.* S-8 333-128396 4.2 9/16/2005 10.15 Nuance Communications, Inc. 1998 Stock Plan.* S-8 333-128396 4.3 9/16/2005 10.16 Nuance Communications, Inc. 1994 Flexible StockIncentive Plan.* S-8 333-128396 4.4 9/16/2005 10.17 Form of Restricted Stock Purchase Agreement.* 10-K/A 0-27038 10.17 12/15/2006 10.18 Form of Restricted Stock Unit PurchaseAgreement.* 10-K/A 0-27038 10.18 12/15/2006 10.19 Form of Stock Option Agreement.* 10-K/A 0-27038 10.19 12/15/2006 10.20 2005 Severance Benefit Plan for ExecutiveOfficers.* 10-Q 0-27038 10.1 5/10/2005 10.21 Officer Short-term Disability Plan.* 10-Q 0-27038 10.2 5/10/2005 10.22 Technology Transfer and License Agreement, datedas of January 30, 2003, between KoninklijkePhilips Electronics N.V. and the Registrant. S-1/A 333-100647 10.30 2/7/2003 10.24 Letter, dated February 17, 2003, from the Registrantto Jeanne McCann regarding certain employmentmatters.* 10-Q 0-27038 10.1 5/15/2003 10.25 Employment Agreement, effective August 11, 2006,by and between the Registrant and Paul A. Ricci.* 8-K 0-27038 10.1 11/8/2006 10.26 Employment Agreement, dated March 9, 2004, byand between the Registrant and John Shagoury.* 10-Q 0-27038 10.1 8/9/2004 Table of Contents Incorporated by ReferenceExhibit Filing FiledNumber Exhibit Description Form File No. Exhibit Date Herewith 10.27 Letter, dated May 23, 2004, from the Registrant toSteven Chambers regarding certain employmentmatters.* 10-Q 0-27038 10.2 8/9/2004 10.28 Letter, dated September 27, 2004, from theRegistrant to James R. Arnold, Jr. regarding certainemployment matters.* 10-K/A 0-27038 10.39 1/6/2005 10.29 Letter dated September 25, 2006, from theRegistrant to Don Hunt regarding certainemployment matters. 10-K/A 0-27038 10.29 12/15/2006 10.30 Registration Rights Agreement, dated as ofAugust 13, 2007, among Nuance Communications,Inc. and Citigroup Global Markets Inc. andGoldman Sachs & Co. 8-K 0-27038 10.1 8/17/2007 10.31 Purchase Agreement, dated as of August 7, 2007,by and among Nuance Communications, Inc.,Citigroup Global Markets Inc. and Goldman,Sachs & Co. 8-K 0-27038 10.1 8/9/2007 10.32 Amended and Restated Credit Agreement dated as ofApril 5, 2007, among Nuance Communications,Inc., the Lenders party thereto from time to time,UBS AG, Stamford Branch, as administrativeagent, Citicorp North America, Inc., as syndicationagent, Credit Suisse Securities (USA) LLC, asdocumentation agent, Citigroup Global Markets Inc.and UBS Securities LLC, as joint lead arrangers,Credit Suisse Securities (USA) LLC and Banc OfAmerica Securities LLC, as co-arrangers, andCitigroup Global Markets INC., UBS SecuritiesLLC and Credit Suisse Securities (USA) LLC, asjoint bookrunners. 8-K 0-27038 10.1 4/11/2007 10.33 Amendment Agreement, dated as of April 5, 2007,among Nuance, UBS AG, Stamford Branch, asadministrative agent, Citicorp North America,INC., as syndication agent, Credit SuisseSecurities (USA) LLC, as documentation agent, theLenders, Citigroup Global Markets Inc. and UBSSecurities LLC, as joint lead arrangers and jointbookrunners, Credit Suisse Securities (USA) LLC,as joint bookrunner and co-arranger, and Banc OfAmerica Securities LLC, as co-arranger. 8-K 0-27038 10.2 4/11/2007 10.34 Increase Joinder, dated as of August 24, 2007, byand among Nuance Communications, Inc. and theother parties identified therein, to the Amended andRestated Senior Secured Credit Facility dated as ofApril 5, 2007. 8-K 0-27038 10.1 8/30/2007 Table of Contents Incorporated by ReferenceExhibit Filing FiledNumber Exhibit Description Form File No. Exhibit Date Herewith 10.35 Stock Option Agreement, dated as of October 10,2006, by and between the Registrant and DonHunt.* 10-Q 0-27038 10.1 2/9/2007 10.36 Restricted Stock Purchase Agreement (PerformanceBased Vesting), dated as of October 10, 2006, byand between the Registrant and Don Hunt.* 10-Q 0-27038 10.1 2/9/2007 10.37 Restricted Stock Purchase Agreement (Time BasedVesting), dated as of October 10, 2006, by andbetween the Registrant and Don Hunt.* 10-Q 0-27038 10.1 2/9/2007 10.38 Amended and Restated 2000 Stock Plan. 8-K 0-27038 10.1 3/15/2007 10.39 Letter, dated June 3, 2008, from the Registrant toThomas L. Beaudoin regarding certain employmentmatters. X 14.1 Registrant’s Code of Business Conduct and Ethics. 10-K 0-27038 14.1 3/15/2004 21.1 Subsidiaries of the Registrant. X 23.1 Consent of BDO Seidman, LLP. X 24.1 Power of Attorney. (See Signature Page). X 31.1 Certification of Chief Executive Officer Pursuant toRule 13a-14(a) or 15d-14(a). X 31.2 Certification of Chief Financial Officer Pursuant toRule 13a-14(a) or 15d-14(a). X 32.1 Certification Pursuant to 18 U.S.C. Section 1350. X*Denotes management compensatory plan or arrangementExhibit 10.39June 3, 2008Thomas L Beaudoin19 Northbriar RdActon, MA 01720Dear Thomas:Congratulations! It is with great pleasure that I confirm Nuance’s offer of employment for the position of Executive Vice President of Finance reporting to PaulRicci, Chief Executive Officer. In addition, within sixty days of your beginning employment with Naunce, I will recommend to the Board that you beappointed an Executive Officer. Your work location will be Burlington, MA. Your anticipated start date will be July 1, 2008.Your starting annual base salary for this exempt level position will be $350,000 paid at the rate of $14,583.33 on a semi-monthly basis. In addition to yourbase salary, you will be eligible to participate in the Nuance Communications, Inc. Incentive for Performance (IFP) Bonus Program, which currently pays atarget of 60 % of base salary, pro-rated in the first year according to date of hire. You will also receive a Car Allowance of $15,000 per year and a Tax andFinancial Planning allowance of $5,000 per year.Once you have accepted the offer, I will recommend to the Nuance Compensation Committee, a New Hire stock option grant of 100,000 options with a 4 yearvesting schedule (25% after year 1 and then monthly thereafter), provided you remain an active employee at such time. Details of the stock option grant will beprovided to you when the grants are finalized.I will also recommend to the Nuance Compensation Committee, a restricted stock grant of 50,000 shares. These shares will vest at 25% per year for 4 years,provided you remain an active employee at such time. Details of this time-based restricted stock award will be provided to you when the grants are finalized.You will also be recommended to the Nuance Compensation Committee a restricted stock grant of performance based restricted shares. The performance-basedaward will consist of 75,000 shares, which will vest in 25% increments, if ever, on the anniversary of each grant date, upon the achievement of certainperformance targets that will be established with your manager. If achievement is not met or you terminate employment before vesting, you will not vest in theinstallment for the applicable measurement period and that portion of the award will lapse. Details of the restricted stock award will be provided to you when the grants are finalized.Should your employment with Nuance be terminated involuntarily by Nuance for any reason other than cause, death or disability, you will be eligible toreceive 6 months base salary & COBRA coverage if you execute Nuance’s specified severance agreement (including, among other things, a full release ofclaims and non-competition agreement). If there is a change of control transaction and your employment is terminated within twelve months following thechange of control transaction by Nuance (or the successor company) for a reason other than cause, death or disability, and you execute a severance agreementspecified by Nuance (or the successor company) (including, among other things, a full release of claims and non-competition agreement), you will receive12 months of base salary & COBRA coverage, plus immediate acceleration of any unvested time based stock grants, excluding any stock grants issued asperformance-based grants.For purposes of this Agreement, “Cause” means your employment with Nuance is terminated after a majority of the Board has found any of the following toexist: (i) the commission by you of a felony, either in connection with the performance of your obligations to Nuance or which adversely affects your ability toperform such obligations; (ii) gross negligence, dishonesty or breach of fiduciary duty; or (iii) the commission by you of an act of fraud or embezzlementwhich results in loss, damage or injury to Nuance, whether directly or indirectly; (iv) disclosure of Nuance’s confidential or proprietary information whichviolates the terms of the Non-Compete, Proprietary Information, & Conflict of Interest Agreement; (v) your continued substantial willful nonperformance(except by reason of disability) of your employment duties after you have received a written demand for performance by the Board and you have failed to curesuch nonperformance within 15 business days of receiving such notice.As a full-time employee, you will be eligible for our comprehensive benefits package which goes into effect on your first day of hire. The enclosed materialoutlines all of our benefits to which you are entitled as a Nuance employee. In addition to our Standard Life Insurance Policy you will be eligible for anadditional $500,000 in coverage should you pass the eligibility requirements. Also you will be eligible to receive our enhanced Executive Disability Insurancecoverage and Executive Wellness Benefit.Your employment with Nuance will be “at will”, meaning that either you or Nuance will be entitled to terminate your employment at any time and for anyreason, with or without cause. Any contrary representations which may have been made to you are superseded by this offer. This is the full and completeagreement between you and Nuance. Although your job duties, title, compensation, and benefits, as well as Nuance personnel policies and procedures, maychange from time to time, the “at will” nature of your employment may only be changed in an express written agreement signed by you and a duly authorizedofficer of Nuance Communications, Inc.This offer is contingent upon your satisfying the conditions of hire including: • Employment Eligibility Verification; proof of eligibility to work in the United States (All Employees) • Nuance standard Non-Compete, Proprietary Information, & Conflict of Interest Agreement (All Employees) • Background Check (Finance/control positions and Director level & above) — Complete • Application completed in full and signed • 3 Professional References -CompleteWe, at Nuance Communications, are proud of our reputation and we feel confident that you will be a positive addition to the Sr. Management Team, while theposition will afford you the opportunity to grow your professional skill set.Thomas, please confirm your acceptance of our employment offer by signing this offer confirmation letter, indicating your anticipated start date in the spaceprovided and scan/email to Laurence Plotkin at Laurence.plotkin@nuance.com. Or call Laurence if you have further questions regarding our offer (781) 565-5000. This offer expires on June 3, 2008.We look forward to having you join us.Sincerely,/s/ Dawn FournierDawn FournierVP Human Resourcescc: Paul RicciLaurence PlotkinI ACCEPT THE OFFER OF EMPLOYMENT AS STATED ABOVE: /s/ Tom Beaudoin June 3, 2008 New Hire Signature Date of Acceptance Exhibit 21.1 Subsidiary Name Jurisdiction TypeART Advanced Recognition Technologies, Inc. Delaware DomesticBeVocal LLC Delaware DomesticCaere Corporation Delaware DomesticCommissure LLC Delaware DomesticDictaphone Corporation Delaware DomesticeScription, Inc. Delaware DomesticFocus Infomatics, Inc. Delaware DomesticLocus Dialogue Technologies USA, Inc. Delaware DomesticMobile Voice Control LLC Delaware DomesticNuance Communications International, Inc. Delaware DomesticNuance Communications LLC Delaware DomesticPhonetic Systems Inc. Delaware DomesticRhetorical, Inc. Delaware DomesticSpeechWorks International, Inc. Delaware DomesticViecore Inc. Delaware DomesticVocada LLC Delaware DomesticVoice Signal Technologies, Inc. Delaware DomesticVoice Signal International, Inc. Massachusetts DomesticVoice Signal Korea, Inc. Massachusetts DomesticViecore Federal Systems Div., Inc. New Jersey DomesticTegic Communications, Inc. Washington DomesticDictaphone Pty. Ltd. Australia InternationalNuance Communications Australia Pty. Ltd. Australia InternationalPhilips Speech Recognition Austria InternationalDictaphone NV Belgium InternationalNuance Communications International BVBA Belgium InternationalNuance Communications Ltd. Brazil InternationalBlueStar Options Inc. British Virgin Islands InternationalBlueStar Resources Limited British Virgin Islands InternationalSpeechWorks BVI Ltd. British Virgin Islands International1448451 Ontario Inc. Canada InternationalDictaphone Canada 1995 Inc. Canada InternationalMultiVision Communications Inc. Canada InternationalNuance Communications Montreal Limited Canada InternationalNuance Communications Canada, Inc. Canada InternationalVoice Signal China Inc, China InternationalVoice Signal Technologies Europe OY Finland InternationalNuance Communications France Sarl France InternationalDictaphone Deutschland GmbH Germany InternationalNuance Communications Aachen GmbH Germany InternationalNuance Communications Germany GmbH Germany InternationalPhilips Speech Recognition GmbH Germany InternationalScanSoft FSC Guam InternationalNuance Communications Hong Kong Limited Hong Kong InternationalCaere Kft Hungary InternationalNuance Recognita Corp. Hungary InternationalFocus Infosys India Private Limited India International Subsidiary Name Jurisdiction TypeNuance India Pvt. Ltd. India InternationalNuance Communications Israel, Ltd. Israel InternationalPhonetic Systems Ltd. Israel InternationalNuance Communications Italy Srl Italy InternationalNuance Communications Japan K.K. Japan InternationalVoice Signal K.K. Japan InternationalNuance Communications Netherlands B.V. Netherlands InternationalNuance Communications Asia Pacific Pte. Ltd. Singapore InternationalPhilips Speech Recognition Spain Spain InternationalNuance Communications Korea Ltd. South Korea InternationalNuance Communications Sweden, A.B. Sweden InternationalRhetorical Group plc. Scotland InternationalRhetorical Systems Limited Scotland InternationalScanSoft Taiwan Taiwan InternationalDictaphone Company Limited United Kingdom InternationalDictaphone International Limited United Kingdom InternationalNuance Communications UK Limited United Kingdom International EXHIBIT 23.1Consent of Independent Registered Public Accounting FirmNuance Communications, Inc.Burlington, Massachusetts We hereby consent to the incorporation by reference in the Registration Statements on Form S-3 (Nos. 333-151088, 333-151087, 333-147715, 333-142182,333-100648, and 333-61862), and Form S-8 (Nos. 333-153911, 333-148684, 333-141819, 333-134687, 333-128396, 333-124856, 333-122718, 333-108767, 333-99729, 333-75406, 333-49656, 333-33464, 333-30518, 333-74343, 333-45425, and 333-04131) of Nuance Communications, Inc. of our reportsdated December 1, 2008, relating to the consolidated financial statements and the effectiveness of Nuance Communications, Inc.’s internal control overfinancial reporting, which appears in this Form 10-K. Our report relating to the consolidated financial statements indicated that Nuance Communications, Inc.adopted Statement of Financial Accounting Standards No. 158, “Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans — AnAmendment of FASB Statements No. 87, 88, 106 and 132(R),” effective September 30, 2007, and also adopted Financial Accounting Standards BoardInterpretation 48, “Accounting for Uncertainty in Income Taxes — an Interpretation of FASB Statement No. 109,” effective October 1, 2007. /s/ BDO Seidman, LLP Boston, Massachusetts December 1, 2008 Exhibit 31.1CERTIFICATION OF CHIEF EXECUTIVE OFFICERPURSUANT TOSECTION 302(A) OF THE SARBANES-OXLEY ACT OF 2002I, Paul A. Ricci, certify that: 1. I have reviewed this Annual Report on Form 10-K of Nuance Communications, Inc.; 2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make thestatements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by thisreport; 3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects thefinancial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report; 4. The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined inExchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and in 15d-15(f)) for the registrant and have: a) designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision,to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others withinthose entities, particularly during the period in which this report is being prepared; b) designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under oursupervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements forexternal purposes in accordance with generally accepted accounting principles; c) evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about theeffectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and d) disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s mostrecent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likelyto materially affect, the registrant’s internal control over financial reporting; and 5. The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to theregistrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions): a) all significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which arereasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internalcontrols over financial reporting. By: /s/ Paul A. Ricci Paul A. Ricci Chief Executive Officer and Chairman of the Board December 1, 2008 Exhibit 31.2CERTIFICATION OF CHIEF FINANCIAL OFFICERPURSUANT TOSECTION 302(A) OF THE SARBANES-OXLEY ACT OF 2002I, Thomas L. Beaudoin, certify that: 1. I have reviewed this Annual Report on Form 10-K of Nuance Communications, Inc.; 2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make thestatements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by thisreport; 3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects thefinancial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report; 4. The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined inExchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and in 15d-15(f)) for the registrant and have: a) designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision,to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others withinthose entities, particularly during the period in which this report is being prepared; b) designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under oursupervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements forexternal purposes in accordance with generally accepted accounting principles; c) evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about theeffectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and d) disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s mostrecent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likelyto materially affect, the registrant’s internal control over financial reporting; and 5. The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to theregistrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions): a) all significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which arereasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internalcontrols over financial reporting. By: /s/ Thomas L. Beaudoin Thomas L. Beaudoin Senior Vice President and Chief Financial Officer December 1, 2008 Exhibit 32.1CERTIFICATION OF CHIEF EXECUTIVE OFFICER AND CHIEF FINANCIAL OFFICERPURSUANT TO18 U.S.C. SECTION 1350,AS ADOPTED PURSUANT TOSECTION 906 OF THE SARBANES-OXLEY ACT OF 2002I, Paul A. Ricci, certify, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that the Annual Reportof Nuance Communications, Inc. on Form 10-K for the period ended September 30, 2008 fully complies with the requirements of Section 13(a) or 15(d) of theSecurities Exchange Act of 1934 and that information contained in such Annual Report on Form 10-K fairly presents in all material respects the financialcondition and results of operations of Nuance Communications, Inc. By: /s/ Paul A. Ricci Paul A. Ricci Chief Executive Officer and Chairman of the Board December 1, 2008 I, Thomas L. Beaudoin, certify, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that the AnnualReport of Nuance Communications, Inc. on Form 10-K for the period ended September 30, 2008 fully complies with the requirements of Section 13(a) or15(d) of the Securities Exchange Act of 1934 and that information contained in such Annual Report on Form 10-K fairly presents in all material respects thefinancial condition and results of operations of Nuance Communications, Inc. By: /s/ Thomas L. Beaudoin Thomas L. Beaudoin Senior Vice President and Chief Financial Officer December 1, 2008

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